Question

Kyle Ritter, Manager of the Strategic Sourcing Group (SSG) at Velocity Oil & Gas Company, sat at his desk and ran through his briefing points for his meeting later in the day. Kyle was the manager of the first-ever SSG at Velocity. A year ago, he had left a promising career as a purchasing manager with a consumer-packaged goods firm back in the mid-west for a complete change of scenery, geography (Denver), and profession (oil and gas exploration and production, or "E&P"). Velocity drilled and operated wells in the "DJ Basin" and the Bakken Formation, oil and gas-rich regions in Colorado and North Dakota. Kyle had been approached by a senior VP at Velocity about starting a professionalized PSM function for Velocity. Like many E&P companies, Velocity did not have a sophisticated PSM operation. In fact, they didn't have one at all. The engineers and project managers who designed the wells and ran day-to-day operations made all the key PSM decisions such as, which suppliers to do business with, negotiations of price and delivery terms, and contractual issues. Kyle was brought on board to change that—he was to bring the advantages of a more sophisticated and strategic PSM approach to an industry badly in need of it.

Rough Landing

Unfortunately, Kyle's "honeymoon" lasted about a week. Johnny Grumpman, one of the most senior engineers, had approached him in the cafeteria and said, "Welcome aboard. I don't even know why you're here." When Kyle had tried to clarify what he meant a few days later, Johnny seemed dismissive, "Look, I know you mean well, but this isn't like making laundry detergent or breakfast cereal. We move fast, we all talk in 'engineering language,' and we've already got strong relationships with the important suppliers we want to use. I can pick the suppliers better than somebody with a business background could, so why even have you here?" While most of the engineers weren't quite as blunt as Johnny, his sentiments were shared by a majority of them.

In the year that followed, Kyle built his team and embraced the steep learning curve in educating himself about the oil and gas industry and the supplier markets serving it. He attended meetings that felt like they were being conducted in another language ("Engineese" as one co-worker called it) and utilized his communication skills to make inroads with his engineering and operations internal customers. But he still felt that he was being held at arm's-length. The engineers were happy enough to hand him work they felt "wasted their time" and wasn't as important to them, but were very reluctant to let his team have significant input on supplier selection or negotiation on large and critical needs. Even after his team saved over $1M annually by negotiating a contract for well-site MRO (machinery, repair and operations) supplies, he was still relegated to "second class status" in his mind. It was quite frustrating. In other industries, PSM was recognized for its strategic value, why not here?

The Supplier Selection Meeting

Kyle was convinced that the meeting today would finally move things forward and show the value that a professionalized PSM function could bring to Velocity. The team would be making a final selection on the supplier for well-site fracking services, a very large and important buy. Kyle's team had done extensive research, and had discovered the following:

• Velocity had used Ferocious Fracking, a smaller outfit with whom many of the senior engineers had close personal relationships, for most of their wells in the last fifteen years.

• Occasionally, due to the bid prices being too far apart, or the difficulty of getting the right people in place (especially in North Dakota), Behemoth Oil Field Services (BOFS), a global leader in such services, had been used. But Behemoth clearly seemed to be the "backup" supplier in the mind of Velocity.

• As many as ten companies had tried to bid on the current well project, and at least five of them seemed to meet the minimum financial, quality, delivery and price requirements to be considered for the business. Two of those five were fairly new companies.

• Based on market analysis, Velocity seemed to be overpaying for fracking services, and a couple of the companies mentioned above were bidding at or slightly below market rates.

Usually, the engineers would simply decide whom to use by having a general discussion around the table, and would do a quick glance at the basic price quote from Furious and Behemoth. Kyle's intention was to use the data his team had assembled to make the case for a formal bidding procedure. He planned to argue that five companies should be considered, and that they should be required to submit detailed proposals for how they planned to meet Velocity's needs in all areas: quality, price, delivery, etc. He knew he'd have a tough time – when he mentioned it to Johnny earlier that month, Johnny simply snorted "Eh, why fix what isn't broken? I've known Furious Fracking for years, I trust them. And if they screw up or can't do it, Behemoth's ready to snatch it away from them. I don't know any of these other guys, why should I spend a lot of time evaluating them?"

Kyle headed towards the conference room, feeling slightly nervous. Today he was making the pitch for why the synergies between his team's commercial expertise and the engineering group's technical knowledge would bring great value to Velocity. How would his proposals be greeted?

Question:

Why has Velocity taken so long to try and professionalize its PSM function? Every industry thinks it is completely different and unique – is the E&P industry really that different, in your opinion? Why/why not?

Answer 1

Before the professionalized PSM service, Velocity was using Ferocious Fracking, a company which had close personal relationship with several senior managers at Velocity. The interpersonal relationship between the 2 companies had delayed the process of professionalizing PSM function. Moreover the management in the company was putting a blind eye to the evolving and growing needs of the company to have a formal forum for supplier selection. Hence the process was being delayed.

E&P i.e. oil and gas exploration and production is, in my views, quite different from other sectors or industries. The primary reason being that the exposure of risk is quite high in these companies. When the risks are high, the rewards are deemed to be higher. Other industries employ less risk in their business model and usually opt for a stable business. An E&P business keeps evolving everyday as every exploration is different and there is so much to learn from each exploration project.