Three companies from the oil and gas industry are losing significantly more than ten per cent of their profits. The Global Simplicity Index (GSI) identifies these firms as ENI, Total and SK Holdings. The GSI, which was published jointly by Warwick Business School and consulting firm Simplicity Partnership quantified, for the first time, the true financial impact of various types of complexity on company profits.
It found that on average, complexity is costing businesses over ten per cent of their profits, equivalent to $237 billion of EBITDA for the top 200 firms in the Forbes Global 500. This complexity tends to manifest itself in over-complicated product portfolios, organisation designs, complex business processes, strategies and management behaviours.
The study showed that the relationship between complexity and profit takes the form of an inverted U-shape curve: the Complexity Curve. This curve sees firms initially gain performance, as they add complexity through additional people, products and processes, but they quickly reach a tipping point, after which additional complexity significantly undermines profitability. In other words, over time companies tend to overcomplicate their businesses. In the oil and gas industry, simpler, more agile, companies tend to outperform their rivals, with international oil and gas companies that suffer from less internal bureaucracy tending to outperform their nationalised rivals.
The sector faces a growing range of complexity challenges. The risks associated with exploration and production have become more complicated as firms look to new sources of oil (like tar sands) in uncharted regions, using new refining technologies. The technical challenges alone are complex and increasingly involve co-ordinating R&D networks across specialist engineering firms and industry contractors, rather than investing solely in in-house technology development. For these reasons capital investment projects are becoming larger and more complex, not just at the exploration and production end of the value chain, but through to the distribution and sales end of the business. New and more complex commercial arrangements for distributing and selling in partnership with other businesses are proving profitable, but add to the coordination costs of managing these functions.
At the same time oil firms are becoming more international, expanding the geographic portfolio of assets and capabilities they manage, across different economies with different regulations, business infrastructures and national cultures. This has a knock-on effect on the due-diligence, legal and other support services required, and on overall co-ordination costs for the firm. Part of this international expansion is driven by the search for new sources.
These changes within the industry have seen the levels of complexity grow. This has had a negative effect on firms, with ENI, Total and SK Holdings lying beyond the complexity tipping point. Importantly, despite high levels of external complexity, the GSI indicates that some companies are coping with this far better than others. This suggests that they have lower internal complexity within their firms.
The GSI identifies five distinct areas, which contain the sources of internal complexity and which need to be understood and simplified in combination to achieve the performance improvements we highlight at the start of this article:
So what should senior executives do to reduce complexity?
- People - the everyday behaviors of employees and managers
- Process - the complexity of business processes
- Strategic - the goals and decisions the board makes in terms of where to focus and how to win in a particular market
- Organisational - how the business is structured, talent management and decision-making
- Products and services - their number, design and the structure of the portfolio
Firstly, executives need to identify the biggest sources of harmful complexity within their organisations. Every company has different complexity problems, so it is important to start with a clear diagnosis of where the most damaging complexity is hiding. The GSI identified the 100 sources of complexity that have the biggest impact on performance. By comparing complexity scores across these 100 dimensions with other companies, and competitors, it is possible to quickly identify where the complexity hotspots are in an individual business. Oil and gas companies do not operate in isolation and additional complexity impacts upon firms operating around them. It is, therefore, important to get external views on complexity from customers and suppliers.
Once there is a clear diagnosis of the problem a detailed strategy needs to be formulated to remove complexity. However, most big companies, including those within the oil and gas industry, do not have a complexity reduction strategy. We believe that all major companies should formulate a comprehensive strategy to address this problem, otherwise profits, agility and employee motivation will continue to suffer. The strategy should include putting a dedicated complexity reduction team in place to implement these plans.
Complexity does not create itself. It is created by the decisions and behaviours of managers, who need to be made aware of how their decisions create unnecessary complexity and need to be given the tools and capabilities to enable them to reduce complexity. Most managers do not know how to identify or remove harmful complexity from their teams or departments. Because complexity hides in every corner of a business, it can only be fully attacked by engaging the help and support of all of the organisation’s managers.
Finally, managers can then start the process of solving internal complexity issues. This should include both quick wins that can help to reduce complexity and that can be implemented right away, alongside more in-depth efforts to change culture and management behaviours to ensure the greatest long-term returns for the firm.
Once the changes have been made, managers should ensure that evaluation processes are in place so that complexity does not slowly creep back into the company, undermine growth and damage profitability in the future. Although the trend is for increasingly globalised oil companies, it is important to evaluate new initiatives such as entering new countries, to ensure this is not going to further increase complexity problems.
By taking a concerted and strategic approach, harmful complexity can be identified and removed from firms in the oil and gas industry. Employee engagement, strategic and operational focus and enhanced performance will result.
The Global Simplicity Index 2011 can be accessed by registering your details at: www.simplicitypartnership.com
Simon Collinson is professor of international business and innovation at Henley Business School, University of Reading, UK. He was previously at Warwick Business School, where he held the posts of deputy dean and associate dean (MBAs). He is a co-founder and the research director of the Simplicity
Partnership and builds on over 20 years of executive teaching and consulting experience with a wide range of multinational companies. In the past year, his research on how to make organisations more innovative, adaptive and resilient has been featured in the Sunday Times, BBC Radio 4, the New Statesman and the US News and World Report.
Melvin Jay is a co-founder and CEO of the Simplicity Partnership. He has over 25 years of commercial and consulting experience. Most recently, he was CEO and founder of the global consultancy Clear, which grew to over 100 consultants in less than six years. Melvin’s early career was spent working for blue chip companies like Danone and Novartis, where he saw and battled the reality of complexity from the management side. As a consultant, he has worked with a wide variety of the world’s biggest companies, across different sectors including, media, pharmaceuticals, financial services, technology and consumer goods.