Ludicrous Indeed

Unsurprisingly, the BBC gives us a puff-piece on Tesla’s latest offering:

[T]his upgrade enables the Model S to travel from 0 – 60 mph in 2.5 seconds, giving it the fastest acceleration of any currently available production car … Like all electric vehicles, that more powerful battery delivers 100% of its dual-engine torque immediately, pushing the four-wheel-drive saloon past records heretofore the domain of million-dollar supercars.

Million dollars? Let’s first be generous and assume this car actually can do 0-60 in 2.5 seconds and will make it into production (visit Streetwise Professor to see why skepticism over Elon Musk’s pronouncements is warranted).  According to Wikipedia, the Porsche 991 can match this which, according to Porsche USA, costs about $188,000.  This isn’t so cheap, but it’s not a million dollar supercar.  And the Tesla is no bargain, either:

The Model S P100D saloon will start at £114,200 and the Model X 100D sport-utility vehicle begins at £117,200, and older Teslas can upgrade their battery packs for a mere £15,000.

£114k is about $150k in today’s money.  That would buy you an awful lot of Porsche.

That’s expensive, but Tesla is taking the Toms shoes model approach to your wallet. “While the P100D Ludicrous is obviously an expensive vehicle, we want to emphasize that every sale helps pay for the smaller and much more affordable Tesla Model 3 that is in development.” In other words, your need to go very far, very fast helps fund the electric vehicle needs of others less fortunate than you.

Hmmm.  As a business model, this doesn’t sound very sustainable.  You could probably expect some cross-subsidising between models in order to maintain a brand and market share, but this seems to be ass-backwards: it’s normally the high-volume margins on the cheaper brands which provide the cash for developing high-end niche products, not the other way around.  Are Tesla really going to be selling enough of these $150k supercars, and the margins high enough, to be able to reduce the cost of the mass-produced models?  I’d love to see the numbers on that.

The holy grail of EV range has long been 300 miles, which would bring electrics into the full-tank range of most petrol-powered vehicles. Now, 300 miles doesn’t make for a stress-free cross-county road trip, but there’s a lot to be said for enjoying a real meal while your Tesla charges rather than buying Slim Jims and Diet Dr Pepper in the 10 minutes it takes to gas up your petromobile.

If sitting and having a meal for a couple of hours is preferable to stopping for 10 minutes, why don’t more people do that already?  After all, there is nothing preventing owners of petrol cars doing so, is there?  What the article is doing is trying to make light of the biggest issue facing electric cars, which I’ve written about before:

The limited range isn’t actually the issue, as petrol cars also have a limited range.  The problem is the charging time, which renders the vehicle unavailable for several hours.  If you run low on petrol, you spend 5 minutes filling up and you’re on your way again.

The whole concept on which the current breed of electric cars is based will collapse as soon as there are more than a handful of stories of people being caught out miles from home – children in the back, howling – and having to wait at a charging station for hours before being able to continue the journey start to appear on the internet.

The author’s glib suggestion that people will be happy to sit and have a nice meal while waiting to continue their journey isn’t supported by people’s actual behaviour.  A decent journalist would have addressed this issue properly, but then this is the BBC: the entire article is simply a puff-piece for the latest darling of the political establishment:

Mr Musk is betting big on batteries. He’s going to make sure we get to the future  — and quickly.

This is what £3.7bn per year gets you.  Couldn’t they at least send Tesla an invoice next time?

Incentives matter, so best not ignore them.

A story was doing the rounds last week that was drawing praise and admiration from various quarters:

The idea began percolating, said Dan Price, the founder of Gravity Payments, after he read an article on happiness. It showed that, for people who earn less than about $70,000, extra money makes a big difference in their lives.

The idea began percolating, said Dan Price, the founder of Gravity Payments, after he read an article on happiness. It showed that, for people who earn less than about $70,000, extra money makes a big difference in their lives.His idea bubbled into reality on Monday afternoon, when Mr. Price surprised his 120-person staff by announcing that he planned over the next three years to raise the salary of even the lowest-paid clerk, customer service representative and salesman to a minimum of $70,000.

If it’s a publicity stunt, it’s a costly one. Mr. Price, who started the Seattle-based credit-card payment processing firm in 2004 at the age of 19, said he would pay for the wage increases by cutting his own salary from nearly $1 million to $70,000 and using 75 to 80 percent of the company’s anticipated $2.2 million in profit this year.

Those doing the praising were generally of a left-wing bent, and some went so far as to say this was a vision of the future and an example for other firms to follow.  Me, I’m not so sure, and I think Mr Price’s company is going to run into trouble over this at some point.

Now I’ll start by saying that Mr Price is perfectly within his rights to distribute his own salary among the workforce in such a manner.  And as I understand he is the owner, hell he can pay them $1m per year to watch TV for all I care.  I just don’t think he’s thought through the implications.  There are several problems which I think will arise, all of them to do with incentives.

The paychecks of about 70 employees will grow, with 30 ultimately doubling their salaries, according to Ryan Pirkle, a company spokesman. The average salary at Gravity is $48,000 a year.

His idea bubbled into reality on Monday afternoon, when Mr. Price surprised his 120-person staff by announcing that he planned over the next three years to raise the salary of even the lowest-paid clerk, customer service representative and salesman to a minimum of $70,000.

Firstly, if the lowest paid clerk is now on $70,000 per year there is almost no incentive for anyone to grow professionally by taking on more responsibility, tackling harder tasks, volunteering for the shit jobs, and putting in additional hours to increase their own value within the company.  If the clerk is on $70k, why would somebody from the middle-ranks with marketable skills and a higher education apply themselves if they were on similar wedge, or work extra hard just to earn $80k when by loafing he can earn $70k?  Better to take it easy and spend more time with the family.  And this will be made worse by the plan being phased in over 3 years.  Who is going to be interested in the new night manager role now the main incentive to take the crap hours is gone?  This will be felt even more keenly in sales: how much effort is the junior salesman going to put in now he’s on $70k per year?


Hayley Vogt, a 24-year-old communications coordinator at Gravity who earns $45,000, said, “I’m completely blown away right now.” She said she has worried about covering rent increases and a recent emergency room bill.

“Everyone is talking about this $15 minimum wage in Seattle and it’s nice to work someplace where someone is actually doing something about it and not just talking about it,” she said.

From the above quotation I think it is safe to assume that Hayley Vogt will never leave Gravity of her own free will because she is now paid 55% above market rate for being a communications coordinator.  Nobody above her is going to leave either, so it is an equally fair assumption that as long as Gravity exists, Ms Vogt – currently 24 – will be a communications coordinator.  So by the time she’s 40, Ms Vogt will still be a communications coordinator.  Do you see the problem here?  She’s undergone no professional growth.  She can’t be promoted internally because her superiors – also being paid well over market rate – will hang onto their jobs for all they’re worth.  So if Gravity goes tits-up in the future, Ms Vogt will find herself on the job market not only facing a severe cut in her income but also competing against people much younger from whom she cannot differentiate herself in any meaningful way.  For those on the lower rungs doing jobs which don’t require much skill or training, and thus youth, energy, and flexibility are major selling points, this could be a problem.

Of course, many people doing those kind of jobs aren’t looking for a career anyway, they just want to pay the bills.  Which brings me onto the third problem: with nobody leaving, how do you get rid of the underperformers?  Normally these people would leave because, having been passed over for promotion and higher pay for a few years running, want to try their luck somewhere else.  Now Mr Price is stuck with them.

Finally, how does Mr Price intend to bring new talent into the company?  Nobody is leaving, so that means only newly created positions will bring outsiders in.  Aside from not being a very healthy environment for any company, this creates an additional problem.  If a new position is created and advertised, every store clerk within 200 miles is going to apply for the job if it pays $70k per year.  Having an avalanche of CVs hit your desk is not helpful. When I worked in Dubai we advertised for an assistant accountant position and put an advert up somewhere.  Even though we were a small, unknown company we were receiving CVs by the thousand, mostly from Indians.  The problem was almost all the CVs were from labourers, forklift drivers, and other unskilled workers chancing their arm having seen a “big” salary (and indoor work) on offer.  Sifting through them all, trying to identify who was genuinely interested in the position and had the matching skills was a hopeless task.  Gravity Payments is going to find themselves with a similar problem: how many of the tens of thousands of CVs they will receive are from people who aren’t motivated solely by the incredible pay and couldn’t care less about the actual job?  And even those who are qualified, are they confident they will secure a suitable candidate from a shortlist all of whom are overwhelmingly motivated by the pay above everything else (and know they can likely loaf once they get in)?  HR departments in major oil companies will recognise this problem.

Despite his obvious success in business thus far, having set up Gravity Payments at he impressively young age of 19, I can’t help think Mr Price is still a bit wet behind the ears:

“Is anyone else freaking out right now?” Mr. Price asked after the clapping and whooping died down into a few moments of stunned silence. “I’m kind of freaking out.”

Whilst I might be persuaded that executive pay is too high in the US and the disparity between the lowest and highest paid is too wide in some companies, progressive pay scales are used and market rates adhered to for good reasons which might not be immediately obvious.  As Tim Worstall is fond of telling us, incentives matter.  Mr Price might end up learning this the hard way.

This will have Ronald quaking in his boots!

Michael Jennings alerts me to a new business idea in Russia:

Russia has a grand plan to launch its own, patriotic fast-food chain to rival Western burger joints like McDonald’s and rescue its struggling farmers.

The $18-million initiative stems from brothers Nikita Mikhalkov and Andrei Konchalovsky, two of the country’s most famous film directors.

Both have poured scorn on Western influence in the past and are known for their close ties to the Kremlin.

The brothers have already picked a name for their brainchild: “Let’s Eat At Home!” (Edim Doma!)

Andrei Vorobyov, the governor of the Moscow region, has welcomed the project.

“It’s a good idea,” he said. “Small businesses and chains create jobs, and the food produced on our territory is perfectly suitable for these cafes.”

The deputy chairman of the regional government, Denis Butsayev, has already hailed the proposed chain as a “McDonald’s killer.”

“The goal of this project is to promote import substitution and create alternatives to Western fast-food chains,” the brothers wrote in their proposal, quoted by the Kommersant daily.

The brothers want to open 41 cafes in the Moscow and Kaluga regions, all supplied by local kitchens and factories. Up to 40 percent of the menu will be made from regional produce.

This is dumbassed on so many levels.  Firstly, as I mentioned here:

The primary beneficiary of McDonald’s in Russia are those Russians wishing to purchase its products, who number in the millions.

The secondary beneficiary of McDonald’s in Russia are the Russian owners (it is a franchise), managers, employees, and suppliers whose income derives from its operations.

Pinching customers from McDonald’s is unlikely to result in a boost for Russia at the expense of the west.

Secondly, Russians eat at McDonald’s because they like McDonald’s.  They don’t eat at McDonald’s because they cannot find cafes selling pel’meni and borsch to sate their hunger.  As has been proven in any country you care to mention – but let’s take France as a good example – you can easily find an alternative burger which is almost always better.  But something about the whole McDonald’s setup, i.e. not just the food, attracts people.  I suspect eating in McDonald’s for young Russians is, like in France, seen as a cool thing to be doing.  Good luck getting the kidz to buy into the idea that ordering buckweat washed down with kompot is now cool.  As the article points out:

McDonald’s remains hugely popular among Russians, despite a number of recent setbacks amid deepening tensions between Russia and the United States.

Thirdly, given the low probability of being able to compete with McDonald’s, if this scheme gets lanched it will likely take business away from the dozens and dozens of small, independent stolovayas and cafes that already sell Russian food using locally-sourced produce.  The knock-on effect will therefore be felt by their existing suppliers and probably result in some of the current alternatives to McDonald’s going out of business.

Fourthly, if prominent Russians wants to “rescue its struggling farmers”, “create alternatives to Western fast-food chains”, and “create jobs” then they might want to start by getting rid of the brazen gangsterism, thuggery, and corruption that infest the entire country and prevent these things happening of their own accord.  But no, this is Russia so:

The $18-million initiative stems from brothers Nikita Mikhalkov and Andrei Konchalovsky, two of the country’s most famous film directors.

Mikhalkov and Konchalovsky had reportedly called on Russian President Vladimir Putin to help secure government backing for the project in light of its “sociopolitical character.”

According to Kommersant, Putin had personally ordered Deputy Prime Minister Arkady Dvorkovich to “examine and support” the proposal.

Under the program, 70 percent of the sum is provided by banks under a state-guaranteed loan, with the remaining 30 percent coming from private investors.

State-controlled Sberbank has been touted as a potential lender.

[The government] rejected the brothers’ request for direct funding at a government meeting late on April 9, suggesting that the would-be entrepreneurs should instead seek funding through Russia’s existing scheme to support small businesses.

Instead we have two politically-connected multi-millionnaires looking for state-financing of their pet project whose major selling point is that it represents the type of crude patriotism that is currently in vogue with the President.  And although they appear to have had their appeal for direct funding rejected our multi-millionnaires, who were able to meet with Putin in person, have been advised to raid the state fund set up to assist small businesses.

I’m wondering how this project represents anything different in Russia, let alone an improvement.

The Failure of Russian Projects

The Streetwise Professor writes about another ambitious Russian state project which has gone badly off the rails, this time the Vostochny Cosmodrome project.  As usual, the project is way behind schedule, way over budget, and workers haven’t been paid for months.

All of this would seem drearily familiar to anyone who has worked on Russian projects, but outsiders might not know the mechanism behind the failures.  Russian certainly would, but only those who have gotten their hands dirty on a project, i.e. the mal’chiki-mazhory who are the most enthusiastic of grand Russian projects won’t have a clue.

The problem is not in the experience, competence, or attitude of the technical workforce.  Russia has a ready supply of clever, motivated, experienced, and competent engineers and technicians.  These men and women are more than capable of designing and constructing pretty much anything in Russia.  Granted, it might not look too pretty and the design might be a bit dated, but it will work as intended.  The problem is in the management of these skilled resources.

The root cause is that owning a successful company in Russia is a result of your being allowed to do so by virtue of your personal connections or the muscle you can deploy (preferably both).  Without one of these, you are never going to be able to run a company large enough to execute a sizeable project, as you will be shut down or forced out by the local powerbrokers – either government authorities or gangsters – before your business is anywhere near mature enough to bid for large contracts.  Competence, a sound business plan, or good management practices count for nothing if you don’t have connections or the muscle to defend yourself.

As such, all players bidding for a large engineering and construction contract will have achieved and maintained their position by something other than technical competence and delivery.  The problem is further compounded by the fact that those very same connections which allow them to operate are used to determine which company gets the juicy contracts.  The award of contracts in Russia is therefore an exercise in nepotism; the selection of contractors is done not on the expectation of competent execution, but by which company offers the most beneficial kickbacks, favours, counterfavours, and financial rewards to those who have the final say.

This would not be a problem in itself if the winning contractor has within its organisation the skills required to execute a project competently.  Surprisingly, quite a few of these contractors do: they have on their staff the experienced technical resources that I mentioned earlier in the post.  Or even if they don’t, at the beginning a contractor will hire in the competent people and the project will start well.

The problem comes when the cashflow situation goes belly-up.  This always happens for the simple reason that cashflow is very difficult to manage on any project and especially so in Russia.  Whereas normally any contractor will have demonstrated their skill in managing cashflow by virtue of a proven track record and still being in business, in Russia this isn’t a requirement at all: personal connections are what matter.  So on Russian projects there is a strong likelihood that the management of the entity in charge doesn’t know much about cashflow, or indeed any other aspect of running a normal business.

Whereas some aspects of business can be ignored in favour of lies, threats, and pig-headedness, e.g. HR, HSE, quality, accounting, etc. cashflow isn’t so easily ignored.  If your bank account is empty, then you can’t pay suppliers; if suppliers aren’t paid, you don’t get the materials and equipment; if you can’t get the materials and equipment, you can’t make progress; and if you can’t make progress, you can’t invoice for the next stage payment.  Managing cashflow on a project is a very specific skill, and even major oil companies get it wrong and have to rely on the parent company and partners having large cash reserves to keep the project solvent.  Most Russian companies simply don’t possess this skill and probably few CEOs appreciate what it is, not having attained their positions through business acumen.

If a project experiences a problem with cashflow, one of the early signs is the workforce not being paid on time.  This is particularly true in Russia.  In countries like Russia and Nigeria, shafting the workforce by not paying them on time (or at all) appears to be perfectly acceptable behaviour in the eyes of many Managing Directors.  Indeed, some almost seem to think it a very clever way of saving money and engage in this practice even when they are flush with cash.  I knew several engineers and technicians in both Russia and Nigeria who had quit previous jobs having been owed months and months of wages, and given up hope of ever seeing it.  So if the company in question had experienced and competent technical staff on their books at the beginning, the best of these will leave once the pay problems start, with the rest following in a steady trickle depending on how bad the situation gets.  They will be replaced by inferior people, who will also get fed up and leave, to be replaced by even less-qualified people, and so on in a vicious circle until – like I saw in Russia – the site is filled with undocumented, uneducated rural folk from Tajikistan and North Korea working for meagre cash-in-hand wages.  When this manpower drain is coupled with the other side of the cashflow problem – the suppliers not being paid, hence materials not being delivered to site – the situation is almost impossible to reverse without massive cash injections from somewhere.  And this being Russia, the project owners are not the sort to be handing out extra cash even assuming it is available.

So in short it is a management problem, particularly their inability to manage cashflow.  This is compounded by the fact that the sort of people who manage large contracting companies in Russia are the sort of people who would treat the project account as their own personal fund for the purchase of dachas and Porsche Cayennes in the days after the initial advance payment, and also the sort of people who would think nothing of shafting the workforce and suppliers by not paying them for months or years.  Few, even in 2015, seem to understand the concept of a market for skilled labour which enables a skilled Russian welder to walk off the job if he hasn’t been paid and pick up another one elsewhere.  For those managers skilled only in Soviet-style thuggishness and corruption, they have yet to understand the Soviet labour system of being shackled to your workbench doesn’t, for the large part, exist any more.

This is why, despite Russia having easily enough technical resources to complete such a project, the Vostochny Cosmodrome project has been unable to even pay its bill for lighting.  The failure was never about Russian engineers being useless, or lazy, or too few in number, or Russian contractors not knowing how to do complex works.  It was always about that one thing Russia never had in the Soviet times or now, the one thing which they increasingly insist the West cannot help them with: managerial competence.

If somebody in Russia could harness Western management practices with local technical resources, we’d see a vast improvement.  One chap did this once, went by the name of Mikhail Khodorkovsky and had a company called Yukos.  Whatever happened to him?

Meetings in France

Over at Tim Worstall’s gaff, reader Andrew M alerts me to this piece in the New York Times on the subject of French, English, and American conversations.  This bit had me nodding along vigorously:

But many modern-day conversations [in France] make more sense once you realize that everyone around you is in a competition not to look ridiculous. When my daughter complained that a boy had insulted her during recess, I counseled her to forget about it. She said that just wouldn’t do: To save face, she had to humiliate him.

This is probably worse in Paris, and among the professional classes. But a lot of French TV involves round-table discussions in which well-dressed people attempt to land zingers on one another. Practically every time I speak up at a school conference, a political event or my apartment building association’s annual meeting, I’m met with a display of someone else’s superior intelligence.  Jean-Benoît Nadeau, a Canadian who co-wrote a forthcoming book on French conversation, told me that the penchant for saying “no” or “it’s not possible” is often a cover for the potential humiliation of seeming not to know something. Only once you trust someone can you turn down the wit and reveal your weaknesses, he said.

Meetings in France are perhaps the greatest single source of puzzlement in the working lives of expats.  Anyone from the Anglo-Saxon world will sit through a meeting with no agenda that started late and concludes (also late) with no substantial decisions being made and wonder what the purpose of it was other than to offer workers an opportunity to demonstrate how wonderfully clever they are in front of their peers.  The way in which meetings are conducted in France was a major subject covered in my intercultural awareness training when I first arrived, and remains a frequent topic of conversation among the expats.  Apparently, according to the article, this sort of behaviour has a long history:

Life at Versailles was apparently a protracted battle of wits. You gained status if you showed “esprit” — clever, erudite and often caustic wit, aimed at making rivals look ridiculous. The king himself kept abreast of the sharpest remarks, and granted audiences to those who made them. “Wit opens every door,” one courtier explained.

Indeed it does.  An inability to answer a random, irrelevant, and often daft question in a French meeting will demonstrate that a speaker is “unprepared”, and thus possibly unsuitable for promotion.  Hence he or she must “prepare” by stuffing their presentation with dozens of slides containing table after table of raw data in Font 8 or smaller, which are preceded by five or more slides of “context” containing sentences such as “In the beginning God created the heaven and the earth” and “When viewed in an inertial reference frame, an object either remains at rest or continues to move at a constant velocity, unless acted upon by an external force.”  Given French presentations normally consist of the speaker reading the contents of a slide line by line, one after another, it’s no surprise to learn that meetings can run on for hours.

Whether these practices are fit for a modern business operating in an increasingly competitive and globalised world is a matter for debate.  A glance at the French economy and unemployment rate would suggest not.  Us Anglos could learn a lot from the French in many fields, but conducting meetings and delivering presentations are not among them.

Où est la Thatcher française?

This article speaks volumes about the French government’s understanding of global business practices:

French President Francois Hollande has met the boss of General Electric’s (GE) to discuss his firm’s interest in buying part of engineering firm Alstom.

It follows reports the US company is preparing a deal to buy Alstom’s power turbines business.

Alstom, which also makes TGV high-speed trains, is one of France’s biggest private sector employers.

Alstom is one of France’s biggest private-sector employers, with 18,000 staff across the country.

Its share price jumped by 11% on Thursday after reports of the interest from GE, but the firm said on Sunday night that its shares would remain suspended from trading on the Paris stock exchange until Wednesday.

The French firm has suffered from heavy debts and a fall in orders over the past decade, and was bailed out by the French government in 2004.

So, a struggling private French firm looks to be taken over by a more successful foreign one, and the French government sees fit to stick its beak in.  But to what end?

France’s economy minister has already said the government would block any deal it sees as unfit.

“We are working to improve the offers to make sure that French companies…do not become prey,” said Arnaud Montebourg, before Monday’s meeting.

Erm, fella.  Alstom already is prey: it’s struggling, and ripe for a takeover.  What you mean is “we want to make sure any potential buyer doesn’t make any changes that we don’t like.” Such as make the necessary changes to turn the company around.

“On the other hand we are open to alliances that help to equip us for globalisation.”

Right, but is GE interested in such “alliances”?  I suspect not; my gut feeling is they intend to buy Alstom and manage it however they see fit with the aim of turning a profit, and are not much interested in helping equip Frenchman for globalisation, whatever that means.

But Mr Montebourg has ruled out nationalising the firm if neither the Siemens nor GE offers go through.

No, you just want to interfere and veto any proposal you don’t like in the vain hope that a competitive and successful foreign company will plough capital into a politically sensitive French company without making any changes which will upset the management and workers.

Obviously Mr Montebourg hasn’t learned much from his previous experience of dealing with potential American buyers of French companies:

The head of US tyre manufacturer Titan International told the French government Wednesday that his firm will not take over a loss-making Goodyear factory because the unions there are “crazy” and its employees “only work three hours a day”.

“How stupid do you think we are?” Titan Chief Executive Maurice Taylor asked French Minister for Industrial Renewal Arnaud Montebourg

“I have visited that factory a couple of times. The French workforce gets paid high wages but only works for three hours.

“They get one hour for breaks and lunch, they talk for three and they work for three. I told this to the French union workers to their faces. They told me that’s the French way!”

Taylor was responding to a proposition by Montebourg to see if Titan, which makes tyres for agricultural vehicles, wanted to invest in the plant in Amiens, northern France.

Titan had approached Goodyear Dunlop Tyres France in 2012 to discuss a possible takeover, but negotiations were blocked by the Communist-backed CGT union.

Montebourg’s appeal to Taylor was a last-ditch attempt to woo Titan back and save the plant and its employees after Goodyear announced at the end of January that it was definitively closing the plant – which employs 1,173 workers – following a long struggle with the unions.

Poor sales at the plant resulted in a loss of 61 million euros in 2011, according to company figures.

Taylor warned Montebourg that despite his tougher stance toward EU trade protection, the French manufacturing sector was doomed if the government did not face up to the realities of Asian competition and deal more effectively with troublesome unions.

And sure enough, the Goodyear plant in Amiens is now on course for closure this year.  One would have thought that Mr Montebourg would this time around be standing well clear and allowing a foreign company to take over Alstom, but his meddling is likely to scare off any suitors.

Which is a shame, because the French make for extremely good engineers and technicians and there is probably an enormous residual value in Alstom in the form of personnel, products, and patents which GE could put to use without destroying the company or its presence in France completely (which is presumably why they wanted to buy it in the first place).  But should the actions of the French government and the unions prevent such a takeover, it increases the likelihood that the company will cease to exist altogether within a decade, as we’ve seen with the Goodyear factory.  And how does that help anyone in the long term?

Managing Contractors in the Oil Industry – Part 2

Part 2 – Respect your contractor’s technical knowledge.

There are two reasons why oil companies subcontract work.

The first is when you know how to do a job, but you don’t have the manpower to carry it out.  For instance, no oil company has enough engineers and draftsmen to design even a small oil and gas facility, even if they have the technical expertise to actually do so.

The second is when you don’t have the necessary technical expertise (mainly because the area concerned does not fall within an oil company’s core business) and so you need to engage somebody who does, and it is this latter case which I will talk about now.

You must start by understanding that the reason you have hired this contractor is because he knows how to do the job and you don’t.  He is an expert in his field, and you barely know what field you’re standing in or if there is a bull lining itself up behind you.  Therefore, if you are sensible, you will listen to what he advises and restrict your role to identifying a vehicle by which his advice can be put into practice at an acceptable cost.  You may and you should ask clarification questions, and you may ask him to explain in precise detail every aspect of his proposal, and if he is any good he will be quite happy to oblige.

Now in these cases you do run the risk of being ripped off by a contractor who realises that you don’t know his business.  You could end up being sold a far more expensive solution than you actually need, but there are various ways to minimise (note I didn’t say eliminate) this.  For instance:

  1. Tender the work.  If you know enough to put a scope of work together, then get several companies to bid.  Unless all the contractors have formed a cartel, what you get would be around about a market price.
  2. Find out whether a similar job has been done before, and see what it cost.  But be sure to identify any major differences between that scope and yours.
  3. Phase the work: tell the contractor that you will give him Phase 1, which is to prepare a scope of work document for Phase 2; and that Phase 2 will most likely go to him but might be tendered if you feel the proposed workscope is excessive or you are being ripped off.  This will give the contractor a strong incentive to give you a fair proposal in terms of scope and cost.  I’ve done this on a job recently, and it allowed us to obtain crucial information about the works without committing the whole project cost.
  4. Best of all, use a contractor you know and trust.  Nothing can beat working with people you know who have done the job before to your satisfaction.  Or at least, try to get feedback from colleagues in the industry about the performance of potential contractors.

So in summary, what you should do is to listen to what your contractor proposes but remain on your guard, especially if you are not familiar with the contractor in question; you should ask pertinent questions about various aspects of the proposal, and listen to the answers; and you should structure the contracting process through which the work will be awarded in such a manner as to minimise the risk of your contractor exploiting your relative lack of knowledge.

What you should not do is smugly sit there assuming that because he works for a contractor he must be as thick as pigshit compared to you who, working for an oil company, must be ten times smarter on all subjects because that is what you were told during your graduate induction.  You should not second-guess every piece of technical advice he is giving you, and make condescending comments like “Well, I don’t think that is really necessary” or “You need to demonstrate…” when you have not the faintest idea what you’re talking about and your contractor, who has been doing this all his life, advises you do something so mundanely commonplace that he can’t believe it’s even being discussed.  All you will do is run a flag up the pole saying you are either to be ripped off magnificently or left well alone.

I have personal experience in being grilled by a manager of an international oil company regarding equipment I was proposing to mobilise for a job.  This took the form of him reviewing my list of equipment (all of it pretty basic), none of which he could identify, demanding a justification of why it was required, and then sneering at my justifications with the heavy implication that it wasn’t needed.  This wouldn’t have been so bad, but he had with him a trade supervisor from his own department who knew his stuff inside and out, had reviewed the list with me the day before, and was strongly advising his boss to stop fannying about and go ahead.  Had I been that manager, I’d have gone along with whatever the supervisor said.  But most of them, driven by pure ego and an inflated idea of their own understanding of a situation, wouldn’t lower themselves to acting on the advice of a mere supervisor.  The meeting ended with the supervisor being as frustrated as me.

What you also should not do is start telling the contractor how to do his job.  You should make clear the project intentions and expected outcomes or deliverables in the scope of work, and identify applicable standards and any specific peculiarities you want incorporated.  And then you should leave him to do his job.  After all, he’s the expert, which is why you hired him.  Unfortunately, there are a lot of people working for oil companies who hire an expert and then go on to dictate to him how he should execute the work.  I know one instance whereby somebody, who didn’t know very much about the subject in question but assumed he did, hired a contractor to carry out some very specialist work – and then proceeded to issue instructions as to how the calculations should be done, what factors to include, and what materials to specify.  Had I been that contractor, I’d have been tempted to ask “Why did you hire me if you’re the f***ing expert?!”  Unsurprisingly, the job ran into serious problems later on as the deliverables were found to represent a mixture of specialised engineering by experts and the interference and unwise inputs from a client who didn’t have a clue.

There are ways of making sure your contractor does a good job; second-guessing their proposals, telling them how to do their job, and assuming you are superior by virtue of your position in the contracting chain are not among them.

(Part 1 is here.)

Managing Contractors in the Oil Industry – Part 1

One of the main tasks in my current position is to manage contractors, i.e. companies to whom we are outsourcing work, on behalf of my employer, a major oil company.  In fact, this is pretty much the main role for a lot of people working for major oil companies, as they are set up more to manage works than execute them.  Almost everything is outsourced, and so the management of contractors is essential to the operation of any department in an oil company.  But somewhat surprisingly, this is an area in which oil company employees are often very weak, and you’ll be hard pushed to find any formal training which contain what I consider to be the fundamentals of managing contractors.

One of the reasons for this is that oil companies like to recruit people fresh from university, blank canvasses ready and willing to be turned into a production-line automaton in the service of the Company.  Most managers (I would say well over half) in a major oil company have been recruited straight from university, and hence have never worked for any other company.  In my case, since university, I have worked for a telecoms giant which collapsed within 6 months of my joining (not my fault!); a third-rate American risk and engineering consultancy which stayed in business largely because its parent company reaped the financial rewards of protectionist policies back home; a rough and ready scaffolding and insulation company whose coarseness did not prevent them from being able to do a pretty damned good job when it came down to it; an independent oil and gas operating company, albeit managed by a supermajor, which was a hoot to work for; a reasonable brownfield engineering firm whose Sakhalin operations were thankfully not typical of the company as a whole; and now a major oil company.  With the exception of a major EPC contractor like Fluor or Foster-Wheeler and specialist vendors, I have covered pretty much the whole contracting food chain in the oil and gas business, albeit only for short periods in each one.

It’s drawing on this wide, albeit shallow, experience that enables me to do my job and bring to you a multi-part guide on how to manage contractors if you find yourself working for a major oil company.  Additional parts will be added from time to time.

Part 1 – Understand how to negotiate.

Firstly, learn what your contractor does and how he makes money.  Understand that contractors make money by employing human capital to directly produce something, which is then sold.  Contrast this with the fact that oil companies make money by opening a tap and flogging what comes out the end.  Understand that whereas the profits of an oil company are wholly unrelated to the utilisation of human capital, for contractors the two are almost always one and the same.  So whilst you in your comfy oil company seat do not feel the wasted costs of ten blokes sat around doing nothing, or do not see the costs of bringing an additional five bodies onto the job, a contractor will live and breathe this concept from day one.  If you want him to do extra work, he will need more money.  If you want him to do something different, he will need more money.  If you want him to take on commercial, contractual, or technological risk, he will need more money.  Finally, if you want him to do some work then you must pay him.  There is no such thing as a free lunch.

One of the most annoying habits of oil companies (and some EPC contractors) is to immediately ask for a 10% discount on commercial figures submitted in response to a call for tender.  This is pathetic, yet is sadly all too common.  Somebody in the contracts and procurement department thinks he is saving the company 10% on costs expended, without having to put any effort in himself.  Good, yes?  Well, no.  If a contractor is going to reduce his costs across all items by some arbitrary amount, then he is going to reduce his effort expended on that job by that same amount.  Oh, he’ll not tell you that he’s skipping NDT inspections, using second-hand parts, or not bothering with functional tests to get his costs down by 10%, but that’s what he’ll do.  So what part of the job does the client want removed?  The smart-arse in contracts and procurement doesn’t know, as he thinks the contractor will take the hit out of his profits.  The contractor isn’t going to tell you which corner he’s cut, so it’s up to the client to find out when the equipment or design fails in mid-operation costing several million dollars in lost production.  In order to save 10% on a $50,000 job.

You need to understand that buying engineering or oilfield services is different from buying soya beans in a Lagos market.  If somebody offers you a kilo of beans for 1,000 Naira in Lekki market, then it is fair enough to haggle down the price of those beans as you’re still going to be getting a kilo of them.  But if you get offered a kilo of new potatoes in a Tesco in Manchester for £1, and you refuse to pay more than 50p, then you’ll be going home with half a kilo by the time the deal is wrapped up whether you realise it or not.  Buying oilfield services has far more in common with a British Tesco than a Nigerian farmers’ market, but surprisingly few people in the industry understand this.  Part of the problem is culture and egos (or both, to the extent that the former often drives the latter). There are some cultures in this world that forbid anyone with any self respect from accepting the first price he is offered.  Like the comical scene in Monty Python’s Life of Brian, “you have to haggle”.  But there’s a big difference between haggling and negotiating a price.  Haggling is arguing about the price assuming the product stays the same.  Negotiating a price is the process by which you arrive at a product and price acceptable to both parties.  The problem with haggling is the person on the receiving end often finds out that what he’s bought isn’t what he thought it was.

The added value a decent manager can bring to an oil company is the ability to break down a contractor’s price, identify which items or services being offered were requested or are desirable, and ascertain whether the price being charged for each is reasonable given prevailing market conditions.  But first, he needs to look at where the actual costs lie.  If you are looking at a total price of $100k and $60k is in personnel hire, $38k is in equipment hire, and $2k is in consumables, there is no point arguing for a week over the consumables.  You’d be amazed at how many people don’t understand this, or allow their egos to get the better of them and attempt to argue about everything.

The skill of a manager is in being able to identify the major costs items and ask the right questions – without prejudice.  Perhaps the $130 per day you’re being asked to pay for hire of a compressor is a fair price?  But without a comparator, how do you know?  Well, you can ask – or find out online – what the capital cost of the compressor (or other piece of equipment) is.  From there you can work out how quickly it will have been paid for at the proposed hire rate.  Then  you take a guess at the lifespan of the item and judge whether the payback period is reasonable.  If you’re hiring a compressor which costs $10k to buy and typically lasts 2 years under site conditions with some maintenance, then charging it out at $1k per day is taking the piss somewhat.  Charging it out at $30 per day will have it paid for in about a year, which is more reasonable.  I had a client grill me on this very issue with regard to vehicle hire in Sakhalin once, and I learned from it.  He had bought identical vehicles a short time previously and (quite rightly) objected to me trying to get them paid for in under a year.  I reduced my prices sharpish.

The point is, don’t automatically assume you’re being ripped off when presented with a high price.  If you’re going to challenge it, you must have a basis for doing so.  Moaning that “this is very expensive” without being able to say why is not going to get the price down any.  Personnel costs are a bit harder to judge, and chances are you won’t be in a position to challenge the rate much.  So you challenge the man-hours or man-days instead.  Find somebody to give you a rough idea how long the job should take, if you can’t figure it out for yourself.

If you think what you’re being charged is fair but the price is still too high, then you need to look at the scope of work.  Is there anything which can be removed?  Did some dickhead in HSE bolt on ill-defined “training” at some stage of the scope development which is now a major cost item?  Is your contractor really the best person to be updating Company documentation on this project?  Is that new deluge system really required?  This is the time to get rid of the expensive “nice-to-haves” and concentrate on what is essential.  But if the “nice-to-haves” comprise only a fraction of the overall cost, by all means leave them in.

Finally, you need to remember that you’re only looking to avoid getting ripped off here, not to get the bargain of the century and impress the bosses with your supposed business acumen.  (If you think you’re getting a bargain in the oil and gas business, come and see me when the job gets delivered and we’ll talk then.)  So if somebody is proposing 20 days to do a job and you think it should be 10, get it down to 10 or 12.  But if you think it should be 18 or 19, then leave it at 20.  The small stuff doesn’t matter, and if you’re a manager, you cannot get bogged down in such details.  Get the price approximately right, and don’t worry if the contractor is making a little bit more than the absolute minimum.  Provided he’s not taking the piss and ordering his Sunseeker when walking out of your office, you’ll have done your job.