Six basic shifts mark the new economy, and most oil company executives don't know how to take advantage of them.

This article is an authorized condensation of Rober Peebler's "From eSizzle to eFizzle: Does our industry get it?"

For all the hype surrounding e-business in E&P, I wonder if most industry executives really get it? Almost every company has launched Web sites, both internal and external. Much attention is focused on cost-effective e-commerce and e-procurement - buying and selling over the Internet. And we're beginning to hear talk about using the Web to connect industry experts and to work more collaboratively across traditional boundaries. New e-ventures pop up almost every week.
But I have serious doubts that many exploration and production executives are re-examining their businesses through the lens of the new economy. Few understand how radically the landscape is shifting, or how to gauge their competitive position in a global marketplace increasingly dominated by the Internet.
Geoffrey Moore, Silicon Valley marketing guru and venture capitalist, recently laid out key principles of the new economy in his book, "Living on the Fault Line: Managing for Shareholder Value in the Age of the Internet" (HarperBusiness, 2000). Moore's geologic analogy seems particularly fitting for our industry: "Living on a fault line causes one to take an interest in what geologists call plate tectonics. These are the forces under the earth that create the conditions for recurrent and severe earthquakes. In the case of the new information economy, the emergence of the Internet is demonstrating itself to be just such a force."
Tectonic forces that are subtly reshaping the business world can be best understood as a series of six "remarkable transitions," Moore writes. Each is effectively shifting power away from a trusted source of value creation under the old economy.
These transitions shift power from profit and loss (P&L) statements to market capitalization, from assets to information, from products to services, from vertical to virtual integration, from command and control to self-organizing systems and from money to time.
Profit and market capitalization
Despite massive mergers and consolidation, tighter cost controls and higher commodity prices, stock prices of many oil companies have not significantly improved. I suspect many E&P executives are perplexed, but the lackluster market response probably can be understood best within the context of the transition from P&L to market capitalization.
The flow of capital, Moore said, is a Darwinian process of natural selection that seeks out the highest risk-adjusted returns.
Capital markets are looking for companies that "get it" and betting on those they believe are creating sustainable models for the future. Those companies are rewarded with high stock prices relative to current earnings. As Moore wrote, in emerging markets, stock price is the only common denominator that "unambiguously ranks every publicly held company vs. every other."
Based on the past year's stock prices, investors clearly believe Enron has got it. That's why Enron has higher multiples than most of its peers.
According to recent data, traditional oil company shareholders gain about US $20 of market capitalization for every dollar of earnings. Enron shareholders, by contrast, are getting more than $50. Market capitalization, therefore, is a far more meaningful metric than earnings alone.
Web-based initiatives in E&P have focused primarily on reducing transaction costs through e-procurement systems. Savvy investors in the new economy understand e-procurement is like electricity; everyone will have to have it to stay in business, but it will never be a long-term differentiator. Oil companies must be willing to look beyond today's obsession with short-term profits and losses and create value that will be sustainable for years to come.
Assets to information
Twenty years ago, 80% of the market capitalization of US public companies came from the value of hard assets, 20% from intangibles. Today, that ratio has flipped. For the most part, however, this remarkable change has missed the E&P business. Considering oil and gas in the ground as part of this industry's assets, I suspect our ratios today are roughly the same, if not more asset-intensive than before.
In "In Being Digital," Moore wrote, "It is now more profitable...to own information about oil than to own oil." That is precisely what Enron has discovered by moving into trading over the Internet (bits) and selling off its asset-intensive E&P business (atoms).
As Moore said, "The more information you have, and the better (and faster) your analysis, the greater the probability you will make winning investments." The Internet is a powerful force in enabling more profitable decisions because it's all about connecting people with information in real time.
If the E&P business was more like the high-tech industry in which product shelf life was measured in months rather than years, what companies would be on top?
Will the oil company of the future own proven reserves, or will it more efficiently monetize reserves and release lower-return capital to higher-return investments? Will the value of an energy company be measured by the number of offshore platforms, refineries and gas stations it owns, or by its know-how in creating new shareholder value?
Value creation in the E&P industry of the future will focus on the knowledge-intensive activities of finding and managing oil and gas reserves and their associated risks. Therefore, any move toward the new economy will require a new E&P business model, which must include ways of shedding assets and gaining more value from knowledge and intellectual capital.
Products to services
The shift from atoms to bits underlies one of the most profound transitions taking place in the age of the Internet: products are less valuable than services, Moore wrote. "The fewer the atoms in your business, the higher the valuation investors are giving it. Services have fewer atoms than products."
What's more, he asserted, any product can be delivered as a service. "All products have benefits, to be sure, but it is the benefits, not the product, that you want to buy. I don't want to own a 1-in. drill. I want to buy a bunch of 1-in. holes." To an industry that drills a lot of holes, Moore's analogy rings particularly true. Major oil companies used to purchase drilling products - ships, rigs and bits. Now they contract drilling services.
As oil companies embrace the new economy, they will turn more to providers of "virtual IT (information technology) services." In this model, transaction services will replace traditional computing products; applications, data, even central processing unit power, will be accessed remotely via secure Internet connections.
To create maximum shareholder value, therefore, E&P companies must move from purchasing products to contracting for services. This means, of course, that they must be willing to integrate more tightly with outside service providers.
Vertical to virtual integration
Vertical integration is based on the idea that competitive advantage, and therefore sustainable future earnings, can be created more effectively by doing almost everything yourself. As Moore noted, third parties contribute best-of-breed technology to almost any given specification.
The E&P industry has a history of partnering and outsourcing. In fact, outsourcing certain operations is how the oilfield service industry was born. But the idea of sharing the value chain by virtually integrating with best-of-breed third parties has never been widely embraced. If anything, the chasm between the service sector and oil companies has widened under endless price pressures and cost-cutting initiatives.
A good starting point for the virtual E&P value chain of the future is distinguishing between what is "core" and what is merely "context." This is different from the familiar idea of core competencies.
According to Moore, a particular activity "is core when its outcome directly affects the competitive advantage of the company in its targeted markets." He suggested a simple litmus test. "Any behavior that can raise your stock prices is core - everything else is context." Too many corporations deploy too many resources on context.
What are the financial markets saying by not rewarding oil companies with higher share prices? The message is loud and clear: they don't see sufficient core activities related to the new economy. The most challenging task for executives today is to determine what activities are truly core, and how to allocate the majority of the company's intellectual and financial resources to them. They won't figure that out by looking backward.
As Moore observed,
in technology-enabled markets, what was core yesterday is likely context today.
In the age of the Internet and virtual integration, is operating a mature field on the Gulf of Mexico shelf still a core activity? Only if it boosts the company's stock price.
Control to self-organizing
Command and control just doesn't work when, as Moore said, the people "don't belong to you." The most difficult leap for traditional managers will be realizing that "the value chains of companies that interoperate to make up an open architecture market are self-organizing systems...At no time can you point to anyone or anything that is in total control of this process."
Voluntary alignment is perhaps the most significant difference between conventional outsourcing and virtual integration.
Even though E&P companies have made progress in alliances and partnerships, few, if any, have perfected the business alignment and collaboration required for the new model to work effectively. The biggest challenge for executives is to stretch their management models sufficiently to accommodate virtual integration.
They must understand that by integrating with partners whose core is an oil company's context, the market pie can be enlarged enough to generate additional cash flows and create the necessary economic alignment.
Oil and gas may be one of the slowest industries to adapt to the age of the Internet because of this entrenched resistance to change. The companies that break out first will enjoy a significant competitive advantage since others may drag their feet for years.
Money to time
While most energy companies still focus on optimizing P&Ls, companies like Enron have envisioned potential new markets and invested at whatever rate is necessary to ensure leadership in their targeted segment. In some cases, they've consciously sacrificed money, at least in the short term, to buy time - and mindshare. Think about www.Amazon.com.
"It is in the gestation phase that market leaders and followers are determined - more or less permanently," Moore said. "Therefore, in emerging markets, in the trade-off between time and money, time wins hands down...no short-term profits could ever match the lifetime value of...the market leader position. It is this principle that underlies the fundamental shift in stock market valuations over the last half decade."
Oil companies, oilfield service providers and technology suppliers are leaping into cyberspace, forming new dot-com ventures almost every week. The stakes are high. I suspect many industry "firsts" will end up e-fizzles like so many of the other dot-coms because they will fail to alter the underlying business model.
Today, the E&P business is stuck in the old economy in every one of Moore's categories. Oil and gas companies still depend primarily on improving profits to drive shareholder value. They are asset-intensive, purchasers of products, vertically integrated, heavily weighted toward command and control and unwilling to take a short-term P&L hit to capture emerging market leadership.
If executives and their management teams would take Moore's six transitions seriously and apply them to their businesses, I'm convinced they would be able to craft appropriate strategies for the age of the Internet.
The race is on. Only time will tell who the long-term winners and losers will be.