Apr 9, 2009

- History Structure of Shell - The New Shell Matrix -- (Part 1)


At the beginning of 2000, the Royal Dutch/Shell Group of Companies (Shell) was emerging from one of the most ambitious and far-reaching organizational restructurings of its 93-year history. The restructuring had involved the shift from a geographically-based to a primarily business sector-based structure, the elimination of over 1,000 corporate positions, the sale of much of its London headquarters, and the redesign of its systems of coordination and control.

The restructuring had been precipitated by the realization that Shell would need to change the way it did business if it was to retain its position as the world’s largest energy and chemicals company and offer an adequate return to shareholders in an increasingly turbulent industry environment.

By the end of 1999, it was clear that the changes were bearing fruit. Head office costs had been reduced and the increased coordination and control that the new sector-based organization permitted were helping Shell to control costs, focus capital expenditure, and prune the business portfolio. Return on capital employed (ROCE) and return on equity (ROE) for 1999 were their highest for ten years. However, much of the improvement in bottom-line performance was the result of the recovery in oil prices during the year. Once the benefits of higher oil prices were stripped out, Shell’s improvements in financial performance looked much more modest.

At the same time, Shell’s competitors were not standing still. BP, once government-owned and highly bureaucratized, had become one of the world’s most dynamic, profitable, and widely admired oil majors. Its merger with Amoco quickly followed by its acquisition of Atlantic Richfield had created an international giant of almost identical size to Shell. In the meantime, Shell’s longtime archrival, Exxon, was merging with Mobil. Shell was no longer the world’s biggest energy company – its sales revenues lagged some way behind those of Exxon Mobil.

Other oil and gas majors were also getting caught up in the wave of mergers and restructurings. In particular, Shell’s once-sluggish European rivals were undergoing extensive revitalization. The merger of Total, Fina, and Elf Aquitaine in September 1999 had created the world’s fourth “super-major” (after Exxon Mobil, Shell, and BP Amoco). Also asserting itself on the world stage was Italy’s privatized and revitalized ENI S.p.A.

The reorganization that had begun in 1994 under chairman of the Committee of Managing Directors, Cor Herkstroter, and continued under his successor, Mark Moody-Stuart, had transformed the organizational structure of Shell. From a decentralized confederation of over 200 operating companies spread throughout the world, a divisionalized group with clear lines of authority and more effective executive leadership had been created. Yet, Shell remained a highly complex organization that was a prisoner of its own illustrious history and where corporate authority remained divided between The Hague, London, and Houston. Had enough been done to turn a sprawling multinational empire into an enterprise capable of deploying its huge resources with the speed and decisiveness necessary to cope with an ever more volatile international environment?


HISTORY OF THE ROYAL DUTCH/SHELL GROUP
The Royal Dutch/Shell Group is unique among the world’s oil majors. It was formed from the 1907 merger of the assets and operations of the Netherlands-based Royal Dutch Petroleum Company and the British-based Shell Transport and Trading Company. It is the world’s biggest and oldest joint venture. Both parent companies trace their origins to the Far East in the 1890s.
Marcus Samuel inherited a half share in his father’s seashell trading business. His business visits to the Far East made him aware of the potential for supplying kerosene from the newly developing Russian oilfields around Baku to the large markets in China and the Far East for oil suitable for lighting and cooking. Seeing the opportunity for exporting kerosene from the Black Sea coast through the recently opened Suez Canal to the Far East, Samuel invested in a new tanker, the Murex. In 1892, the Murex delivered 4,000 tons of Russian kerosene to Bangkok and Singapore. In 1897, Samuel formed the Shell Transport and Trading Company, with a pecten shell as its trademark, to take over his growing oil business.
At the same time, August Kessler was leading a Dutch company to develop an oilfield in Sumatra in the Dutch East Indies. In 1896 Henri Deterding joined Kessler and the two began building storage and transportation facilities and a distribution network in order to bring their oil to market.
The expansion of both companies was supported by the growing demand for oil resulting from the introduction of the automobile and oil-fuelled ships. In 1901 Shell began purchasing Texas crude, and soon both companies were engaged in fierce competition with John D.
Rockefeller’s Standard Oil. Faced with the might of Standard Oil, Samuel and Deterding (who had succeeded Kessler as chairman of Royal Dutch) began cooperating, and in 1907 the business interests of the two companies were combined into a single group, with Royal Dutch owning a 60 percent share and Shell a 40 percent share (a ratio that has remained constant to this day).
The group grew rapidly, expanding East Indies production and acquiring producing interests in Romania (1906), Russia (1910), Egypt (1911), the US (1912), Venezuela (1913), and Trinidad (1914). In 1929 Shell entered the chemicals business, and in 1933 Shell’s interests in the US were consolidated into the Shell Union Oil Corporation. By 1938, Shell crude oil production stood at almost 580,000 barrels per day out of a world total of 5,720,000.
The post-war period began with rebuilding the war-devastated refineries and tanker fleet, and continued with the development of new oilfields in Venezuela, Iraq, the Sahara, Canada, Colombia, Nigeria, Gabon, Brunei, and Oman. In 1959, a joint Shell/Exxon venture discovered one of the world’s largest natural gas fields at Groningen in the Netherlands. This was followed by several gas finds in the southern North Sea; and then between 1971 and 1976 Shell made a series of major North Sea oil and gas finds.
 
During the 1970s, Shell, like the other majors, began diversifying outside of petroleum:
        • In 1970 it acquired Billiton, an international metals mining company, for $123 million.
        • In 1973 it formed a joint venture with Gulf to build nuclear reactors.
        • In 1976–7 it acquired US and Canadian coal companies.
        • In 1977 it acquired Witco Chemical’s polybutylene division.
 
By the beginning of the 1980s, Shell had built global metals and coal businesses and established several smaller ventures including forestry in Chile and New Zealand, flower growing in the Netherlands, and biotechnology in Europe and the US.
 
The 1980s saw a reversal of Shell’s diversification strategy, with several divestments of “non-core businesses” and a concentration on oil and gas – especially upstream. One of Shell’s major thrusts was to increase its presence within the US. After acquiring Belridge Oil of California, it made its biggest investment of the period when it acquired the minority interests in its US subsidiary Shell Oil for $5.4 billion.


SHELL’S ORGANIZATION STRUCTURE PRIOR TO 1995
Shell’s uniqueness stems from its structure as a joint venture and from its internationality – it has been described as one of the world’s three most international organizations, the other two being the Roman Catholic Church and the United Nations. However, its organizational structure is more complex than either of the other two organizations. The structure of the Group may be looked at in terms of the different companies which comprise Royal Dutch/Shell and their links of ownership and control, which Shell refers to as governance responsibilities. The Group’s structure may also be viewed from a management perspective – how is Royal Dutch/Shell actually managed? The day-to-day management activities of the Group, which Shell refers to as executive responsibilities, are complex, and the structure through which the Group is actually managed does not correspond very closely to the formal structure.
 

The Formal Structure
From an ownership and legal perspective, the Royal Dutch/Shell Group of Companies comprised four types of company:
• The parent companies. Royal Dutch Petroleum Company N.V. of the Netherlands and the Shell Transport and Trading Company plc of the UK owned the shares of the group holding companies (from which they received dividends) in the proportions 60 percent and 40 percent. Each company had its shares separately listed on the stock exchanges of Europe and the US, and each had a separate Board of Directors.

• The group holding companies. Shell Petroleum N.V. of the Netherlands and The Shell Petroleum Company Ltd of the UK held shares in both the service companies and the operating companies of the Group. In addition, Shell Petroleum N.V. also owned the shares of Shell Petroleum Inc. of the US – the parent of the US operating company, Shell Oil Company.
 
• The service companies. During the early 1990s, there were nine service companies located either in London or The Hague. They were:
– Shell Internationale Petroleum Maatschappij B.V.
– Shell Internationale Chemie Maatschappij B.V.
– Shell International Petroleum Company Limited
– Shell International Chemical Company Limited
– Billiton International Metals B.V.
– Shell International Marine Limited
– Shell Internationale Research Maatschappij B.V.
– Shell International Gas Limited
– Shell Coal International Limited

The service companies provided advice and services to the operating companies but were not responsible for operations.
 
• The operating companies (or “opcos”) comprised more than 200 companies in over 100 countries (the 1993 annual report listed 244 companies in which Shell held 50 percent or more ownership). They varied in size from Shell Oil Company, one of the largest petroleum companies in the US in its own right, to small marketing companies such as Shell Bahamas and Shell Cambodia. Almost all of the operating companies operated within a single country. Some had activities within a single sector (exploration and production (E&P), refining, marketing, coal, or gas); others (such as Shell UK, Shell Canada, and Norske Shell) operated across multiple sectors.

 

Coordination and Control
Managerial control of the Group was vested in the Committee of Managing Directors (CMD), which forms the Group’s top management team. The Committee comprised five Managing Directors. These were the three-member Management Board of Royal Dutch Petroleum and the Chairman and Vice Chairman of Shell Transport and Trading. The chairmanship of CMD rotated between the President of Royal Dutch Petroleum and the Managing Director of Shell Transport and Trading. Thus, in 1993, Cor Herkstroter (President of Royal Dutch) took over from J. S. Jennings (Managing Director of Shell Transport and Trading) as Chairman of CMD, and Jennings became Vice Chairman of CMD. Because executive power was vested in a committee rather than a single chief executive, Shell lacked the strong individual leadership that characterized other majors (e.g., Lee Raymond at Exxon and John Browne at BP).

The CMD provided the primary linkage between the formal (or governance) structure and the management (or executive) structure of the Group. The CMD also linked together the two parent companies and the group holding companies.
 
The combination of diffused executive power at the top together with operating authority and financial responsibility dispersed through nearly 250 operating companies meant that, compared with every other oil major, Shell was highly decentralized. However, the technical and economic realities of the oil business limited the autonomy of each operating company – interdependence resulted from linkages between upstream and downstream, between refining and chemicals, and from common financial and technological needs. It was the job of the service companies to provide the necessary coordination. During the early 1960s, Shell created, with the help of McKinsey & Company, a matrix structure within its service companies to manage its operating companies. This structure was viewed as a critical ingredient of Shell’s ability to reconcile the independence of its operating companies with effective coordination of business, regional, and functional commonalties. This matrix organization continued into the 1990s.

The three dimensions of this matrix were represented by the principal executives of the service companies, who were designated “coordinators.” Thus, the senior management team at the beginning of 1995 included the following:

Committee of Managing Directors
• Chairman
• Vice Chairman
• three other Managing Directors
 
Principal executives of the service companies
• Regional coordinators:
– Europe
– Western Hemisphere and Africa
– Middle East, Francophone Africa, and South Asia
– East and Australasia
 
• Sector coordinators:
– E&P Coordinator
– Chemicals Coordinator
– Coal/Natural Gas Coordinator
– Metals Coordinator
– President – Shell International Trading
– Marine Coordinator
– Supply and Marketing Coordinator
 
• Functional coordinators:
– Director of Finance
– Group Treasurer
– Group Planning Coordinator
– Manufacturing Coordinator
– Group HR and Organization Coordinator
– Legal Coordinator
– Group Public Affairs Coordinator
– Group Research Coordinator
– Director of the Hague Office
– Director of the London Office
 

Strategic Planning at Shell
Within this three-way matrix, the geographical dimension was traditionally the most important. The fact that the operating companies were national subsidiaries provided the basis for the geographical emphasis of operational and financial decision making. This was reinforced through the strategic planning process, which put its main emphasis on planning at the national and regional levels. Shell’s planning system lay at the heart of its management system. It was viewed as one of the most sophisticated and effective of any large multinational. It was much discussed and widely imitated. Its main features were the following:

• A strong emphasis upon long-term strategic thinking. Shell’s planning horizon extended 20 years into the future – much further than the four- or five-year planning that most companies engage in. Unlike most other companies, the basis for these strategic plans was not forecasts but scenarios – alternative views of the future which allowed managers to consider strategic responses to the different ways in which the future might unfold.

• A breadth of vision, and emphasis on the generation and application of ideas rather than a narrow focus on financial performance. Shell’s planning department was receptive to concepts and ideas drawn from economics, psychology, biochemistry, biology, mathematics, anthropology, and ecology. As a consequence, Shell pioneered many new management techniques, including multiple scenario analysis, business portfolio
planning, cognitive mapping, and the application of organizational learning concepts to planning processes.

• More generally, Shell was in the vanguard of the transition from the role of the strategy function as planning towards one where the primary roles of strategy were encouraging thinking about the future, developing the capacity for organizational learning, promoting organizational dialogue, and facilitating organizational adaptation to a changing world. Planning at Shell was primarily bottom-up. The CMD identified key issues, set strategic direction, and approved major projects, and the planning department formulated the scenarios.
 
However, most strategic decisions and initiatives originated among the operating companies.
The role of the planning staff and the regional and sector coordinators was to coordinate the operating company strategic plans.
 
FORCES FOR CHANGE
Between the early 1970s and the early 1990s, the world petroleum industry was transformed by a number of fundamental changes. The growing power of the producer countries was seen not just in the sharp rise in crude oil prices during the first oil shock of 1974, but even more fundamentally in the nationalization of the oil reserves of the international majors. By the 1990s, the list of the world’s top 20 oil and gas producers was dominated by state-owned companies such as Saudi Aramco, Petroleos de Venezuela, Kuwait Oil, Iran National Oil Company, Pemex (Mexico), and Russia’s Gasprom and Lukoil. In addition, the old-established majors faced competition from other sources. The “new majors,” integrated oil companies such as Elf Aquitaine (France), Total (France), ENI (Italy), Nippon Oil (Japan), Neste (Finland), and Respol (Spain), were expanding rapidly, while in North America and the North Sea independent E&P companies such as Enterprise Oil, Triton, and Apache were becoming significant global players.

Between 1970 and 1990, the share of world oil production of the “Seven Sisters” fell from 31 percent to 7 percent. The loss of control over their sources of crude oil was a devastating blow for the majors – their whole strategy of vertical integration had been based around the concept of controlling risk through owning the downstream facilities needed to provide secure outlets for their crude oil. As market transactions for crude oil and refinery outputs became increasingly important, so prices became much more volatile. Between 1981 and 1986, crude prices fell from $42 a barrel to $9 before briefly recovering to $38 in the wake of the Iraqi invasion of Kuwait, and then resuming their downward direction.

Between 1985 and 1993, almost all the world’s oil majors underwent far-reaching restructuring. Restructuring involved radical simultaneous changes in strategy and organizational structure in a compressed time-frame. Key features of restructuring by the oil majors were:

• Reorienting their goals around shareholder value maximization.
 
• Greater selectivity in their strategies, involving the divestment of unprofitable businesses, refocusing around core petroleum and gas businesses, withdrawing from countries where investments were not justified by the returns being earned, and outsourcing those activities that could be performed more efficiently by outside
suppliers.

• Cutting back on staff, especially at the corporate level.

• Reducing excess capacity through refinery closures and sales and scrapping of oceangoing tankers.
 
• Decentralization of decision making from corporate to divisional levels and from divisional to business unit levels at the same time as giving divisions and business units full profit and loss responsibility.

• Shifting the basis of organizational structure from geographical organization around countries and regions to worldwide product divisions (many of the majors formed worldwide divisions for upstream activities, downstream activities, and chemicals).

• “Delayering” through eliminating administrative layers within hierarchical structures. For example, Amoco broke up its three major divisions (upstream, downstream, and chemicals) and had 17 business groups reporting direct to the corporate center. Mobil also broke up its divisional structure, and created 13 business groups.

 

SHELL IN THE EARLY 1990s
Shell was the only major oil company that did not undergo radical restructuring between 1985 and 1993. The absence of restructuring at Shell appeared to reflect two factors:

• Shell’s flexibility had meant that Shell had been able to adjust to a changing oil industry environment without the need for discontinuous change. For example, Shell had been a leader in rationalizing excess capacity in refining and shipping, in upgrading its refineries with catalytic crackers, in establishing arm’s-length  elationships between its production units and its refineries, in moving into natural gas, and in taking advantage
of opportunities for deepwater exploration.

• Because of Shell’s management structure, in particular the absence of a CEO with autocratic powers, Shell was much less able to initiate the kind of top-down restructuring driven by powerful CEOs such as Larry Rawl at Exxon, Jim Kinnear at Texaco, Serge Tchuruk at Total, or Franco Bernabe at ENI. Nevertheless, during the early 1990s, a combination of forces was pushing the CMD towards more radical top-down change. The most influential of these pressures was dissatisfaction over financial performance. The early 1990s were difficult years for the industry. The fall in oil prices to the mid-teens meant that returns from the traditional fount of profit – upstream – were meager. At the same time, refining and chemicals suffered from widespread excess capacity and price wars. Meanwhile, investors and the financial community were putting increased pressure on companies for improved return to shareholders. The CMD was forced to shift its attention from long-term development to short-term financial results. 


Against a variety of benchmarks, Shell’s profit performance looked less than adequate:
• Cost of capital was the most fundamental of these – during the early 1990s Shell was earning a return on equity that barely covered the cost of equity.
 
• Long-term stability was a further goal. Top management asked, “What rate of return is needed to provide the cash flow needed to pay dividends and replace assets and reserves?” The returns of 1990–4 were somewhat below this figure.

• Shell’s rates of return, margins, and productivity ratios were below those of several leading competitors.

Evidence of the potential for performance improvement through restructuring was available from inside as well as from outside the Group. During the late 1980s and early 1990s, several Shell operating companies – notably those in Canada, the US, UK, South Africa, Germany, Malaysia, and France – showed the potential for organizational restructuring, process redesign, and outsourcing to yield substantial cost savings and productivity improvements.

The operating company executives that had been in the vanguard of cost cutting were increasingly resentful of the corporate structure. By 1994, Shell employed 6,800 people in its central organization (in London and The Hague) and in its corporate research and support functions. Even allowing for the differences in organizational structure between Shell and its competitors, this was bigger than the corporate and divisional administration of any other oil and gas major. As the operating companies struggled to reduce their own costs and improve their bottom-line performance, so they became antagonistic towards what they saw as a bloated corporate center whose support and services offered little discernable value. A major gripe was the failure of Shell’s elaborate matrix structure to provide effective coordination of the operating companies. Lack of coordination in Europe resulted in UK refineries selling into Spain and Portugal, the Marseilles refinery supplying Belgium, natural geographical units such as Scandinavia split between different operating companies, and difficulties in launching Europewide initiatives such as the Shell credit card.
 
As Chairman Cor Herkstroter noted:
Many Operating Companies are sending us clear signals that they feel constrained by the management processes of the Service Companies, that the support and guidance from them is ineffective or inefficient, and that the services are too costly. They do not see the eagerness for cost reductions in the Operating Companies sufficiently mirrored in the center.
 
The essential issue, however, was to prepare Shell for an increasingly difficult business environment:
While our current organization and practices have served us very well for many years, they were designed for a different era, for a different world. Over the years significant duplication and confusion of roles at various levels in the organization have developed. Many of you notice this on a day-to-day basis.
We anticipate increasingly dynamic competition. We see the business conditions of today, with flat margins and low oil prices continuing into the future. In addition, there will be no let up on all players in the industry to strive for higher productivity, innovation quality and effectiveness.
 
Our vision of the future is one of increasing competitive surprise and discontinuity, of increasing change and differentiation in skills required to succeed; and of increasing demands by our people at the front line for accountability within a framework of clear business objectives, and with access to a global source of specialist expertise.

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