TLC Management: The Key to Reducing Opex
Authors: Flatt R.N. , Condic Sam , Williams Vicki 
Published: June 2014

Increasing sensitivity to crude-oil price fluctuations will require operators to reduce costs for drilling, completion, and production operations. A key component of this strategy is collaborative management of equipment assets by operators and suppliers to reduce cost over the complete life cycle of the equipment. This paper analyzes the benefits derived from through-life-cost (TLC) management programs undertaken with customers worldwide to reduce operating expenses (Opex).

Supply-Chain-Cost Management

Traditional purchasing strategy for much of the 20th Century focused on price as the key determinant for vendor selection. Market price was dictated by whoever had the "big stick" of economic power, which depended on the current business cycle. In the oil industry, we saw 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. Then, 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 a request for a quote. Vendors respond with bids, often sealed, with little interaction with the customer. The customer selects a vendor (usually the one with the lowest price tag) who manufactures the product and ships it to the customer. The vendor is involved with the product again only if there is a problem with the product during the warranty period.

The attractiveness of this sort of procurement process is obvious. From the customer's standpoint, purchase price is a known quantity and one price is easily compared with another. Purchasing agents can be satisfied with—and be measured by—their performance on the basis of 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.

This process has its advantages from the vendor's stand-point as well. If the primary determinant is price, the vendor's objective is to convince the customer to buy the highest-priced product, then produce it at the lowest possible cost. Furthermore, because products are sold and forgotten, the vendor's other mandate is to limit liability with strict and limited warranties. A "good" sale is the one with the highest possible margin and the lowest possible ongoing liability.

While the traditional procurement model makes it easy to judge good and bad sales, it 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.

This, however, is not the only way to manage procurement. As early as the 1960's, Deming1 taught that procurement strategy should be based on total cost of ownership, not on price tag. This simply stated, but nevertheless radical, 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 rather 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 1970's, Toyota began selling automobiles that were demonstrably better and at a lower cost than their U.S. 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 decrease supply-chain costs constantly and create a truly "lean enterprise." 2

This procurement strategy began in earnest in the U.S. in the early 1980's with Ford's Q1 program. Ford developed a rigorous vendor-selection process to reduce their vendor base dramatically and to give vendors "life-of-parts" contracts. This allowed their vendors to invest in capital programs to decrease their costs significantly. Vendors were measured rigorously for both quality improvement and cost reduction.3 In the late 1980's, Chrysler used the new concepts of supply-chain-cost management to save their company. They created an "American keiretsu" 4 by involving their vendors in a cooperative fashion very early in the design and development stages of their LH-platform automobiles.

While the exact extent of the improvements is always debatable, the massive quality and value improvement in the auto industry is evident to anyone who has shopped recently for a car. A key factor in this 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.