Performance Measurement and Evaluation of Royal Dutch Shell Plc - Case Study Example

Management Control Systems: Performance Measurement and Evaluation of Royal Dutch Shell Plc Businesses in modern times run through elaboratesystems of management and these systems are most necessarily, mechanisms of control over the capacity of the business entity over unforeseen eventualities that the entity encounters during its operation vis-à-vis the business plans it had made during inception. These control systems are expressed in well established indicators of performance and steering in the business process. In the present paper we seek to highlight some of the most accepted control mechanisms in business with a specific focus on Royal Dutch Shell plc, a multi national petroleum business enterprise commonly known as Shell. From the analysis of information on management control indicators gathered from the annual reports of the Shell, we seek to understand the use and relevance of these control mechanisms. Introduction Businesses are conceived at a time when one makes a choice of operation based on certain goals. In a conventional market structure, such goals may be in the form of expected profits and estimated costs of a future date. In order to forecast expected profit and estimated costs one needs to do a lot of cost benefit analysis based on several assumptions. Bob Ryan points out three major forms of assumptions such as capability, situation (state) and facts, as the backbone of all financial planning in a business enterprise. All these assumptions need to be tested against the realities when the review process is undertaken (2004 292). But these assumptions need to be tested against time in order to know whether the realities are in consistency with the assumptions. Control is the process of ensuring that a firm’s activities conform to its plan and that its objectives are achieved. Control systems are measurements and information that assist in determining management control and decision making. It encompasses all the methods and procedures that guide employees towards the achievement of organisational goals and objectives. (Drury, 2001) Management control systems provide a mechanism to suggest whether the business strategies implemented by an organisation benefited them. (Kimmel, Weygandt, & Kisco, 2000) According to Kaplan & Norton (1996), what an organisation cannot measure, the organisation cannot manage. In that sense, a management control system is also a performance measurement system. These measurement systems focus on improving the business processes and achieving breakthrough performance that are most critical for customers as well as shareholders. (Kaplan & Norton, 1996) Such systems may incorporate financial and non-financial systems. However, the focus of this paper is on the financial performance measurement system. Ryan focuses on forecasting as well as reviewing as processes of control. Forecasting is done on the expected profit through price and volume adjustment in forecasting. On the other hand, reviewing is a process to understand the influence of external factors and deviations to the indicators of forecasting through comparison between budgeted items and actual outcomes (Ryan 267-313). Bob Ryan highlights yet another significance of exogenous factors that might have a lot of impact on the performance of the business entity irrespective of the suitable plan. External economy or external reality plays a critical role in changing the situations quite distinctively than the perceived manner. These external realities can be in the form of cost drivers such as supply chain changes, dynamics of labour market conditions and so on and external revenue drivers in the form of market booms, dynamic situations that may provide a comparative advantage etc.. These external realities along with internal constraints such as USP, capacities in the revenue side and operational methods, technology and organizational structure in the cost side, put a lot of challenges in a financing model for the institution. In a business model that is influenced by both external realities and internal constraints need proper control mechanisms in place in order to make suitable arrangements (Page 272) Ryan expresses financial budgeting as a mechanism of organizational control by the management. The budgeting helps in making comparison between the expectations or estimations and the actual outcomes. Ryan further point out different methodologies of budgeting such as plan budgeting, incremental budgeting and zero based budgeting as suitable instruments on management control. (Ryan 301) Another mechanisms of management control as highlighted by Ryan is the variance analysis that is more or less related to budgeting. Variance is the level of dispersion of the reality from the budgeted items. Ryan specifically mentions about price and volume variance as instruments to assess the level of gap between the budgeted and the actual figures. He also describes efficiency and activity variances as well as direct cost variances as significant tools of business control (2004: 303-6). Whatever be the case, the bottom-line of all management control exercise is to predict some future operation and use control mechanisms to check the deviations from the expected outcomes. In the following section we have made an attempt to analyse the relevant issues taking Shell as a case. Shell: A Background The Royal Dutch Shell plc is a global group of petrochemicals and energy based enterprises with around 102,000 employees in more than 100 countries across the world. As per the public relation materials issued by the Shell including its web site it produced around 2 percent of all finished oil products and 3 percent of all gas produced in the world. To be more elaborate, it produces around 3.2 million barrels of gas and oil every day with 45000 shell service stations around the world serving 10 million customers every day. With more than 25 functional refineries across the globe Shell enjoys number one position among fortune 500 companies and second position among the FTSE 250 companies in terms of its market capitalization worth £ 107 billion in 2009. Let us discuss the financial control mechanism adopted by Shell in some most recent years. For the sake of convenience, we have made attempts to study the annual reports of the Royal Dutch Shell plc for the year 2005 and compare the same with the outcomes for the year 2008. Forecasting about Future Risks and Returns for Shell Risk Factors and Controls for their Abatement In the year 2005, the Shell identified a few factors operating as risks in the business ctivities of the company. A list of these risk factors is presented in box-1. Box-1 Identified Risks of the Royal Dutch Shell plc Risk of change in legislation and fiscal and regulatory policies Risks related to currency fluctuations and exchange controls Availability of skilled employees, changing global demographics, declining numbers of science graduates in Europe and the US Risk related to fluctuating prices for oil, natural gas, oil products and chemicals. Risk of information technology failures and resulting disruption to business activities and legal penalties Risk of doing business in politically sensitive or unstable countries Risks related to economic and financial market conditions Risks related to operational hazards, natural disasters, pandemics and breaches of technical integrity Risks related to the impact of climate change which is leading to government action to manage emissions and societal challenge to future oil and gas developments. Ource: Shell Annual Report 2005, p 17 In order to face the risk situations the company adopted a multi dimensional strategy.It insured most of its properties and assets. This provided security to the company in a manner that the uninsured losses for any one incident lessed and unlikely to exceed $400 million. In order to avoid treasury and trading risks the company adheres to several financial instruments, most impotantly, financing of operating companies is structured on a floating-rate basis and, interest rate risk management was discouraged. Since Shell operate in over 140 diverse countries with fairly different internaational standards, the Group companies comply with Group HSE standards through an intensive HSE management system. The costs of prevention, control, abatement or elimination of pollution and waste management is estimated at around $1.2 billion and is a part of the operating costs. Assumptions and Projections With all these risks on paper, the Shell made a productin forecast at the lower end of the range 3.5–3.8 million barrel per day and expected to eventually grow and reach 3.8-4 million barrels per day by 2009 and 4.5–5.0 million arrel per day by 2014. Shell expected a demand growth for natural gas at 2–3% per annum and liquified natural gas(LNG) at 10 percent per annum in the next 10 years. Shell assumed that the two key drivers of growth were consumer resilience to higher energy prices and interest rates, and mild inflationary pressures in prominent industrialised economies The impact of External Realities Not withstanding the assumptions and projections made by the Shell about the robustness of the world demand for oil and energy product, situations changed drammatically. The financial crisis in US sub-prime mortgage market followed by the bankruptcy of a major US investment bank initiated a world economic crisis of a serious nature. In USA GDP growth rate turned negative in the later part of the 2008. Oil prices saw wide ranging volatility in 2008 with at $97 per barrel in January, reaching around $145 in July and then dived to a low of just under $34 per barrel in December. Ll these made Shell to change its strategies to cope with the new situation. Shell selectively strengthened its existing assets and pursued growth via attractive long-term investments. The basic premise under which this new strategy was adopted was that although the present demand situation was shattered due to crisis, it will be coming back to the track in future as long term demand for energy is going to remain intact. (Annual Report 2008, 11) A careful study of the financial informaion provided in the Financial and Operational Informtion 2004-08 reveals interesting trend in the financial indcators over last five years. The financial results do show a slight impact of the severity of the economic crisis it went through. Company made appropriate adjustments owing to its financial control mechanisms that enabled the company to cope with the situation. Performance evaluation Although the total assets of the company increased even in these turbulent years, its total income epecially the same from the operations fell down in the year 2008 (See figure-1 and 2)(Annual Report 2008). Fgure-1: Trends of Total Assets and Equity Attributable to Shareholdres between 2004 and 2008 Source: The Royal Dutch Shell plc 2009 [online] available at < http://www.faoi.shell.com/2008/servicepages/keyfigurescomparison.html > Balance Sheet Data 2004 2005 2006 2007 2008 Total assets (in $ million) 187,446 219,516 235,276 269,470 282,401 Equity attributable to shareholders (in $ million) 86,070 90,924 105,726 123,960 127,285 Balance sheet gearing ratio (1) (in percent) 5.6 1.2 5.6 6.3 5.9 Adjusted gearing ratio (2) (in percent) 20 14.9 14.8 16.6 23.1 (1)   net debt as percentage of total capital (2)   adjusted net debt as percentage of adjusted total capital The income of the Shell did show consistent increase between 2004 and 2007 although there was stagnation between 2005 and 2006. The year 2008 marked a decline in income due to the economic crisis. Figure-2: Statement of Income from Operations Source: The Royal Dutch Shell plc 2009 [online] available at < http://www.faoi.shell.com/2008/servicepages/keyfigurescomparison.html > Statement of Income Data in $ million 2004 2005 2006 2007 2008 Income from continuing operations 19,491 26,568 26,311 31,926 26,476 Income for the period 19,257 26,261 26,311 31,926 26,476 Income attributable to shareholders 18,540 25,311 25,442 31,331 26,277 However, taking this crisis as a short term phenomnon, the company tried to invest more on long term assets and the capital investment went up significantly during 2008. As can be seen from figure-3 the capital investment for the purpose of exploration and production increased exponentially during the year. Figure-3: Statement of Capital Investment in US$ Million Source: The Royal Dutch Shell plc 2009 [online] available at < http://www.faoi.shell.com/2008/servicepages/keyfigurescomparison.html > Capital Investment (1) in $ million 2004 2005 2006 2007 2008 Exploration & Production 9,568 11,772 17,079 15,919 24,718 Gas & Power 1,652 1,656 2,351 3,532 4,346 Oil Sands 140 274 865 1,931 3,124 Oil Products 2,823 2,844 3,457 3,856 3,917 Chemicals 868 599 877 1,419 2,097 Corporate 224 291 267 415 242 In terms of returns, the company althugh encountered a decline in the basic earning per share; it could retain the divident it would give to its investors. Figure-4: Returns per Share Source: The Royal Dutch Shell plc 2009 [online] available at < http://www.faoi.shell.com/2008/servicepages/keyfigurescomparison.html > Per Share Data in $ 2004 2005 2006 2007 2008 Basic earnings per €0.07 ordinary share 2.74 3.79 3.97 5   Diluted earnings per €0.07 ordinary share 2.74 3.78 3.95 4.99   Dividends (1) 1.07 1.13 1.27 1.44   (1)  From 2007 onwards, dividends are declared in US dollars. 2005 and 2006 dividends were declared in euros and translated, for comparison purposes, to US dollars (based on the dollar dividend of American Depositary Receipts converted to ordinary shares in the applicable period). (2)  Comprises Royal Dutch interim dividend of €0.75 made payable in September 2004 and a second interim dividend of €1.04 made payable in March 2005 as well as a Shell Transport interim dividend of 6.25 pence and a second interim dividend of 10.7 pence that are used to calculate the equivalent dividend on a Royal Dutch Shell basis. Problems with the Shell Group However, all is not that rosy with the Shell. While we have highlighted some of the brighter sides of the operation of the Royal Dutch Shell plc, the group of companies has been involved in a number of controversies as well. The safety standards of Shell have been recorded as amongst the worst in the world in the similar trade. As per Table-1 below, among comparable groups, the number of incidents of death is not only highest in case of Shell but also there seem to have no action taken in reducing the same (WS Journal 2007). In 2005 also, Shell was fined a sum of £ 0.9 million for a major gas leak tragedy that caused death of some workers in its Brent Bravo platform (BBC 2005). The Shell has also been accused of employing thousands of slave and forced labourers during WWII period (Shell Group 2004). Not only that, the company has also been alledged of corruption and intellectual theft. A US District court did verdict against Shell of infringement of patents of other companies in 2005 (The Shell Group 2005). Table-1 World wide Death of employees of Shell and comparable Oil Refineries. Source: Wall Street Journal (2007) Figure-4: Use of Forced labourer in Shell Refineries Source: Shell Group, 10 May 2004 Thus, while on making money, the goup has made all efforts to use its control instruments to generate wealth , in terms of ethics and the rationality norms, the group of companied fail to address some critical issues. This indicates a failure on part of the Shell to comply with the basic norms of the business operation. List of References BBC News (27 April, 2005) Shell fined £900,000 over deaths [online] http://news.bbc.co.uk/2/hi/uk_news/scotland/4490187.stm >[Accessed on 14th October 2009] Drury, C. (2001). Management Accounting for Business Decisions (2nd ed.). London: Thomson Learning. John Donovan (Dec 5th, 2008) Shell, Saudi Arabia, Arms-for-Oil, Corruption, & Radioactive Contamination [online] < http://royaldutchshellplc.com/2008/12/05/shell-saudi-arabia-arms-for-oil-corruption-radioactive-contamination/ > [Accessed on 15th October 2009] Kaplan, R. S., & Norton, D. P. (1996). The Balanced Scorecard: Translating Strategy into Action. Boston: Harvard Business School Press. Kimmel, P., Weygandt, J., & Kisco, D. (2000). Financial Accounting (2nd ed.). New York: Wiley. Ryan, Bob (2004) Finance and Accounting for Business, [Online] available from < http://books.google.co.in/books?id=o6htAepmtC4C&pg=PT609&lpg=PT609&dq=Bob+Ryan+Finance+and+Accounting+for+Business&source=bl&ots=kiteahsp6O&sig=jPPvdmRW8k0aWGWjS6cM-gbeE-E&hl=en&ei=rrLNSqqxKp706gPLw6X1AQ&sa=X&oi=book_result&ct=result&resnum=1#v=onepage&q=&f=false > [accessed 3rd October 2009] The Royal Dutch Shell plc. (2009) The History of Shell [online] < http://www.shell.com/home/content/aboutshell/who_we_are/our_history/1980s_to_new_century/1980s_to_new_century_22112006.html > [Accessed 4th October 2009) The Royal Dutch Shell plc. (2009) Financial and Operational Informations: A Fact Book, [online] < http://www.faoi.shell.com/2008/servicepages/welcome.html > [Accessed 4th October 2009) The Royal Dutch Shell plc. (2009) Annual Report 2008 [online] < http://www.annualreview.shell.com/2008/servicepages/downloads/files/entire_shell_review_08.pdf > [Accessed 4th October 2009) The Royal Dutch Shell plc. (2006) Annual Report 2005[online] < http://www-static.shell.com/static/investor/downloads/financial_information/reports/2005/2005_annual_review.pdf > [Accessed 4th October 2009) The Shell Group (10 May 2004) Class Action Statement By Us Law Firm Cohen, Milstein, Hausfield & Toll P.L.L.C: Slave Labor At Royal/Dutch Shell Group [Online] < http://shell2004.com/2004%20Documents/rsodds/slavelabormay.htm > Accessed 15th October 2009 The Shell Group (2005) United States Court of Appeals for the Federal Circuit in Union Carbide Chemicals & Plastics Technology Corporation And Union Carbide Corporation, Vs Shell Oil Company, Shell Chemical Company, [online] < http://www.shell2004.com/2005%20docs/UnionCarbidevShell%20(2).pdf > [Accessed on 14th October 2009] Wall Street Journal (2007) FT Data: Is Shell’s Record Worse Than BP’s? [online] < http://blogs.wsj.com/environmentalcapital/2007/03/20/ft-compares-deaths-at-oil-majors/ > [Accessed on 14th October 2009] Read More