FINANCE, FUNDING, AND LEGISLATIVE FRAMEWORKS FOR SUCCESS M004LON S4

BALANCED SCORECARD OF TULLOW OIL PLC

[Type the document subtitle]

COVENTRY UNIVERSITY LONDON CAMPUS

April 2, 2012

ROBERT Z. SONKARLAY STUDENT ID # 3995565

WORD COUNT (EXCLUDING TABLES, EXECUTIVE SUMMARY, AND LIST OF REFERENCES): 2,570

EXECUTIVE SUMMARY A Balanced Scorecard (BSC) for Tullow that translates the companys vision and strategy into implementation, along with a strategy map that that shows relationships amongst the perspectives have been developed in this paper. Sixteen objectives comprising both qualitative and quantitative measures have been used in the development of the scorecard and were underpinned by four key principles.

From an analytical review of the scorecard, and the critical cause and effect relationship between the various perspectives from the strategy map, four key points that encapsulate the sixteen objectives were recommended. Summary of the recommendations are below. The company should identify additional sources of demand for its products by extending to new markets and new customers. The company should conduct a customer satisfaction survey to understand how customers feel about Tullow, the performance of its products, and the customers expectations. The company should expand its global operations through strategic acquisitions and joint ventures with other companies. The company conduct an employee satisfaction survey to gain a critical understanding of the people that implement strategic decisions for the company, their motivational factors (financial rewards, recognition, promotion, independence, etc.) and what they think of management and leadership in the company.

M004LON (C01) Coursework II

Page 1

TABLE OF CONTENTS

I.

Executive Summary1

II.

Introduction...3

III.

Vision an Strategy of Tullow Oil PLC4

IV.

Balanced Scorecard (BSC) of Tullow Oil PLC.4

V.

Strategy Map of Tullow Oil PLC..8

VI.

Recommendations.10

VII.

Discussion and Evaluation of BSC..11

VIII.

List of References..15

M004LON (C01) Coursework II

Page 2

II.

INTRODUCTION

This business report is a continuation of the research conducted on the financial analysis of Tullow Oil PLC during 2009 and 2010. The report explores the use of not just financial performance indicators but non-financial ones as well, to provide a more plump methodology to managing business performance.

The paper first identifies the vision and strategy of Tullow Oil PLC and then moves on to prepare a Balanced Scorecard that will be suitable for use by the directors and managers of the company to align business activities to the identified vision and strategy, and monitor performance against strategic goals.

A strategy map is then constructed to describe and explain how each objective in the scorecard can assist Tullow achieve its goals and targets; recommendations are proffered to the board for review and consideration. A critical discussion and evaluation of the balanced scorecard as an effective tool for performance management and monitoring follow.

M004LON (C01) Coursework II

Page 3

III.

VISION AND STRATEGY OF TULLOW OIL PLC

The vision of Tullow Oil is to be the leading global independent Exploration and Production Company in the Oil and Gas industry. The overall objective is to deliver substantial returns to shareholders. The strategy to accomplishing the vision and objective is to achieve sustainable long-term growth through balanced funding, exploration and production in core geographic areas (Tullow Oil 2010).

IV.

THE BALANCED SCORECARD (BSC) OF TULLOW OIL PLC

The balanced scorecard for Tullow PLC is developed as below. The balanced scorecard covers a scope of three years during which a review of the company will be conducted to see if the objectives set out in the scorecard were achieved.

Financial Perspective No.

1.

Objectives
To increase return on capital employed

Measures/KPIs
Return on capital employed ratio

Targets
From 3.4% to 5% (Sonkarlay et al 2012)

Initiatives
Design mechanisms that increase operating profit without increasing ROCE

2.

To increase profit margin

Profit margin ratio

From 56% to 65% (Sonkarlay et al 2012)

Implement an effective costreduction program Identify additional sources of demand (new markets and new customers)

3.

To grow revenue

Sales revenue

From 19% to 25% (Sonkarlay et al 2012)

4.

To increase operating cash flow

Operating cash flow ratio

From 30% to 40% (Tullow Oil 2010)

Use more equity placing to raise capital

5.

To increase asset utilisation

Asset utilisation ratio

From 15.8% to 25% (Sonkarlay et al 2012)

Maximise use of existing assets

M004LON (C01) Coursework II

Page 4

Customer Perspective No.

1.

Objectives
To satisfy our customer needs

Measures/KPIs
Customer Retention

Targets
A minimum of 75%

Initiatives
Conduct customer satisfaction survey

2.

To increase reliability

On-time deliveries

80% every quarter

Product dispatch automation

3.

To improve customer loyalty

Customer loyalty rating

Minimum 75%

Customer loyalty program

Business/Internal Processes Perspective No. 1. Objectives

To increase exploration and appraisal success

Measures/KPIs
Exploration and appraisal success ratio

Targets
Currently at 83% to 90% (Tullow Oil 2010)

Initiatives
Acquire more exploration licences; increase operators interest in jointly operated fields

2.

To improve working capital management

Cash-cycle period

Reduce from 94.96 days to 23.64 days (Sonkarlay et al 2012)

Encourage early payment by offering discounts to customers Research and development programs in production and development technologies

3.

To develop more cost-effective methods of production and development

Cost of exploration and development

Cut production and development costs by 30% (Tullow Oil 2010)

4.

Increase production profile(working interest production)

Resource base

Currently at 58,100 barrels of oil equivalent per day (boepd) to 70,000 boepd (Tullow Oil 2010)

Expand global operations through strategic acquisitions and joint ventures

M004LON (C01) Coursework II

Page 5

Innovation/Learning and Growth Perspective No.

1.

Objectives
To increase staff competency

Measures/KPIs
Hours in technical skills training

Targets
20 hours per quarter for employees

Initiatives
Staff competency profiling

2.

To lead employee satisfaction

Employee satisfaction rate Staff turnover ratio

At least 8 on a 10point scale From 1.3% to 0.5% (Tullow Oil 2010)

Employee satisfaction survey Staff recognition and reward program

3.

To reduce staff turnover

4.

To create a company of effective leaders

Number of employees trained

Sixty employees per quarter across the group

Leadership training programs

Justifications for Choice of Objectives The objectives stated in the BSC above are geared towards achieving the vision and strategy of the company. A. The Financial Perspective is crucial to the survival of any company and is the focus of all the business activities for Tullow. a. The return on capital employed is the most significant to investors and is the first objective to be met because it shows the rate at which the business is making profit; if Tullow is to deliver substantial returns to shareholders, this ratio has to be increased consistently. b. The profit margin has been chosen as a financial objective because the underlying reason for any company doing business is profit. It is therefore important to increase this margin as it impacts the return on capital. c. Asset Utilisation is a key component of the financial objectives. Once Tullow uses its assets efficiently, the company will be able to extract more oil from its existing fields, thereby increasing its output which will ultimately lead to increase in sales. d. Tullows revenue growth is essential to supporting the deliverance of value to its shareholders. Once there is a growth in the revenue

M004LON (C01) Coursework II

Page 6

stream, the direct result is an increase in operating profit that leads to a jump in the profit margin and the return on capital employed. e. Tullow has a large requirement for capital to fund major project developments and a very active exploration and appraisal program; therefore, operating cash flow must be increased to fund substantial proportion of capital expenditure (Tullow Oil 2010). B. As an oil and gas company, Tullows Customer Perspective is in three fold. Without the customers, Tullow has no business. a. It is paramount for customers are satisfied and that their needs are met as a business. Dissatisfied customers mean financial objectives will not be achieved because these customers will look to competitors for satisfaction. This may affect revenue and the ripple effect could mean fall in profits and decline in returns to shareholders. b. Reliability is essential in the oil and gas business. Customers must be confident and sure that there would be constant supply of products, and that the products are not only constantly supplied but also on a timely basis to protect their own business interest as well. c. The oil and gas market is a volatile market in terms of price fluctuation and instability in oil producing regions; hence, loyal customers are very crucial to the survival of Tullow. Just in case of a sharp increase in price on the market or drop in supply from Tullow as a result of political upheavals in regions where the company operates, which could trigger a change in price to customers, only loyal ones would be in the position to purchase the companys product at the new price. C. The Internal Business Perspective of Tullow concentrates on how the company can improve its core business activities of exploration and appraisal, and production and development to deliver maximum shareholder value. a. Increasing exploration and appraisal success will put the company in a strong position to becoming the number one independent Exploration and Production Company. Successful exploration and low risk appraisal add transformational resources to the growing resource base, thereby creating value for shareholder. b. Developing cost-effective methods of production and development will turn oil and gas resources into reserves and then into production M004LON (C01) Coursework II Page 7

revenues and cash flow to fund the business activities at minimum cost, which in turn will increase operating profit. c. The production profile of Tullow drives revenue growth and underpins future cash flow generation. In this light, strong focus is placed on increasing the production profile to ensure sustained contribution to value creation. d. In addition to exploration and production activities, Tullows working capital management is pivotal to the success of the company. Shortening its cash cycle indicates that the company has ready cash to run day-to-day activities of the company and will have a positive effect on the return on capital. D. Learning and Growth Perspective drives all the activities in the company for the fact that Tullow is built around the employees. a. Tullow operates in an industry that requires efficient technical and managerial know-how. When staff competencies are increased, the employees have the ability and knowledge of the industry and would contribute to the development of the company by enhancing business practices through new ideas and innovative work processes. b. A satisfied workforce means increased productivity, the result which springs up in increased revenues and profit margins. Satisfying employees is cardinal to the growth and development of Tullow. c. The goal of Tullow is to be the employer of choice in the industry so that the company can attract and retain the best people. By reducing the number of employees leaving the company, Tullow avoids skills shortage and can use its motivated workers to achieve company objectives. d. Leadership in the oil and gas industry is the hallmark of any responsible exploration and production company. Creating a company composed of employees who have leadership abilities guarantees effective delivery of strategy and adherence to best industry practices.

V.

STRATEGY MAP OF TULLOW OIL PLC

The strategy map below evolves from the four perspectives model of the balanced scorecard above. It is a visual representation of the cause-and effect relationships M004LON (C01) Coursework II Page 8

among the components of Tullows strategy; it adds a second layer of detail that illustrates the time-based dynamics of strategy and how an organisation creates value (Kaplan & Norton 2004).

Leading Global Independent Exploration and Production Company

Substantial Returns to Shareholders

FP

Increase ROCE

Grow Revenue

Increase Profit Margins

Increase Operating Cash Flow

Improve Asset Utilisation

CP

Customer Satisfaction

Reliability

Customer Loyalty

IP

Increase Exploration & Appraisal Success

Improve Working Capital Management

Develop Cost-effective Methods of Production

Increase Production Profile

LG

Effective Leadership

Employee Satisfaction

Reduce Employee Turnover

Increase Staff Competency

M004LON (C01) Coursework II

Page 9

NOTE: FP = Financial Perspective; CP = Customer Perspective; IP = Internal Perspective; and LG = Learning and Growth Perspective

VI.

RECOMMENDATIONS

To deliver substantial shareholder value, and to effectively translate Tullows vision and strategy into implementation, the recommendations below should be taken into consideration. a) The company should identify additional sources of demand for its product by extending to new markets and attracting new customers. By expanding its presence in different markets which will increase its customer base, sales revenue of the company will grow as oil prices are set to increase further in the coming years due to increasing demand for oil and gas and their related products, worldwidely. Revenue growth translates into higher profit margins and can be an indication of efficient use of assets; undoubtedly, this impacts the return on capital employed. Strong growths in revenues support the primary ratios that create direct shareholder value. b) The company should conduct a customer satisfaction survey to understand how customers feel about Tullow, the performance of its products, and the customers expectations. Customer satisfaction is a key to retention of the companys already existing customer and this has the ability to also generally create customer loyalty. Satisfied customers indicate that the companys services are reliable and that delivery of products is on time. Greater customer satisfaction has a direct relationship to revenue growth in that customers have the ability to promote the company to others by word of mouth, and this could attract new customers to the company (Kotler et al. 2009). c) Tullow should expand its global operations through strategic

acquisitions and joint ventures with other companies. Even though the company currently operates in twenty two countries around the world, achieving the companys vision requires building a world-class portfolio of exploration and development licences, which now stands at ninety (Tullow Oil 2010). This will ultimately increase the production profile of the company; the production profile drives revenue growth and M004LON (C01) Coursework II Page 10

underpins future cash flow generation, and in turn supports future production growth opportunities. d) The company should conduct an employee satisfaction survey to gain a critical understanding of the people that implement strategic decisions for the company, their motivational factors (financial rewards, recognition, promotion, independence, etc.) and what they think of management and leadership in the company. Employees that are satisfied exhibit positive attitudes and behaviours that influence the activities of the company and are evidenced by profitability and the level of customer satisfaction. Employees will be enthusiastic about programs initiated by the company and be willing to contribute wholeheartedly to business processes once they are happy and satisfied. This will in turn drive productivity and efficiency, reduce employee turnover, and enhance leadership in the company.

VII.

DISCUSSION AND EVALUATION OF THE BALANCED SCORECARD

The Balanced Scorecard (BSC) developed by Robert S. Kaplan and David P. Norton is a strategic approach and performance management system that enables organisations to translate a companys vision and strategy into implementation. The BSC uses strategic and financial measures to assess the outcome of a chosen strategy, and acknowledges the different expectations of the various stakeholders and it attempts to use a scorecard based on four prime areas of business activity to measure the results of the selected strategy (Lynch 2009).

According to Lynch (2009) the BSC combines qualitative and quantitative measures of the selected strategy. There are four key principles behind the BSC: Translating the vision through clarifying and gaining consensus Communicating and linking by setting goals and rewards for success Business planning to align objectives, allocate resources and establish milestones Feedback and learning to review the subsequent performance against plan

M004LON (C01) Coursework II

Page 11

Kaplan and Norton recognised that every strategy is distinct, yet identified four strategic perspectives that should appear on every scorecard (Kaplan & Norton 1996) and are summarised below: Financial Perspective translates the purpose of the organisation into action and includes measures such as operating income, return on capital employed, and economic value added. Customer Perspective purpose needs to be seen in the context of customeroriented strategy and includes measures such as customer satisfaction, customer retention, and market share in target segments. Business Process/ Internal Perspective concerns internal performance measures related to productivity, capital investment against cost savings achieved, labour productivity improvements and other factors that will indicate the way the organisation was undertaking the strategy inside the company. Innovation/Learning and Growth Perspective provides feedback and learning through strategy reviews and includes measures like employee satisfaction, employee retention, personnel development, skill sets, etc.

Integrated Four Perspectives of the BSC

The four perspectives in the balanced scorecard are interrelated and should be integrated as is demonstrated in the diagram below.

Source: (Balanced Scorecard Institute 2011)

M004LON (C01) Coursework II

Page 12

Benefits of the Balanced Scorecard

Considered as an improved performance measurement system, the BSC soon became a useful management system to implement strategy. According to Proctor, the major objective of the BSC is to align organisational objectives and activities in order for the organisation to achieve continuous improvement through effective strategy implementation (Proctor 2009).

There have been several organisations that have been successful in using the BSC, such as CIGNA Property & Casualty Insurance, Brown & Root Energy Services, Chase Retail Bank, etc. (MAAW 2012). A survey conducted by the International Institute of Management of 500 companies indicated that using the balanced scorecard as an integral part of strategic planning gave a breakthrough result of 100% (IIM 2002).

Malina and Selto (2001) argue that BSCs can make other significant contribution to improve business performance by expounding strategy through quantifiable measures; communicating strategic objectives by turning high level objectives into operational objectives; planning, setting targets and aligning strategic initiatives through ambitious but achievable targets for each perspective and initiatives; and obtaining strategic feedback and learning on whether the strategy implementation is going on according to plan. Limitations of the Balanced Scorecard The use of the balanced scorecard has been subject to increasing scrutiny and criticism in academic literature; even the authors of the balanced scorecard concept admit that it may not be suitable for all firms. Research has shown that BSC users are not very knowledgeable of the cause and effect relationships that govern the selection of performance measures; moreover, the BSC model is not theoretically innovative, convincing or valid (Norreklit 2003). Another criticism of the balanced scorecard is that its goals are highly aggregated and typically influenced by several causal factors, and that goals are merely hopes that may not be feasible within the current system (Schonberger 2008). Although the M004LON (C01) Coursework II Page 13

balanced scorecard promises to outline the theory of the firm by clearly linking the driver/outcome measures in a cause and effect chain, the precise cause and effect relationships between measures for each of the perspectives on the balanced scorecard will be complex because the driver and outcome measures for the various perspectives are interlinked (Brabazon 1999). Other writers argue that the balanced scorecard is too fixed and that a more effective, systemic perspective in measuring/managing intangible assets needs to be adopted. They view the balanced scorecard as a tyrannical model that is beginning to endanger the survival of firms, hinder much-needed business ecosystem innovation, thereby negatively affecting customer value rejuvenation, shareholders benefits, other stakeholders as well as societal benefits in general (Voepel et al 2006). Other limitations of the balanced scorecard model include choice of strategy, that is, getting the right strategy in place; quality of the management information system; time lags; subjectivity because the BSC is designed and actioned by people; semantics and language, which could lead to an objective been interpreted differently by different people; and management guru ethos (Proctor 2010: 466-467).

M004LON (C01) Coursework II

Page 14

LIST OF REFERENCES 1. Balanced Scorecard Institute (2011) Balanced Scorecard Basics [online] available from http://www.balancedscorecarg.org/BSCResources/AbouttheBalancedScoreca rd/tabid/55/Default.aspx> [15 March 2012] 2. Institute of International Management (2002) Strategy Alignment and Performance Management Tool [online] available from <http://www.iimedu.org/executiveeducation/executive_seminar_havard_balanced_scorecard. pdf> [16 March 2012] 3. Kaplan, R.S & Norton, D.P. (2004) Strategy Maps: Converting Intangible Assets to Tangible Outcomes. Boston: Harvard Business School Publishing Corporation 4. Kaplan, R.S & Norton, D.P. (1996) The Balanced Scorecard. Boston: Harvard Business School Press 5. Kotler, P; Keller, K.L; Goodman, M; Hansen, T. (2009) Marketing Management. Harlow: Pearson Education Limited 6. Lynch, R. (2009) Strategic Management, 5th edn. Harlow: Pearson Education Limited 7. Malina, M.A., Selto, F.H., (2001), Communicating and Controlling Strategy: An Empirical Study of the Effectiveness of the Balanced Scorecard, Journal of Management Accounting Research, 13: p47 8. Management and Accounting Web (2012) Article Summaries [online] available from <http://www.maaw.info/ArticleSummaries/ArtSumKaplanNorton2001.htm> [12 March 2012] 9. Norreklit, H. (2003) The Balanced Scorecard: What is the Score? A Rhetorical Analysis of the Balanced Scorecard Journal of Accounting, Organisations, and Society, 28(6): p591-619 10. Proctor, R. (2009) Managerial Accounting for Business Decisions, 3rd edn. Harlow: Pearson Education Limited 11. Schonberger, R.J. (2008) Lean Performance Management (Metrics dont add up) Cost Management Journal, p5-10

M004LON (C01) Coursework II

Page 15

12. Sonkarlay, R.Z; Aboagye-Wiafe, E; Sumaila, N. (2012) Financial Analysis of Tullow Oil PLC. Unpublished Coursework: Coventry University London Campus 13. Brabazon, T. (1999) The Balanced Scorecard [online] available from <http://www2.accaglobal.com/students/student_accountant/archive/2000/2/43 995> [18 March 2012] 14. Tullow Oil, PLC (2010) Annual Report and Accounts 2010 [online] available from <http://www.tullowoil.com> [20 March 2012] 15. Voelpel, S.C; Leibold, M; Eckhoff, R. (2006) The Tyranny of the Balanced Scorecard in the Innovative Economy Journal of Intellectual Capital, 7(1): p43-60

M004LON (C01) Coursework II

Page 16