KEY INSIGHTS

1. Increasing asset velocity does not result in increased revenues, as intuitively expected, because of the pricing structure that is unique to the industry.

2. Insourcing decreases Return on Assets (ROA) in most scenarios studied in the paper.

3. An all-or-nothing approach to insourcing may be less advantageous than a blended approach that Insources logistics for high-risk, high-delay jobs, yet leaves the Status Quo logistics processes intact for most jobs.

Introduction

ABC Oilfield Services Company1 is in the business of managing and renting out high value tools required for offshore oil exploration. The current logistics of renting out tools is managed by the customer, which results in a very slow rental turnaround time for ABC due to:

1. Operational priorities of customer, which are not aligned with ABC’s operational goals

2. Load consolidation of boats

3. Planning buffer taken by various parties

1 The name of the company has been disguised to maintain confidentiality

Increasing Return on Assets through Insourcing Logistics

By Devjit Ghose and Kevin Murphy Thesis Advisor: Dr. Bruce Arntzen

Summary: This project explores the financial impact of insourcing logistics for a major oilfield services company. Insourcing the transportation of their products to offshore oil rigs at sea – a function currently provided by their customers – will increase asset velocity of their most important tools, and allow them to service more customers with fewer tools. The authors attempt to quantify the asset velocity benefits of insourcing on Return on Asset (ROA).

Kevin Murphy served as a

Battalion Commander in the

US Army prior to joining

SCM. Upon graduation, he

will join IBM as a Managing

Consultant in Washington,

DC.

Devjit Ghose worked in the

consumer goods industry in

India prior to joining SCM. Upon

graduation, he will join

Amazon.com as a Senior

Product Manager in Seattle,

Washington.

Expecting an increase in demand in the coming years, ABC has two options:

1. Maintain Status Quo – The customer manages the rental trip and ABC continues its existing policy of procuring tools to meet increased demand.

2. Insource Logistics – ABC hires boats and manages the rental trip itself and thereby reduces the rental turnaround time. This step would be expected to increase utilization and reduce procurement (as compared to Status Quo) tools to meet increased demand.

Status Quo Logistics

ABC manufactures these sophisticated tools at the cost of several hundred thousand dollars each. These tools are maintained at a base location which also serves as a customization and maintenance facility. In a typical trip, the tools are picked up from the maintenance facility by the drilling contractors, trucked to a dock, and then transported by boat to offshore rigs for use (see Figure 1). The time that a tool stays on a rig depends on the unique circumstances of that drilling operation, but typically lasts from 1 to 3 weeks. Once the customer has finished using the tool, the tool is returned to the maintenance base by the reverse route, where it is refurbished for the next use.

Figure 1.Space-Time Diagram for a tool rental journey

Historical data shows that tools typically spend an excessive amount of time onboard the rig after use, waiting for the client-arranged transportation to bring the tool back to the base. Reducing this waiting time by providing ABC-arranged transportation is the essence of the insourcing initiative.

Price Structure

ABC, typically, is paid two types of charges while the tools are being rented: ‘operating’ and ‘standby’ charges. The Operating charge is only applicable when the tool is actually being used in the drilling process; that is, when the tool is physically attached to the drill bit on a drill string and inserted below the floor of the oil rig, or ‘below the rotary table’ (BRT) in industry terms. Standby charges, on the other hand, are applicable at all other times, including when the tool is being transported to and from the rig, and when it waits on the rig before and after usage (‘waiting time or ‘standby time’). Although the exact charges (or daily tool rental rates) are negotiated on a case-by-case basis, the standby charges are almost always less than the operating charges.

Methodology

Our modeling efforts were divided into six parts (see Figure 2).

ABC used Global Positioning System (GPS) tracking devices over a 9-month period to gain an accurate picture, or profile, of how their tools progressed through the rental trips. This data provided the foundation of our Status Quo Time Analysis. Relying on real-world contract proposals and interviews with industry personnel, we then constructed an alternative time profile for the same trip, but with transportation assets leased and scheduled by ABC, instead of the client. The Time Savings per Trip translated into a shorter Total Cycle Time for each of the 5 major tool families, thus increasing asset velocity.

We then used this information to model revenue, costs, and required assets associated with both scenarios. The asset estimation was particularly important because it allowed us to compare not only different cycle times of each scenario, but also different tool inventory levels needed to service similar demand. ABC, we reasoned, could reap the benefits of increased asset velocity and a reduced asset base – and thus enhance two important levers to increasing ROA. At each of the six stages, we made reasonable assumptions based on extensive interviews with industry personnel to quantify the effects of insourcing.

Figure 2. Schema of proposed methodology

Results

Collectively, our models point to two results.

First, for a given future level of output, the Status Quo Logistics solution will result in a better ROA than the Insourced Logistics solution (See Figure 3). All other things being equal, it is better to meet increased demand by purchasing more tools than by insourcing logistics (and keeping tool inventory constant). However, the competing scenarios produced ROA outcomes that were very close, with the results being very sensitive across the range of reasonable inputs.

Figure 3. Comparison of ROA calculation The second important result is that, in most cases, a higher level of output -- servicing more jobs (meeting a higher level of demand) actually results in less revenue (and lower ROA) than by keeping output constant. The benefits of increased asset velocity (more days when ABC can charge for operating

charges instead of standby charges) are often outweighed by the loss of standby charges resulting from less tool waiting, and the increase in non-revenue-generating maintenance days resulting from more turns. This counterintuitive conclusion may be important in shaping future pricing and logistics decisions.

Sensitivity Analysis

We ran our models across a broad range of pricing schemes, trip profiles, and transportation costs. We found that a principal driver of ROA was the 2-part pricing structure itself, and specifically the ratio between Standby and Operating charges that applied in a given job. The other major factor was the cost of leasing a boat to manage one’s own logistics; with annual leasing estimates ranging upwards from $2.4 million, it is no surprise that fluctuations in this cost will have a dramatic effect on ROA.

Conclusion

Together, sensitivity to boat rental prices and the Standby-Operating Ratio reinforce the fact that Insourcing is certainly not a ‘no-brainer’. The fact that the two options – insourcing transportation or buying more tools – can yield results that are relatively close in terms of revenue and ROA, magnifies the importance of the costs that we have not endeavored to quantify here, such as the relationship costs of changing the Status Quo, or other supply chain efficiencies that can be gained from breaking the paradigm of the current logistics strategy.

Time  Savings  Per  Trip