by Al Naqvi
Editors note: I'd like to thank Mr. Naqvi for permitting us to reproduce this piece. He is one of the most insightful analysts and consultants I've met in this business, and anybody contemplating the launch of an alternative fuels enterprise should read and reread this article.
Rising oil prices, Middle East turmoil, unmanageable volatility and ever-increasing dependence on oil has decisively endorsed the future of energy. After several unsuccessful attempts to become a commercial “alternative” to oil – alternative energy fuels are finally here to stay. While the rise of Alternative Energy Fuels may appear to be a revolution in the brewing, this is not the first time such a revolution has been launched. Several alternative energy ideas emerged during the periods that followed unprecedented rise in oil prices (‘70s and ‘80s) – but the flames of innovation were rapidly extinguished when oil prices started the downward trend. Companies, entrepreneurs and investors helplessly watched as decline in oil prices made their projects economically unfeasible. Now oil prices have risen again and once again we are confronted with a rapid influx of new technologies and solutions. As capital is poured into these new companies, one must ask the question: what factors would make an alternative energy fuels company successful? In other words, how can we build a powerful Alternative Energy Fuels company that can sustain and overcome the dual challenges imposed by changes in oil prices and the internal competitive dynamics of the Alternative Energy Fuels market itself? As the article shows, the complexity of managing an Alternative Energy Fuels is overwhelming as perhaps no other business is exposed to so many perilous forces. Extremely meticulous and comprehensive planning and flawless execution are necessary to lead an Alternative Fuels company to success.
Oil is up again. This time, the rise in oil prices cannot be solely attributed to the nervousness of anxious investors traumatized by the Middle Eastern conflict and regional uncertainty. We must acknowledge that finally demand conditions are seriously challenging the supply capacity. The culprits are China and India followed by a long list of emerging economies that are affecting the global demand for energy. Under these conditions one can be reasonably sure that Alternative Energy is neither a political gimmick nor a pie-in-the-sky product of wishful imagination. With the serious rise of Alternative Energy Fuel come the typical problems associated with the gold-rush mentality of profit seekers. At the cusp of these defining times lies the potential of all too familiar mistakes of the past: uncontrolled investments, convoluted strategies, unrestrained greed, technology proliferation, and senseless land grab battles. What further complicates the situation is the overhanging threat of oil price volatility.
A distinct blend of four defining forces formulates the highly uncertain existential structure of Alternative Fuel industry. These forces are:
Complex Layered Competition
Complex Multilayered Competition The competitive dynamics of Alternative Fuels can be categorized into three components a) Internal Competition b) Platform Competition and c) Oil Competition (Figure A). Internal Competition refers to companies competing within a single Alternative Fuel technology domain. For example: competition among all of the biomass based companies involved in the production of commercial Ethanol. Platform Competition refers to the competition among various types of Alternative Fuels. For example: Coal-to-liquid vs. Oil Shale vs. Biomass. A single molecular property that can make one fuel type better than others (for example improved transportability) can give it an edge over competition. Oil Competition refers to the threat of a rapid decline in oil prices that could make the Alternative Fuels uncompetitive. This threat can come from market economics or simply from predatory pricing by the global oil producers (OPEC).
THE MULTILAYERED COMPETITION
A strategy that doesn’t take into account all of the three layers of competition could paralyze the future of a newly launched Alternative Energy Fuels company. Consequently, a highly coordinated but multifaceted strategy is essential to manage the total investment outlay.
Compounded Risks Like a deadly minefield, the Alternative Fuels space is filled with potentially explosive risks. The complexity of its value chain dramatically increases its business exposures. This complexity can be understood by first segmenting the value chain into Upstream, Downstream, and Emissions/Byproducts and then subdividing each of these segments into Tradable Risks and Non-Tradable Risks (Figure B).
Tradable Risks result from contracts that can be packaged and traded in established markets. The tradability of contracts doesn’t automatically provide any safety against unexpected volatility. In fact in many ways it adds significant complexity. Complexity, in this case, is driven by two factors. Firstly, given its scope and scale, an alternative fuels company can have tradable contracts at various points in its value chain. Hence, tradable contracts can exist for inputs, outputs and emissions. Since the nature of market forces that impact or influence volatility of inputs, outputs and emissions may vary, managing profits becomes complex. The market forces that may cause higher volatility in raw material prices can be significantly different than ones that would impact a fuels’ sale price. Spread – which is derived from the complex interaction of inputs, outputs and emissions – can fluctuate dramatically and hence needs to be managed at various points in time. A good analogy would be from merchant power plants where managing profitability involves constantly juggling and managing the sales price of electricity, coal, and emissions – as all three are separately traded and can be impacted by different forces. The spread resulting from their interaction at different time intervals needs to be continuously monitored and managed if a power plant expects to make a profit.
The second driver of complexity results from a company’s inability to establish reliable or predictable strategic advantages that can filter through the operational makeup of a firm and can be reflected in its profits. In other words, an alternative fuels company can be heavily influenced by several market forces that can severely limit the ability to establish a traditional competitive advantage. For example, traditional competitive advantages typically result from securing an edge over competition through a favorable supply arrangement or by creating a sales advantage from a loyal customer base or by building powerful brands. Establishing an advantage becomes extremely hard when you are confronted with tradable commodities on both ends of a value chain. It is extremely important to understand this point. When contracts are traded in active and efficient markets, information is available to all participants and hence can lead to decision uniformity. Such decision uniformity gives no particular advantage to one participant over another. The result is that no player enjoys competitive advantage over another. Commodities such as coal, sugarcane, corn, oil, gas, carbon emissions can all be tradable contracts. With so many tradable factors, the ability to design a winning strategy becomes extremely difficult.
Raw Materials: Coal, Agricultural Commodities, Other Financial
Operational, Construction, Project, Technology, Logistics, Political, Other
Fuels, Distribution, Demand, Infrastructure, Political, Financial, Logistics
Gas Emissions, Alternative usage of byproducts
* Note: in certain regions and contract types – fuels, raw materials and several other contracts may not have established trading markets. Sales and supply contracts can be long-term contracts. Certain trading markets may not exist today but will eventually evolve.
Non-tradable risks include the traditional business risks such as technology risks, supply chain risks, logistics and distribution risks, and other operational risks. Alternative Fuel companies should expect a sudden surge in the prices of non-traded raw materials, land, equipment, logistics and distribution costs. It would be wise to develop a long-term strategy for reducing uncertainty in the non-tradable parts of value chain. The volatility potential on the tradable side is sizable enough and hence major exposures should be avoided in areas where certainty can be established with reasonable ease and accuracy.
Explosive Expansion Since the times of Rockefeller, the energy game has always favored economies of scale. Larger is always better. In a space where smaller players get rapidly swallowed by larger predators, stagnation is a death warrant. Growth is not a choice but a mandate. It is an essential element of competing in this industry. In the 21st century, capital has perfected its deployment potential and has acquired powerful regenerative capability. It is efficiently attracted to good opportunities; it accumulates in great proportions and attaches itself to companies that can fulfill the growth promise. This snowball effect allows companies to reach unimaginable and extraordinary scale in a short time. Companies should draw no artificial boundaries and should be prepared for aggressive growth in all parts of the world. Hence growth should be aggressively pursued.
Regulatory Forces The fourth force is the direction of public policy and regulatory practices. In the beginning these will vary by countries but will eventually converge towards best practices. Government changes, political crisis, wars, or public opinion adjustments can trigger major policy shifts. An alternative fuels company would have to be extra cautious about its regulatory environment. Having international presence may actually guard against sudden regulatory swings in a single country or region.
The Winning Operational Plan
Understanding the above four forces facilitates devising a strategy that can sustain the ups and downs of launching a new company in the emerging and risky industry of Alternative Fuels. With limited investment dollars, overriding dangers and uncertain technologies – the margin of error is limited. In such circumstances, how can a company devise an operational plan that can allow it to achieve extraordinary long-term success?
The answer lies in a company’s ability to activate and coordinate seven interdependent areas. This coordination requires immense planning, meticulous precision, and significant commitment. These seven focus areas are investment, operations, risk management, supply chain, marketing, organizational management and partnerships/alliance management (See Table 1 on page 9).
Investment Model Right from the inception a company should have a sophisticated investment model that guides its investment strategy. Benjamin Graham (Warren Buffet’s teacher) in his book The Intelligent Investor stated1: “An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative.”
Since growth is a necessary condition to build a powerful alternative fuels company, a well-planned investment strategy is imperative to guide through the growth puzzle.
An investment model should have some important ingredients: 1) Disciplined growth requires analytical rigor and every step should be taken to remove personal and organizational biases 2) While most real asset investment models are focused on individual projects, an alternative fuels company model should also include portfolio level analysis. Investment risk should be analyzed from individual project angle but also from the total portfolio perspective. This implies pursuing a multifaceted investment strategy across multiple dimensions, different geographies, diverse (but manageable) technology platforms, and various stages of the value chain. 3) Real Options approach should be used to effectively deal with situations with higher uncertainty. This involves staging investments, experimenting and waiting to make an investment vs. making large upfront investments. 4) Project financing approach should be preferred or at least explored vs. single unit central investment strategy. Furthermore, when investing in different countries, financing should be kept in local currency and obtained in local markets to avoid currency exposure.
Operations Excellence The operations plan has three components a) Platform Design b) Manufacturing Design c) Asset Management. Instead of simply focusing on current set of products, Platform Design thinking involves conceptualizing a product platform that can facilitate product innovation and help a company expand into new markets. Best practices in designing technology platforms should be utilized to enable alternative fuels companies to offer new products without significant incremental costs. Manufacturing Design refers to implementing manufacturing best practices right from the beginning. Since studies show that 80% of the costs are locked in at design time – a firm building new alternative energy plants should think about costs from the very inception of the project. In the long run relative cost advantage would be essential for sustainable profitability. Extremely limited financial latitude of a startup dictates a relentless cost management attitude. This implies putting tremendous upfront effort to design manufacturing processes, deploy quality focused best practices, implement superior information technology, and organize manufacturing content that can reduce the total costs. The best hedge against the predatory pricing practices of global oil producers would be to constantly lower alternative fuels production costs through a continuous improvement and efficiency enhancement program. In other words an operational design that can continuously lower costs can provide protection against a sudden and unexpected decline in oil prices while simultaneously increasing the margins.
The third part of Operational Excellence is Asset Management. Asset Management deals with designing effective solution to improve the performance of plants and to maximize the value of assets for the shareholders. This involves achieving maintenance excellence while minimizing the maintenance, repair, and operating supplies costs.
Risk Management By utilizing a portfolio management approach, at the highest level Risk Management aims to manage risks at various points in the alternative fuels value chain. At a tactical level it involves balancing supply and demand at different points in time and across various geographies. For an alternative fuels company, developing a deep understanding of various global markets and rules/regulations would be essential. This competency facilitates transactions and helps guard against lethal risks. Policies, approaches, and procedures should be implemented for credit risk management, trading optimization and quantitative analysis. Depending upon the scope of the operation a hedging operation should be in place at an early stage. Even when dealing with non-tradable long-term contracts, the complexity of the alternative fuels value chain demands that principles of Risk Management should be consistently applied to manage overwhelming exposures.
Supply Chain The success of an Alternative Fuels company is directly dependent upon the successful planning and execution of its supply chain. From managing the input prices to making sure that plants are completed in time to securing an edge in inbound and outbound logistics and distribution networks – Supply Chain strategy would be the critical differentiation between winners and losers.
Early stage oil industry leaders understood the value of supply chain efficiencies and the importance of integrating a supply chain to achieve scale. Rockefeller (Standard Oil) aggressively pursued supply chain efficiencies and built his success on supply chain integration.2 He understood that a well designed supply chain would secure a strategic advantage, facilitate growth and give strategic flexibility during periods of high volatility.
Excellence in supply chain design implies designing an agile supply chain. Such a design gives a company strategic flexibility along with a favorable cost structure. Cost targets in absolute terms are not good enough – an alternative fuels company should aim to achieve a cost structure that is lower than its competitors.
Rapid growth requires a supply chain plan that can be customized for various global implementations. Translational supply chain management would be critical. Supply chain design should be broken down into upstream and downstream components so that it can be effectively managed at both ends of the value chain.
TABLE 1: Alternative Fuels Startup Checklist
Startup Action Checklist
Prepare for rapid growth
Have an internal guideline, plan and model for investment
Know the difference between speculation and investment
Key elements of investment plan should include unbiased analytical rigor, portfolio planning, project financing and real options approach
Implement manufacturing design for total cost management
Deploy a technology platform to enable future product offerings
Deploy manufacturing best practices, supporting information technology and content management to maximize operational efficiency
Implement Asset Management best practices to improve plant performance
Approach value chain with a portfolio management approach
Implement risk management best practices for trading and transaction management
Establish RM/hedging best practices for Upstream, Downstream and Emissions
Deploy flexible and cost competitive supply chains for Upstream and Downstream businesses
Inbound and outbound logistics, distribution and supply chain models should be designed to provide a clear source of advantage
Retention and confidential information leakage problems would be common
Hire best talent but expect some mistakes due to rapid hiring – act fast to fix
Work with a small dedicated leadership team and create a powerful positive culture
Create a strong brand right from the inception
Commit to improve customer service, retention, value, and experience
Partnerships & Alliances
Cultivate and manage suppliers, regulators, channel partners and financing relationships
Organization Having a perfect plan is not enough; a company should specifically focus on building a solid organization capable of executing the plan. In startups or early stage companies, three factors increase the complexity of managing an effective organization:
1) Key knowledge and best talent typically resides in large companies. The work and management styles acquired in large companies are sometimes very different than the ones needed in entrepreneurially driven ventures. Big company way of life could be very different than what people would find in small growth enterprises. Typical startups require tremendous effort, speed of execution, intense exertion, and long work hours.
2) Rapid growth typically involves hasty hiring decisions. Talent discovery under intense pressure is challenging and vulnerable to mistakes. These mistakes are often costly and should be dealt with immediately.
3) Intense competition often invokes predatory talent acquisition practices such as aggressive poaching. These practices lead to talent retention nightmares and increase costs as well as the risk of confidential information leakage.
There is no easy way to handle these issues. Competitive compensation structures, building incentives such as employee options and creating a positive company culture are important contributors for developing employee loyalty. Building a powerful and positive company culture is the most important factor. A culture that allows people to perform their best and unleash their maximum potential provides a much stronger incentive for employees to stay than an attractive compensation package alone.
Marketing Why should an early stage startup care about marketing? A misconception often carried by startups is that marketing implies mega-expensive nationwide advertising campaigns. In reality marketing based outlook simply implies that every process detail of a company takes into account excellence in customer service and orientation. It implies that a company systematically builds customer trust and reduces uncertainty through effective brand management strategies. While factors such as product attributes and price are important – people prefer to do business with companies they trust and are familiar with. Familiarity reduces the transaction cost of doing business and enhances trust.
Recall the three levels of competition from previous discussion. In certain ways, an alternative fuels company is attempting to build three claims:
1) Its first claim is that it is better than all other companies in its technology domain. For example, it is a better biomass based fuels company than all other biomass fuel companies or that it is a better coal-to-liquid company than other coal-to-liquid companies.
2) Its second claim is that its specific technology domain is better than other technology domains. Biomass fuels are better than Coal-to-liquid or the other way around. One way to handle this battle of technology platforms would be achieve effective portfolio diversification by investing in different platforms.
3) Its third claim is that it is a better option than the traditional oil (better for the environment, better for national security, good for economy).
Improving and transforming customer experience, satisfaction, retention and value are critical pieces of managing a business where customers would receive plenty of choices. A combination of technology and training with powerful marketing insight can help create a powerful customer experience while decreasing the overall cost to serve. Keep in mind that alternative fuels industry is a global business and marketing plans must address the region specific challenges.
Partnerships and Alliances Channel partners, financing partners, suppliers and regulators are all important parts of the total value chain of alternative fuels. Managing the regulatory environment, building strong alliances with channel partners, governments, multilateral and bilateral institutions, and suppliers would be a critical part of building a successful alternative fuels company.
Building a successful alternative fuels company is extremely challenging but not impossible. Many will try but only a handful will succeed. Besides having a comprehensive plan, speed of execution and operational precision would define the winners. Knowledge of what needs to get done is just as important as knowledge of what shouldn’t be done. Holistic planning is critical. Given the fast pace of startups, it is all too easy to miss out on important details. If we don’t pay attention to them, these details follow us; they quietly creep behind us and quickly bring us down when we are least aware and well past the initial excitement of launching a company.
Al Naqvi is a seasoned business executive with a strong track record of creating business value for energy companies. With visionary and transformational leadership experience in energy sector, and a career focus in supply chain, finance, planning and business development – Al Naqvi offers state of the art knowledge and uniquely modern understanding of strategies and solutions fit for the sector. He has built and led high-performance teams at multi-billion dollar organizations as well as small and startup enterprises and has a track record of leveraging his entrepreneurial leadership style and broad business background to deliver strong results. His specialization is in strategy and leadership for startups and turnarounds. He has extensive experience in managing global enterprises and building organizations in 35 countries. He assists companies in situations where margin of error is extremely limited, and surgical precision and speed of execution are of paramount importance. His approach is comprehensive and is based upon a powerful focus on shareholder value creation. Al Naqvi has pioneered the concept of Management by Valuation: a disciplined approach to manage a business entity with a strict focus on shareholder value creation. He is the President of Restructuring Inc. He can be reached at 571 426 9016 or [email protected] Fuel Chain is a Restructuring Inc. offering.
1- Benjamin Graham, “The Intelligent Investor: The Classic Text on Value Investing”,
HarperCollins Publishers Inc. 2005. Page 3
2- Daniel Yergin, “The Prize: The Epic Quest for Oil, Money & Power”, Free Press 1991. Concepts Discussed in chapters 2, and 3.