International Experience in Supplier Development 69221 The World Bank April 2008 Contents 1. Overview of the Different Rationales for Supplier Development 2. Supplier Development Methods Applied Specifically to Extractive Industries 3. Approaches Used in the Non-Extractive Sectors 4. Some Characteristics of Successful Supplier Development 5. Current Local Content Initiatives in Kazakhstan 6. Conclusions 1 1. Overview of the Different Rationales for Supplier Development Countries may have different reasons for engaging in Supplier Development. For the majority. the basic arguments such as the Economic Multiplier will be seen as compelling. That is, that the revenue from sub contractor’s activities supplying foreign investors may have a bigger impact on the economy than the activity of the foreign investor. For example, in 2003, ExxonMobil group recorded $70.7bn in contributions to governments and $132.7bn to suppliers.1 The use of local suppliers/contractors will increase local employment, skills, and may even lead to technology transfer and improved capital provision for local small and medium sized enterprises (SMEs). To an extent, the trend towards global strategic sourcing, highly prevalent in the oil industry, may work against the use of local suppliers. In fact, this trend has favoured low cost/high quality in countries such as China, India and Singapore. In the oil and gas sectors the cost of brokering a deal involving Transnational Corporations (TNCs) and their primary or first tier contractors may be high. For example, in Trinidad and Tobago, BP calculated the cost of having their lead contractor enter into a joint venture on the Cannonball gas field with a local contractors at $3.3 million above the cost of the same work in Houston. 2 While there are then technical and financial constraints on local content, the value of the technology transfer should be far greater than any initial cost implication. It is too simplistic to evaluate Supplier Development in terms of immediate contract value capacity and competence building must be considered also the transferability of the newly gained competences to other sectors and activities.3 Often supplier development is used as a means of reducing social imbalance and not as an economic tool in the strict sense. For example, in the gold mines of South Africa, a voluntary code has been introduced. This uses a charter scorecard which ensures that development opportunities are provided for “Traditionally Disadvantaged South Africans� who predominate in the mining industry though seldom rise to the level of engineer or manager. Clearly goals other than the basic economic ones are being pursued here. 2. Methods Applied Specifically to Extractive Industries Many of the approaches to supplier development currently in use are dependent upon resources from Trans National Corporations often match funded by donors. One format for such co-funded projects are the creation of centres of excellence staffed by local people. A good example of this approach would be the FEED centre in Port Harcourt Nigeria. This is Shell’s front end engineering 1 Source www.exxonmobil.com/corporate/files/corporate/Charts_and_tables.pdf 2 Source www.bp.com/genericarticle.do?catagoryld=2012451&contentld=7002543 3 When designing supplier development programmes in sectors such as oil and gas networking events for SMEs should be built in as these can lead to the formation of bidding groups for contracts and embryonic clusters. 2 support centre and cost some $15 million. This provision is further enhanced by a $30 million revolving credit facility provided by IFC and Diamond Bank. In 2006, SPDC handed over management of two Lonestar Rigs to local contractors. This increased the capacity of the Nigerian company which had shown great potential. Between 2004 and 2006 well engineering local content rose markedly from 46 per cent to 56 per cent in the same period 85 percent of drilling fluid contracts and 75 percent of drilling tool supplies was sourced locally. This was in part due to the Shell commitment to Nigerian content which may have derived from the Nigerian Content Directive which is quite prescriptive about local content. In Trinidad and Tobago, BP are positively discriminating in favour of local suppliers and absorbing a $9 million premium to encourage local content in platform engineering. 4 The adoption of supplier development programmes by Operators can be achieved in a number of ways by Governments. In the case of Trinidad and Tobago, contractors are required to contract local firms, in Nigeria Legislation is in place to ensure local content, in Brazil and Malaysia, state organisations set specific targets for local content. Many producing countries are the subject of WTO observers. This will undoubtedly impact the ability to subsidise local suppliers to help them to become competitive.5 Whilst this interventionist approach to supplier development has proved effective in many ways, it is centred on the immediate needs of specific companies this may prevent the development of transferable skills and capacities which might give access to other markets. There is also the question of sustainability. Many TNCs or their suppliers do not want to deal with low order SME suppliers and so the development support tends to go to the already successful. At the opposite end of the spectrum is the approach taken by the United Kingdom and the Norwegian government to the extractive industry in the 1970’s. Basically this was in the form of observation and monitoring of the North Sea Operators activities and then giving training and development to local companies to enable them to tender for contracts with the Operators. Whilst the impact of this approach was somewhat limited it did satisfy the WTO Trade Related Investment Measures (TRIMS). Additionally, it created scope for both countries to introduce major educational projects to supply suitable graduates to the Operators. Further, in this early period, some of the best non-aggregated metrics for local content were established by the UK’s Offshore Supplies Office. The findings of an Aberdeen University study confirmed that most supplies were coming from US based affiliates of the Operators whilst non-core provision such as catering and insurance were sourced locally6 this remains a feature of this sector to the present day. If a mandatory or voluntary code for local content is to be employed, limits placed on local content by qualification and certification must be taken into account. Problems can often be overcome by dealing not at the Operator level but at the main contractor level. 4 Source http://www.wbcsd.org/web/publications/case/bptt_full_case_web.pdf 5 Source: http://archive.revenuewatch.org/reports/Inter-sectoral%20Linkages%20and%20Local%20Content%20in%20 6 Reported in Wade Locke, and Strategic Concepts Inc April 2004 page 7 “Exploring Issues Related to Local Benefit Capture. Discussion paper for Petroleum Research Atlantic Canada 3 A second approach which is common is the use of Regional Development Agencies, or similar bodies, is to develop SMEs by enhancing their technical skills, managerial competence and financial acumen. The United Kingdom is an example of this approach using the Business Link network to deliver training and consultancy to smaller enterprises. Areas of need are identified by the Regional Development Agencies and the whole programme is coordinated by the Department of Trade and Industry. Similar programmes are run throughout the EU although the delivering agency may be different, say Chambers of Commerce or Regional Government. This form of Supplier Development is supported by networking events such as Regional Promotion and Trade Fairs. There are some inherent difficulties with this approach. Robust metrics for measurement of the return on public money spent in this way are very difficult to define. The period of time over which one should assess the impact of the initiative is unclear. 7 This inevitably leads to misinformation. The business and technical needs analysis for the SMEs can often be inaccurate and therefore lead to wrongly targeted development. Very often, the SME is not aware of its development needs and may be equally unfocused. 8 The last point on this “blanket� approach is cost. The approach is very expensive requiring many staff and Regional facilities from which they can operate. 3. Approaches Used in the Non-Extractive Sectors There are variations on these two approaches which are often hybrids of the two. In Costa Rica, the sourcing department of the investment promotion agency (IPA) is made up of highly qualified engineers who provide local sourcing solution for inward investors. Not only does this body find local suppliers, but it negotiates with inward investors on training and development needs and provision. This quasi governmental IPA (its home is in the Ministry of industry and Economics) was very influential in the decision by Intel to locate in Costa Rica. The most successful hybrid programme to date was undoubtedly that developed in Ireland where and economic revolution was achieved in slightly over a decade. Between 1985 and 1996 major growth was achieved through supplier development in several sectors: plastics, metalwork, tooling, pressed parts, plating, electronic sub assembly, cabling, instrumentation electronic testing and mechanical engineering services. All of these were new sectors for the Irish Republic. Local share of multinational purchases rose from 5% to 22% of total TNC purchases. This represents an increase in local procurement of 260%. The number of SMEs participating went up from 30 in the pilot scheme to 300. Many central and eastern European countries have followed this approach in several variants. The Czech model shown in Figure 1 is typical of this highly focused hybrid approach. There are 7 The business (contract) cycle varies sector to sector. When dealing with Japanese Automotive companies the enquiry to contract period can be as long as three years. In the Oil and Gas sector tender periods are often only a matter of months sometimes weeks. 8 Varney and Braun (KPMG) work in the Czech Republic and later in Serbia showed clearly that companies did not see their own deficiencies in terms of suitability to become suppliers to TNCs. (Knowledge Transfer Conference Istanbul 2005 4 three key stakeholders in this method. Trans-national (or “multinational�) companies, the Government of the country and the SME community working in the selected sectors for the Supplier Development Programme. These three act together to determine what issues are critical for local content, how shortfalls in competence from SMEs can be addressed and what barriers in the business environment need to be overcome to ensure that local content increases. In these respects, this is identical to the Irish approach. Figure 1 Supplier Development Programme Multinational Companies Database First Business Follow up Company Short-term Detailed Business of Czech Review Review Selection Action Plan Action Plan Opportunities suppliers (2 days) (1 day) Supplier Development Support mentoring consultancy action workshops support networking meet-the-buyer Most importantly this approach creates opportunities for third and fourth tier suppliers to have contact with TNCs so that they can present themselves as good potential members of transnational supply chains. In addition to this, linkages are made between SMEs and universities to provide technical assistance, technology transfer is encouraged and SMEs are encouraged and assisted to seek other markets for their products or to apply their technologies gains from the programme in other sectors including export. The Serbian programme which is another variation upon the Irish model, is specifically designed to improve export performance by SMEs through TNCs and to reduce imports at the same time. 9 Both the Czech and the Serbian Programmes have been highly successful. 4. Some Characteristics of Successful Supplier Development  Financial products- variety of loans, leasing, venture capital, credit guarantee funds, micro loans, export credit insurance etc.,  Joint venture support  Management – guidance on business and financial planning, tendering advice, regulatory navigation advice, marketing  Technical support particularly on quality standards, lean manufacturing, etc. 9 Within eighteen months of the completion of the Czech programme $46 million dollars worth of additional business attributable to Supplier Development was achieved. In Serbia $30 million of contract were awarded to companies participating in Supplier Development before the end of the pilot. 5  Improved human capital through human resources department  Matching and merging business to business networks.  Meet the buyer events  Sourcing database to match local suppliers with investors10  Introductions of participant companies for joint tendering and possible cluster initiation  Development of national quality standards 5. Current Local Content Initiatives in Kazakhstan Legislation has been passed for local content encouragement and the KazContract Agency has been in existence since 2002 and is charged with the development of local content. There is also the Kazakh Content Increase Programme, a partnership between government sponsored vocational and enterprise support programmes and a company sponsored competency development initiative between the Kazakhstan government and Karachaganak Petroleum Operating B.V. (a consortium between the BG Group, Eni, Chevron and LUKOIL) 11 is aimed at industrial infrastructure projects (especially industrial estates and export zones) and oil company investments to support local suppliers. In these ways the Government has encouraged local content in the oil and gas industry and as discussed in previous sections of this note has met with some success but perhaps less than Nigeria or Trinidad and Tobago, Timor-Leste. Lessons can be drawn from other countries, Malaysia, Timor and others shown in Appendix 1 . 6. Conclusions Macro solutions have been tried to improve local content in Kazakhstan with varying degrees of success. Many of the reasons cited for not using local suppliers are addressed by the hybrid micro approach described here. We propose that a hybrid supplier development programme pilot should be introduced in Kazakhstan which would improve local content by improving the competitiveness of Kazakhstani SMEs by increasing competency in both technical and managerial aspects of business. In addition, a pilot scheme will introduce networking within supply chains which often leads to the most sustainable forms of clusters. 12 There are numerous spin off benefits which only come from this approach. Some of these are links between smaller businesses and University researchers, technology sharing between SME, direct contact with TNCs. 10 CzechInvest have a field in their database which identifies companies looking for joint venture partners. 11 BG 2002Social and Environment Repor-Case studies www.bggroup.com 12 ACStyria is a very fine example of this effect. 6 Table 1: Overview of International Supplier Development Initiatives The United Trinidad and Economic criteria Norway Denmark Australia Brazil Malaysia Nigeria Angola Kingdom Tobago Accountability 1970s: establishment of 1965: Norwegian No local preference or Australia has no local 1953: Petrobras is created 1974: the state oil Since 1999: gvt. has 1976: the state oil 2004: gvt. adopted the the Offshore Supplies Petroleum Law enacted; purchasing policy in content policy in and granted exploration & company, Petronas, is taken action to increase company, Sonangol, is Local Content and Local Office (OSO). emphasis on joint place, yet a single place, yet operators production licenses established. Petronas local content in domestic established. Sonangol Participation Framework ventures, gvt. equity company (DUC) was are encouraged to throughout Brazil. mid- has been key vehicle to oil & gas industry. Local made exclusive Policy for the energy participation &local provided exclusive use local suppliers & 1990s: Petrobras' monopoly foster local content; it Business concessionaire for oil sector, along its entire content. 1970s: license of North Sea oil manufacturers. 1984: is eliminated and the set registries of Development/Global exploration in Angola; value added chain. establishment of state oil exploration. the Industrial National Petroleum Agency licensed oil & gas local Procurement Unit was allowed to enter into company Statoil & Nirsk Supplies Office (ISO) (ANP) is established to companies. established. 1997: associations w/foreign Hydro. 1972: is established to act regulate petroleum establishment of the companies on oil establishment of Goods & as facilitator for activities in Brazil and Onne Oil & Gas Free exploration, Services Office (GSO). project developers & ensure local benefits of oil Zone. development, & local industry. 2001: projects in a context of production the Australian competitive leasing system Industry Participation of oil blocs. Framework states gvt. policies to support local content in large investment projects. Metric/Definition 1960s: discretionary 1972: Article 54 of Royal The Danish Energy ANP specifies detailed local Petronas' monitoring of Local Business Since mid-1990s, Local content is defined licensing of oil blocs. Decree of 1972 directed Administration does content percentages on the local companies Development/Global Sonangol underwent in terms of ownership, 1970s: OSO monitoring gvt. to support local not calculate capture purchase of goods and defined by (i) local Procurement Unit restructuring & became control, decision- of direction of trade of oil companies provided they rates or levels of local services for exploration & equity participation; (ii) monitors (i) awarding of holding with making, and preferential companies (value of were competitive in prices, content in industry. development of on-shore employment creation & contracts to local firms; autonomous access to financing. contracts w/impact on quality, schedule & and off-shore operations. use of local inputs (ii) farming out of oil subsidiaries. Sonangol International companies local employment & service. 1990s: Article 54 Production Sharing fields to Nigerian oil has currently pivotal role are required to commit valued added creation in was rendered invalid as Contracts (PSCs) with companies; (iii) in the supply & service to contracting local manufacturing & sub- Norway accessed the EU; Petronas' participation technology transfer sector of the local oil firms. Education & contracting). 1990s: emphasis changed to include initiatives; (iv) local industry. training of workers is Entry into EU refocus on support intl. expansion of recommendations on content development critical element under development of export local oil industry. the purchase of goods fairs/events. policy framework. markets. & services locally to maximum extent possible. Efficiency Considerations OSO focused on ensuring Initial conditions were Large platforms & Reports from the US 1970s: Petrobras used Malaysia has developed In cooperation with Numerous Production Gvt. has engaged a competitive domestic favorable. When oil was structures usually Department of numerous foreign a considerable supply international oil Sharing Arrangements business community in industry through range discovered (1960s), supplied by European Commerce on contractors in early years of industry that currently companies the gvt. is w/participation of world supporting broad based of programs offered to Norway had considerable companies; Danish Australia's Oil & Gas off-shore development. In competes for projects trying to meet efficiency oil majors and Sonangol job training efforts, local contractors. industrial technical suppliers strong in Field Equipment the 1980s the focus was on around the world. oil producing standards & are currently in place. small business capacity capacity. Statoil was services and suppliers Market are optimistic development of domestic local content targets on building & technology pivotal on technology of medium-size on local content technology using licensing the use of local development. transfer and personnel structures & equipment shares in projects. agreements w/intl. technology. training. suppliers. Information OSO was an independent GSO was an independent The local oil sector was Local content initiatives Sonangol has Gvt. has Dissemination agency set up expressly agency set up expressly to kept closed for decades; are widely known. established in its establisheddatabase on to help domestic firms in help domestic firms in oil Brazilian labor & companies webpage a resource link projects' status and oil sector. sector. were hedged while on opportunities for local opportunities for local developing skills suppliers. suppliers. &capabilities. Acknowledgement of Limited. Govt. actively focused on Petrobras has an Limited. Sonangol's business Gvt. strategy is also spin-off effects into non- in-country research & aggressive investment interests are in oil & focused on the oil economy technology development program in oil production, non-oil economy. development of in general. but also high-tech. opportunities in the refineries, pipelines, etc. non-oil economy. Sources: Appendix II, Alvesson et. al. (2003), INTSOK (2003), Neff (2005), and Wade Locke (2004). 7