Through-Life-Cost (TLC) management: The key to reducing OPEX

By Robert N. Flatt, Cooper Cameron Corp.

Editor's Note: Although Robert N. Flatt focuses specifically on the oil industry, the issues raised by this article seem applicable to the power generation industry, which must increasingly deal with cutting costs and raising quality. ACM

Abstract
Increasing sensitivity to crude price fluctuations requires operators to reduce costs for drilling, completion and production operations. A key component of this strategy is the collaborative management of equipment assets by operators and suppliers to reduce cost over the complete life cycle of the equipment. This paper analyzes benefits derived from TLC Management Programs undertaken with customers worldwide to reduce operating expenses.

Three bids and a cloud of dust
The traditional purchasing strategy for much of the century focused on price as the key determinant for vendor selection. The market price has been dictated by whoever has the "big stick" of economic power dependent upon the current cycle of business. In our own industry we have seen this most recently with rig rates. In 1998, the shortage of drilling rigs, especially floating rigs capable of drilling in deep water, led to higher drilling rig rates. Likewise, the rapid decline in the price of oil during 1999 led to a rig rate collapse.

This time-honored procurement process, affectionately known as "three bids and a cloud of dust," typically works like this:

The customer sends out the request for quotation. The vendor responds with a bid, often sealed, with little interaction with the customer. The customer then selects the vendor, usually the one with the lowest price tag. The vendor then manufactures the product and ships to the customer. The vendor only gets involved with the product again if there's a problem with it during the warranty period.

The attractiveness of this procurement process isn't difficult to grasp. From the customer standpoint, purchase price is a known quantity, and one price is easily compared against another. Purchasing agents can take comfort in—and be easily measured by—their performance based on price. A "good" buying decision is one that results in the purchase of a quality product, with the required functionality, at the lowest possible price. End of story.

From the vendor standpoint, this process has its advantages, too. If the primary determinant is price, then the vendor must convince the customer to buy the highest priced product and to produce it at the lowest possible cost. Furthermore, since products are "sold and forgotten," the vendor's other mandate is to limit liability with strict and limited warranties. A "good" sale was simply one with the highest possible margin with the minimum possible ongoing liability.

Though the traditional procurement model makes it easy to judge "good" from "bad," it also necessarily places the customer and vendor in an antagonistic relationship. Each attempts to achieve a separate and unrelated objective at the expense of the other. The result of each procurement cycle is always, or nearly always, a win/lose situation.

More than just the price tag—Deming Brings Customer, Vender Objectives Together
But this is not the only way to manage procurement. As early as the 1960s, Dr. W. Edwards Deming taught his Japanese industrial students that procurement strategy should be based upon total cost of ownership and not "the price tag." This simply stated but nevertheless radical shift in procurement strategy opens the door to massive cost savings and quality improvements. It enables a true win/win situation by pitting customer and vendor interests not against each other, but against their common enemy, supply chain cost.

The results of this new approach first became evident to the world in the Japanese auto industry. In the 1970s, Toyota started selling automobiles demonstrably better and at a lower cost than their American counterparts. A major factor in this competitive advantage was their cooperative relationship with a small number of vendors, often sole sourcing products with their alliance partners. Toyota worked cooperatively with their vendors to constantly decrease supply chain costs and create a truly "Lean Enterprise."

The procurement "new wave" swept across the Pacific and started in earnest in the United States in the early 1980s with Ford's Q1 program. Ford developed a rigorous vendor selection process to dramatically reduce their vendor base and to give vendors a "life-of-parts contract." This enabled their vendors to invest in capital programs to significantly decrease their costs. Vendors were rigorously measured for both quality improvement and cost reduction.

Customer, vendor unite against common enemy—cost
In the late 1980s, Chrysler used the new concepts of supply chain cost management to save the company. It created an "American Keiretsu" by involving vendors in a cooperative fashion very early in the design and development stages of the LH platform automobiles (Dodge Intrepid, Chrysler Concorde).

Though the exact extent of the improvements are always debatable, the massive quality and value improvement in the auto industry is evident to anyone who has shopped recently for a car. And a key factor in the improvement has been the cooperative management of the supply chain, which has improved performance by extending the roles and responsibilities of customer and vendor beyond their traditional boundaries into each other's organizations.

Instead of battling each other, customer and vendor enlist each other as partners in combating their common enemy, cost. Traditionally adversaries, the purchasing agent and the sales representative now work cooperatively to eliminate waste and share in the savings. By leveraging each other's resources, each partner adds to the total number of people attempting to improve their bottom line, but without adding any additional headcount to the payroll. In other words, the effort (as measured in manpower) spent applying the "big stick" to each other is now directed instead toward the cause of overall cost reduction and the mutual improvement of financial performance.

Partnerships and alliances evolve over time
The application of supply chain cost management concepts is also visible in the oil and gas industry. Many of the major oil companies implemented, to some extent, these new vendor management techniques. Likewise, oil service companies formed partnerships and alliances with their vendors to decrease costs and improve quality. And, we now have ample evidence to prove beyond a shadow of a doubt that substantial cost can be removed from the supply chain by cooperatively managing through life costs.

We currently have a broad range of cooperative agreements with both customers and vendors from simple pricing frame agreements to full-fledged alliances and partnerships. Agreements we have with our customers include:

• Consignment of spare parts inventory on a drilling contractor's offshore rig.
• Complete asset management—including storage, planned preventative maintenance, repair and recertification, and consigned spare parts inventory located on the platform—for a North Sea operator.
• JIT (Just-In-Time) stocking arrangement with a North Slope operator, including an EDI link to eliminate purchase orders and invoices.
• An alliance with an American operator to improve inventory use (inventory reduced from US$18 million to US$4 million over three years).
• An alliance with a Middle East operator to reduce inventories and nonproductive time.
• A planned preventative maintenance program with an American drilling contractor to cycle BOPs through a reconditioning program every two years.
• EDI links with many customers to allow consolidated billing and eliminate administrative paperwork.
• BOP exchange programs with several drilling contractors to reduce repair cycle time.
• Well file administration and management.

Likewise, we have a broad range of cooperative relationships with our vendors, including:

• Consigned inventory—much of our raw material inventory worldwide—comes from vendors through a JIT program.
• Alliances with tooling vendors to provide consigned inventory and in-plant management of tooling.
• EDI links.
• Long-term pricing frame agreements.

The formation of true lasting partnerships and alliances is an evolutionary process. It takes a lot of effort and work by both parties, but the rewards are worth it.

The supply chain challenge
Though these and other examples make clear the opportunities for better supply chain management, the successes have not been broad-based either within our company or across our industry. Cooperative supply chain management is, in a word, hard. It involves the fundamental reconstruction of the customer/vendor relationship and requires an extremely high level of trust. Rather than simply doing the work within the supply chain, the customer and vendor must each spend time "working on the work" to make the work "better, faster and cheaper." This usually entails selecting key individuals to form process mapping teams, and requires sharing sensitive "tactical" information such as costing data and overhead rates.

And it is precisely here where the problems usually begin. Organizations are typically reluctant to allocate valuable time and resources for something as nebulous as "working on the work." There are also strong taboos against customers and vendors sharing sensitive operational data. And finally, there is no small risk in abandoning the tried and true procurement method in favor of a new process which may not work, that may require extensive retooling or replacement of existing information business systems, and the benefits will not be recognized and rewarded within existing management structures.

The fox, the farmer—the service company, the operator
In a most ironic twist, cooperative supply chain management requires that customer and vendor utterly transform themselves to accept the new way of doing things. Simply arriving at the point where you are ready to attempt a cultural transformation is itself a major cultural shift. In discussions with our customers, we refer to the new required attitude as "letting the fox run the chicken house," and it goes something like this:

I'm the Fox and you're the farmer. You need to let me manage your chicken house. Let me explain why. You don't like chickens very much nor do you care for them very well. You are the farmer, you need to be out in your fields tending to your crops. I, on the other hand, LOVE CHICKENS! I will take special care of the chickens, playing music to them at night, developing a new breeding program, and feeding them newly-developed high-tech chicken food. I will initiate some new service programs with the chickens. I will bring fried chicken to your house for dinner. I will take the chicken manure out to your fields to fertilize them.

I am the service company and you are the operator.You need to let me manage the equipment you need from me throughout its life. You don't like BOPs and Christmas trees and you don't service and maintain them properly. You are an operator; you need to be managing your reservoirs to maximize the amount of production and cash flow you can obtain from them. On the other hand, I love BOPs and Christmas trees and will take special care of them with my through-life-cost management program to maximize their long-term performance. I will implement new service programs to help reduce your OPEX. I will implement a planned preventative maintenance program, I will grease them, I will manage the inventory to reduce your capital requirements, and I will provide consignment stock for your spare parts.

Now I am, after all, the Fox. I will eat some chickens. But I will manage the chickens so effectively that you will have many more chickens by using my services than if you managed them yourself. Now, I'm a service company. I need to be paid for my services to provide a fair return to my shareholders. However, I will manage your assets so effectively that you will save many times over my costs by reduction of your OPEX. And you're still the farmer. You have the gun. You can shoot me anytime I step out of line and eat too many chickens. You can also benchmark me with other foxes to see if they can provide more and better chickens for you. LET ME HAVE YOUR CHICKEN HOUSE!

Letting the fox into the chicken house requires openness and trust on the part of the vendor and the customer to allow work to naturally gravitate to whomever will do it best, regardless of the "traditional" rolls played by each party. This openness, coupled with a willingness to share the cost savings mutually, form the foundation of a successful vendor/customer relationship.

Building a cooperative arrangement
Our experience has shown that the willingness of both parties to consider radical change directly affects the success of a cooperative supply chain or through-life-cost (TLC) management effort. As customer and vendor "working people" join forces to "work on the work," they will inevitably uncover redundancies and inefficiencies that need to be engineered out of the process. But the ultimate success of the effort will depend upon the capability of both organizations to accept and implement the needed changes. Consider the following example from a recent TLC discussion with one of our customers. The graph below illustrates the current As-Is process for drilling and completing a well:

A simple visual comparison of the two flows reveals that the proposed To-Be clearly makes a significant improvement over the As-Is. Handoffs between customer accounting and the vendor are simplified by implementing a blanket purchase order process. Likewise, handoffs between drilling engineering and the vendor are streamlined by agreeing upon sourcing guidelines (prices, equipment sourcing preferences, "not-to-exceed" budgets for every call off, etc.) in advance of the actual need.

Finally, the potential for errors is greatly reduced by minimizing the number of parties involved and by placing customer and vendor "working people" in direct contact with each other as much as possible and empowering them to make decisions within their scope of operations.

But though the mechanics of envisioning a new, better, To-Be world are relatively simple, the real challenge for vendor and customer will be to make such a vision a reality. Notice for example that the To-Be flow entirely excludes two internal and one external vendor, who undoubtedly have an interest in maintaining their involvement and who surely have strong relationships with the customer.

Furthermore, the To-Be vision requires an extremely high level of trust on the part of the customer because the streamlined process hands over not only the execution, but also much of the management of the materials sourcing and installation process to the vendor. This extension of the vendor into the traditional customer role of manager ("the fox in the chicken house") may displace existing personnel within the customer organization and requires the sharing of "sacred" data.

Finally, there is the sobering truth that a single flowchart is not the end of the process, but only the beginning. Before any real change can be enacted, the customer and vendor must both commit the time, the money, and the patience to redefine the working relationship in detail, establish metrics to monitor success, and adjust the process as both gain more experience with the new way of doing business.

Major benefits: quality, technology, cost
These and other examples teach us that, when successful, cooperative supply chain management results in significant improvements in three major areas: quality, technology, and cost reduction. Quality improves primarily because the vendor now has a much better understanding of the customer's requirements and can then offer products and services that better meet them. In the example above, our experience indicates that consolidating the work with a single vendor results in a higher quality level. The vendor now participates in the entire process and is held accountable for the final result (successful installation of equipment) rather than for some incremental step (e.g., staging equipment that someone else installs).

Quality also improves as a result of real-time corrections made possible by better integration. Consider the following example: If I arrive on the scene of the murder and see a person with a big gun with smoke coming from it standing over a body, I can usually solve the crime. However, if I arrive 30 days later and find a decomposed body, the crime is much more difficult to solve.

When a single person or small group is made responsible for the completion of an entire process, two things typically happen. First, there is no longer an incentive to ignore quality in one step and "let the next guy in line deal with the problem," since that person or group is "the next guy in line" and will have to correct the problem anyway. Second, the elimination of handoffs reduces "queue time" delays and allows for the quick discovery and correction of problems. Just as it is easier to solve a murder mystery when the criminal is still in the room, so too is it easier to correct a defect when it is adjacent in time to its cause.

In the area of technology, customer and vendor share technical experts between their organizations. The vendor gains an understanding and appreciation of what the customer is trying to accomplish by using the product, and an understanding of the through-life demands that the product is expected to meet. Sharing technical expertise also allows engineers from different technical fields to interact. This can result in paradigm shifting discoveries.

Finally, cost is reduced not only from the improvement of quality and the introduction of better technologies, but also from the outright elimination of unneeded activities in the supply chain. With successful cooperative supply chain management, real cost is driven out of the supply chain because real cost-generating activities are removed.

The "win" for the customer is the reduction in the total cost of ownership; the customer will spend less, overall, because there are fewer supply chain activities to be funded. The savings are sometimes seen in lower prices but are mostly achieved through improved cycle times on drilling and completion activities and the reduction in rig and/or well down time. The "win" for the vendor is an increased role in the customer's operations, and hence a larger share of the money that is spent. The vendor gains by selling more products and services, sometimes at a lower price, but often at an improved margin. The customer and the vendor both win by sharing in the cost savings.

Expanding the vendor scope of supply
This last point concerning the increased roll for the vendor is a key component in any TLC management effort. As stated earlier, through-life-cost management is a cooperative effort and is only successful when both parties benefit. But, as real cost is driven out, the amount of real money available to the vendor base to claim as revenue shrinks.

At first glance, this would appear to be the perfect disincentive for a vendor to aggressively participate in a supply chain management effort. The most effective, long-term solution to this dilemma is to reduce the total number of vendors used and allow the ones that remain to expand their scope of supply to offset the incremental loss in their traditional scope.

Our own experience indicates the effectiveness of such an approach. In 1994, a major oil company invited Cooper Cameron into an alliance by a major oil company. The alliance wanted to reduce the overall cost of the oil company's domestic upstream operations. The major opportunity for cost savings within our scope of supply was the aggressive use of excess customer wellhead and tree inventory in the place of new purchases. In exchange for agreeing to work with the customer in this area, we were granted "preferred supplier" status for repair/reconditioning work and any new equipment sales.

Over the first four years of the alliance (‘95-‘98), the customer saved more than US$19 million by avoiding new equipment purchases and using existing equipment and/or purchasing reconditioned equipment. On the other hand we, as the vendor, saw revenues from this customer remain stable, despite the dramatic reduction in new equipment purchases.

The key to the arrangement has been the expansion of our traditional scope of supply to include the exclusive (or near exclusive) franchise for the repair of customer-owned equipment and the sale of reconditioned equipment. The revenue from these activities offset the revenue lost from new equipment sales. By granting us all the business, the customer was able to offer us an opportunity to "win" by helping the company reduce its overall cost.

Reinventing the oil field service company
The pressure to help customers manage through life cost is increasing and drives us to rethink our traditional offerings in light of this need. As part of this process, we commissioned a third party marketing survey of Western Hemisphere and North Sea operators and drilling contractors. The two graphs below reflect the responses of operators to the question: "Areas in greatest need of improvement."

An analysis of this and other survey data revealed four major themes influencing our customer's purchasing decisions. Our customers want service that is:

• Good – meets minimum requirements and doesn't do more than is needed
• Fast – fast quotation process, on time delivery, and quick problem resolution.
• Cheap – pricing of goods and services competitive with Non-OEMs
• Easy – Single point of contact, "no hassles," no third-party involvement

The "Good, Fast, Cheap, and Easy" mantra is common across all industries and should come as no surprise to anyone. But the challenge was to understand and meet these requirements in light of the growing demand to manage through life cost. In other words, we had to figure out what it meant to be "Good, Fast, Cheap, and Easy" throughout the entire product life cycle.

The result of the effort was the reformulation of our traditional products and services with a new emphasis on the value they deliver not just at the point of sale, but ongoing. Though the products and services discussed below are not new, the challenge was to identify and improve the ways that they affect through life cost.

Field services
Field services includes the analysis, diagnosis, and repair of equipment in the field along with general equipment maintenance. The traditional use of these services (especially maintenance) was on a "one off" basis when a problem became too big to ignore. However, from a through-life-cost perspective, a regular preventative maintenance program that includes the repair of equipment before critical failure can minimize the loss of revenue due to deferred or lost production.

Customer equipment reconditioning
A growing number of operators and drilling contractors are showing a preference to have equipment repaired by the OEM. To make such an alternative cost effective, we, as an OEM, departed from the usual practice of repairing all equipment to "like-new" or "first-class" condition. As an alternative, we now have several quality plans that specify levels of repair (e.g., working-class repair; fit for service repair).

The customer then selects which level is appropriate for the current application. From the TLC standpoint, this not only avoids the cost of new equipment, but also reduces the cost of any repairs that are performed. As a vendor, we benefit from increased volume by performing repairs that have historically been performed by non-OEMs.

Customer property management
While oil service companies have a long tradition of storing equipment on behalf of their customers, this service evolved beyond a simple "receive, stack, and await-call-out" operation. Our customers increasingly view any equipment not actively involved in the drilling for, or production of, hydrocarbons as a non-performing asset. Part of our refocusing effort has been to find ways to make each and every asset contribute to the bottom line. With several operators we now have personnel devoted to the use of inventory, either through direct use, buy back, or brokering.

The success of such attempts, however, depends on a cooperative arrangement between customer and vendor. The vendor must have timely access to the customer's drilling schedule as well as the current status of all drilling operations. Furthermore, buy-back and brokering opportunities arise on short notice and must be met quickly. The customer must include the vendor in the distribution of drilling information and must trust the vendor to make prudent decisions in utilization, buy-back, or brokering situations.

Reconditioned equipment
Reconditioned equipment is gaining increased worldwide acceptance. However, the use of reconditioned equipment still presents challenges. Since equipment isn't usually returned to "first class" condition, detailed records must be kept on each serialized item to ensure it is appropriate for the proposed application. Again, from a through-life-cost perspective, this requires vendor and customer to work together to minimize and share the cost of maintaining such records.

Replacement parts
Essential to every customer is the ready availability of replacement parts. Equally essential in cooperative supply chain cost management, however, is the correct sizing, ownership, and physical location of replacement parts inventory to minimize inventory carrying costs for both vendor and customer. Rather than simply stocking "one of everything," we now work cooperatively with our alliance customers to "size" replacement part inventory to meet the specific need. Key elements of a successful program include an equipment rationalization effort to reduce the different kinds of spares needed and consigning inventory (especially offshore) when volume usage makes such an arrangement economically justifiable.

Figure 3 - Per well cost savings; Major Oil Company

Seeing major results
The "reinvention" of traditional products and services in light of TLC generated significant results. Working with a major oil company, we have been able to significantly reduce the total cost of completing a well. The chart in Figure 3 indicates the per-well savings by year as measured against the benchmark year.

Further, when the total number of wells completed over the period is taken into account, the total savings to the operator is in excess of US$144 million. Interestingly, the bulk of these savings came from a reduction in total time to complete and a reduction in other vendors' non-productive time (NPT) and not from a price reduction on our products. One of the major outputs of our service "reinvention" was the appreciation for how much we could affect TLC outside of our scope of supply.

Oil service companies as information managers
But reinventing the organization in light of through life cost can take unexpected turns and requires the vendor to embrace new competencies. For example, every major automaker, in addition to their core automobile manufacturing business, has a credit management company. This arose out of the need to provide financing to prospective buyers. While credit management has nothing to do operationally with their core businesses or their core products, it is directly related to their customers from a service standpoint: most people need credit to buy a car. Today, proceeds from their credit management companies comprise a significant portion of each automaker's total revenues.

Likewise, we are under increasing pressure to expand our scope of supply to include not only new and aftermarket equipment and services, but also to provide information management capabilities about these products and services. This need first appeared in earnest with the requirement to store and manage customer inventory located at our service centers. As part of our own Enterprise Resource Planning (ERP) systems implementation, we included extensive custom enhancements to enable the management of customer-owned property.

This need was pushed further by the highly regulated environment of the United Kingdom's North Sea. Government regulations there require detailed certification and maintenance records for all equipment operating offshore. As part of an overall alliance agreement with a United Kingdom operator, we agreed to assume responsibility for the management of this information for all the equipment within our scope of supply.

The operator was thereby relieved of the administrative burden while improving the process by locating the management of the data as close as possible to its source. As equipment supplier, we were normally intimately involved in all inspection and maintenance activities. By assuming the role of manager of this information, we eliminated a hand off, and the overall integrity of the process improved.

Meeting these new requirements has driven us, as a vendor, to develop additional expertise in the area of information technology. As the shear volume of data to be managed increases, our information management tool set has grown to keep pace, and the potential value we provide to our customers correspondingly increased. Our information technology capabilities exclusively driven by customer requirements now include:

• Complete receipt, storage and repair history for serialized customer property held at our facilities.
• Installed asset tracking. A complete history of equipment movement from initial installation through repair, redeployment and eventual retirement.
• Maintenance scheduling. A maintenance schedule customized by well, rig, or even individualized serialized item.
• Maintenance management and results tracking. Management of maintenance jobs, as specified by the maintenance schedule.
• Equipment certification tracking.
• Reporting. Providing on-line access to real-time data, including access via the Internet.

Conclusion
As our customers become increasingly conscious of TLC, our role in the supply chain evolved and grew. Originally, a product manufacturer, we have evolved into a service company in response to the growing need for aftermarket support. As the need changed, we transformed again from a supplier of new and aftermarket products and services to joint managers of information with our customers.

Finally, there are signs that the market may drive us further in this direction to provide complete outsourcing capabilities: a comprehensive service offering—including the IT infrastructure—for the procurement, storage, installation, maintenance, and repair of drilling, wellhead, tree, and other well-related assets. Vendors must quickly develop the capabilities and the infrastructure needed to support these new requirements in a way that is cost beneficial to both parties.

About the author: Robert N. Flatt serves as vice president of Aftermarket Business for Cooper Cameron Corp., Cameron Division. He also serves as an adjunct professor in the Administrative Science Department in the Jones Graduate School of Business at Rice University. 713-939-2321, flattr@camerondiv.com. See Flatt's article, Using the TQM Umbrella to Implement Business Process Reengineering, Power Online, June 7.

Edited by April C. Murelio
editor@poweronline.com