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ROYAL DUTCH/SHELL LOOKED AT THE FUTURE AND DIDN’T LIKE THE VIEW

(LOOK BACK AT AN ARTICLE PUBLISHED DURING THE LAST TRANSFORMATION AT SHELL)

WHY IS THE WORLD’S MOST PROFITABLE COMPANY TURNING ITSELF INSIDE OUT? ROYAL DUTCH/SHELL LOOKED AT THE FUTURE AND DIDN’T LIKE THE VIEW. NOW IT IS CHANGING EVERYTHING FROM THE WAY ITS MANAGERS ACT TO THE WAY IT DOES BUSINESS.

By JANET GUYON REPORTER ASSOCIATE WILTON WOODS
August 4, 1997

(FORTUNE Magazine) – By all the usual measures, Royal Dutch/Shell should be sitting on top of the world. For the third year in a row it leads the Global 500 in total profits, having earned a staggering $8.9 billion in 1996. The company’s stock has been shining too. Since 1992 Shell has pumped out a 20% average annual total return. All of which makes it surprising to learn that this prosperous behemoth is, in fact, suffering a soul-shattering midlife crisis.

Like all such crises, this one isn’t just about money. Sure, Shell’s return on invested capital–a key measurement in the oil industry–has been lackluster. Says Shawn Reynolds, oil analyst at Lehman Brothers in London: “They aren’t generating the profits to justify the stock price.” And yes, the oil giant is sitting on $12.4 billion in cash, which it has no clue how to invest. But the real issue is that this $128-billion-a-year company is dissatisfied with what it has been–and no longer sure what it wants to be.

What Shell indisputably is, of course, is big. It operates in 130 countries around the world and controls every aspect of oil production from the ground to the gas pump. With headquarters in both London and The Hague, the company oversees 101,000 employees, 54 refineries, and 47,000 gas stations. (Shell is one group but two publicly traded companies: Royal Dutch Petroleum in The Hague owns 60% of the group, while London-based Shell Transport & Trading controls 40%.)

Shell is also an insular company, saddled with introverted control freaks, a byzantine organizational structure, and a controversial public image. Many of its managers rarely talk to the rank and file. The top brass at headquarters constantly wrestle for power with the 100 or so influential country CEOs who run local operations. And then there’s the bad press. The company’s association a few years back with the Nigerian dictatorship that executed environmental activist Ken Saro-Wiwa sparked a global uproar that continues to haunt it.

That’s the personality Shell Chairman Cornelius Herkstroter says he would like to shed. The stolid Calvinist, who allowed his company to open up to FORTUNE in a rare series of top-level interviews, is leading his company through its most dramatic overhaul since 1959. That was when McKinsey designed the “matrix” structure that catapulted Shell to the head of the oil pack. A most unlikely revolutionary, Herkstroter wants to create a fast, flexible, environmentally aware organization that runs more efficiently, is more innovative, and is capable of moving Shell into profitable new businesses.

To get there, Herkstroter, aided by an army of American consultants, is, in effect, putting his executives on the psychiatrist’s couch. He’s asked scores of Shell employees to run the gamut of New Age consulting. They’ve helped each other climb walls in the freezing Dutch rain. They’ve dug dirt at low-income housing projects and made videotapes of themselves walking around blindfolded. They’ve tracked their time to figure out whether they’re adding any value. They’ve even taken Myers-Briggs personality tests to see who fits in at the new Shell and who doesn’t.

If this grand experiment works, Shell executives say they can double profits to more than $17 billion by 2001. But getting there won’t be easy. It means that everything–even the most hallowed of Shell’s practices, beliefs, and traditions–is up for grabs. “I don’t think any idea or thought right now is untouchable,” says Maarten van den Bergh, a member of Shell’s six-man committee of managing directors, or CMD. Adds Mac McDonald, who runs Shell’s in-house bevy of change agents called LEAP (for Leadership and Performance Operations): “Transformation is messy. We don’t have this wonderful plan. The company has put growth and profitability numbers on the table. If we don’t change our leadership style, our behaviors and mindsets, we aren’t going to be able to get the results.”

It certainly won’t get them soon. This kind of monumental reinvention takes time–lots of time. It’s only human nature to resist change, and from executives to oil riggers many Shell employees will do just that. Noel Tichy, one of the first American consultants to arrive on the scene, says Shell is only at the beginning of the second act of a three-act play. “Act 1 is recognizing the need for change, Act 2 is crafting the vision, and Act 3 is reactivating the organization,” says Tichy, who teaches organizational behavior at the University of Michigan. “The transformation of a large entity like this is a five- to ten-year journey.” This is IBM before Gerstner, GE before Welch, Coke before Goizueta.

A NEW CULTURE. The ground began to shift in May 1994, when Herkstroter, who had taken over as chairman the year before, called an unprecedented gathering of his top 50 men. (And yes, they were all men.) Assembled at a 17th-century English manor called Hartwell House in Buckinghamshire, these global executives knew one another but had never before met as a group. Herkstroter, an accountant among Shell’s sea of engineers, wanted to know why the company’s return on average capital employed–the main measure of financial success in the oil business–had dropped to 7.9%, far below Shell’s cost of capital and well behind the 9.3% returns being generated on average by the other major oil companies. He was also disturbed that for the past ten years, Shell chairmen had merely expressed regret in their letters to shareholders about missing financial targets.

At Hartwell House, Herkstroter discovered that Shell’s mediocre financial performance was directly related to its inbred corporate culture. “We were bureaucratic, inward looking, complacent, self-satisfied, arrogant,” says Sir John Jennings, a Shell director and former vice chairman: “We tolerated our own underperformance. We were technocentric and insufficiently entrepreneurial.”

Two public events that occurred a year after the Hartwell meeting silenced any lingering doubts about the need to change. Shell’s efforts to sink Brent Spar, an abandoned offshore oil-storage buoy, got derailed by Greenpeace in Germany, which mounted such a well-orchestrated public relations blitz that Shell’s gasoline sales plunged by 50% at some German stations. A few months later the Nigerians executed Ken Saro-Wiwa, a prominent Nigerian author who had protested Shell’s poor environmental record in his country. As a partner with the military dictatorship in Nigeria that props itself up with oil revenues, Shell took lots of heat.

“We had to look deeply at ourselves and say, ‘Have we got everything right?'” says Mark Moody-Stuart, a managing director who is in line to succeed Herkstroter when he retires next year. “Previously, if you went to your golf club or church and said, ‘I work for Shell,’ you’d get a warm glow. In some parts of the world that changed a bit.” In a radical departure from its past, Shell decided to publicly report its environmental record and defend human rights wherever it operates. “That is extremely significant,” says Anne Simpson, director of Britain’s Pensions and Investment Research Consultants. “They are now going to have to figure out what that means in practice” (see box).

Shell’s peculiar governance structure makes it particularly hard for Herkstroter to drive change. Technically, he isn’t chairman of the corporation but of the CMD, Shell’s top committee–a first among equals. “Herkstroter is not in command in the sense that [AlliedSignal’s] Larry Bossidy is in command,” says Steve Miller, an American who is the only non-Anglo-Dutch member of the CMD. The Dutchman must cajole by force of personality–and charismatic he isn’t. “He is one of the most courageous and intelligent people that I know,” says Robert Walvis, head of planning, environment, and external affairs. “But if you had to choose between Tom Peters and Herkstroter to address a group of sales people, I’d choose Tom Peters.”

Herkstroter wasn’t available to be interviewed for this article; he was hospitalized in May for pneumonia and is still recovering. Other CMD members and executives describe him as a private, Old World personality who likes to communicate by document and is deeply committed to making Shell more open to outside ideas. “He’s Shell’s Gorbachev,” says Philip H. Mirvis, an organizational consultant working with Tichy.

What kind of company chooses a Herkstroter? One with a long history in Europe, where men with too much power have caused world wars. Shell executives say that archive films showing the birthday celebrations of Henri Deterding, Shell’s last strong, single master, are eerily reminiscent of Hitler’s rallies. Indeed, Deterding harbored Nazi sympathies; had he not retired from Shell in 1936, the company’s subsequent history might have been different. “We in Europe have always had a fear of the strong man,” says Shell managing director van den Bergh.

It’s not surprising, given Shell’s history, that its culture tends to punish those who don’t seek a consensus. When David Varney, a director in charge of refining and retailing in Europe, tried to force changes on Shell’s European CEOs last year, he met resistance on all fronts. “He jumped in and dictated rather than seeking agreement,” says Chris Fay, the tall, powerfully built chief executive of Shell U.K. A few months later, frustrated and cognizant that his style, which earned him the nickname “Napoleon,” would never get him to the CMD, Varney quit to take a job heading BG (formerly British Gas). “I loved him. He was a grenade thrower, totally unconventional,” says one former Shell executive.

Without a strong single visionary, like GE’s Jack Welch or Microsoft’s Bill Gates, how will Shell get vision? CMD members say they will work it out among themselves. “No single mortal,” says Moody-Stuart, “is blessed with the sort of personal capacity needed to lead this company single-handedly. Throughout the organization, everyone works in teams. You get very robust decisions that are looked at from many angles.” So why then does Shell need the brains of so many consultants? It hired Noel Tichy, who brought in Larry Selden, a Columbia business school professor, and Mirvis, a balding, bearded fellow with a 1960s sensibility. Also on the list: Coopers & Lybrand, McKinsey, Boston Consulting Group, and LEAP, Shell’s own internal consultants.

This army has been putting Shell managers through a slew of workshops. In early February, teams from the gasoline retailing business in Thailand, Chile, Scandinavia, and France spent six hours in a bitter Dutch downpour building rope bridges, dragging one another through spider webs of rope, and helping one another climb over 20-foot walls.

The Shell managers especially liked Larry Selden. He teaches people to track their time and figure out whether what they’re doing contributes directly to growth of both returns and gross margins. Selden calls this “dot movement,” a phrase he has trademarked and which means moving the dot on a graph of growth and returns to the northeast. “The model is very powerful,” says Luc Minguet, Shell’s retail manager in France. “It’s the first time I’ve see such a link between the conceptual and the practical. And I realized I was using my time very poorly.”

In a particularly revealing exercise, the top 100 Shell executives in May took the Myers-Briggs personality test, a widely used management tool that classifies people according to 16 psychological types. Interestingly, of its top 100 managers, Shell discovered that 86% are “thinkers,” people who make decisions based on logic and objective analysis. Of the six-man CMD, 60% are on the opposite scale. They are “feelers” who make decisions based on values and subjective evaluation. No wonder all those “thinkers” had such a hard time understanding the emotion behind Nigeria and Brent Spar. And no wonder the CMD gets frustrated with the inability of the lower ranks to grasp the need for change.

While all this corporate therapy may help Shell in the long run, it is sparking debate and outright revolt in the here and now. Some say the pace of change is so overwhelming that the place is on the verge of chaos. Meanwhile, many wonder if, as lifelong Shell men, they can really change. Myers-Briggs, says Walvis, the planning director, “is one of those self-improvement tools that, of course, is completely wasted on 50-year-old males.” He may have a point. Many say the most transformed executive is Hans van Luijk, Shell’s chief research and technical director of the downstream business (refineries and gas stations). “This guy was a cold technocrat,” says consultant Mirvis. “Now he’s warm and a leader.” Maybe, but van Luijk himself resists notions that he has changed: “I am not a fool,” he says. “If everyone around me speaks Russian, I speak Russian. But emotionally, I still struggle with these silly games on leadership.”

A NEW ORGANIZATION. Chairman Herkstroter is hoping all this cultural cacophony will let Shell get the most out of its new organizational structure. Until now, Shell’s decentralized corporate structure had been key to its success. Its two headquarters make up an oxymoron called “the Centre,” where the CMD oversees Shell’s empire, and where services such as research and planning help guide the group’s hundreds of local operating companies. The real action isn’t at the Centre, however, but at Shell’s 100 or so operating companies spread around the globe. Headed by a single strong CEO, each company is expert at running everything from exploration to gasoline retailing. These local chieftains act more as if they’re running independent local oil companies. Often they form deep relationships with their host governments–in Britain Shell men get knighted. It’s our “essential localness,” says Shell director Moody-Stuart, “that helped Shell grow and overtake Exxon.”

But decentralization has its costs. Shell executives themselves can pinpoint some stupid habits it engenders. Like creating loyalty cards–the oil company equivalent of frequent-flier cards–that are good only in one country. Or trucking chemicals from France to Germany just because the customer is French.

At that 1994 Hartwell House meeting, Shell discovered that the relationship between the CEOs and the Centre had decayed. Loaded with risk-averse bureaucrats, the Centre was taking months to approve budgets; local CEOs, meanwhile, weren’t meeting their targets. So fast and furious did the accusations fly that in presenting the problem to the group, Shell exploration and production director Robert Sprague tossed a blank transparency on the overhead projector. “I don’t know what to report,” he said. “This issue is really a mess.”

After that the CMD called in McKinsey to revamp the central bureaucracy. By mid-1995, McKinsey came up with a plan that cut 30% of the Centre’s 3,000 jobs and flattened the matrix. Many regional and functional jobs went out the door, and five committees sprang up to keep a global handle on Shell’s major operations: exploration and production; oil products; gas and coal; chemicals; and central staff functions, such as legal and personnel. Each committee had a CMD member assigned to it.

Alarmed at the grab for power from the Centre, the country CEOs revolted. The so-called barons of Europe, who run some of Shell’s biggest operations, would in no way be reduced to cocktail chairmen who glad-hand government officials. “The McKinsey study was interpreted by some that from now on we’ll run the business from the Centre,” says Jan Slechte, the president of Shell Netherlands who retired this July. “That concept to me would subtract value rather than add value.”

Maybe so. But Shell is getting new efficiencies from looking at its businesses globally. It’s paying lower prices by buying stuff like gasoline additives as a single giant instead of a bunch of little firms. The Centre’s full control over chemicals, for instance, led Shell to put a new polymer plant closer to customers in Geismar, La., instead of near the existing plant in Britain. Two years ago that plant automatically would have been added to the U.K. fiefdom. Some of this is showing up in the company’s financials. Return on capital has increased to 11.9% from that anemic 7.9% four years ago.

A NEW STRATEGY. Now that the efficiency drive is well under way, Shell must turn its attention to its most pressing problem: growth. In June, Herkstroter exhorted the troops to come up with investment ideas for the company’s $12.4 billion cash hoard. “The growing ‘cash mountain’ is an indictment of our collective failure to bring forward sufficient investment or acquisition opportunities,” reads an internal memo from Herkstroter. With that kind of money, Shell acknowledges it can buy nearly any oil company save Exxon. And as Union Pacific Resources’ recent bid for Pennzoil suggests, the takeover market in oil is hot.

But if Shell is to meet its ambitious growth targets it will need to do more than buy another oil company. That’s because the downstream business isn’t a route to prosperity. In the first quarter, refining and marketing outside the U.S. had returns on capital of only 9.5%. In Europe, where Shell has a third of its downstream assets, it’s worse: Returns on average capital employed last year were just 3%. A tour of France illustrates the perils of selling gasoline. The French hypermarkets sell gas as a loss leader, with prices 8% to 10% lower than at Shell stations. The hypermarkets now have 60% of the motor gas market in France. Things are not so bad in newer markets such as Asia and Latin America. But with the Koreans, among others, building refineries, Miller believes those markets will eventually resemble France.

So Shell needs a fresh strategy. One new plan: selling hot dogs and T-shirts. In France, Shell’s Escapade restaurants enjoy gross margins of over 70%, compared with 10% for gasoline. Different countries are doing this differently: Shell’s Argentine stations sell $11,000 worth of croissants a month, while Australia is the master franchisee for Burger King. Over the next few years Miller plans a global rollout of Shell’s Select brand convenience stores, which usually are attached to a gas station. In June the oil company opened its first Helsinki Select, which doesn’t even sell motor gas. Miller is creating separate retail groups headed by newly hired retailing executives to test the idea of becoming a global convenience retailer.

Reinventing the drive-in food store is a laudably radical thought for a company that’s based its identity on the glamorous oil business. What’s far from obvious is whether Shell really brings anything special to the business of selling hamburgers, toothpaste, and coffee. Clearly Shell is still struggling to answer the all-important question: how to grow? What it has so far is merely a work in progress, a frenzy of activity whose end remains uncertain. As Shell’s Sprague puts it, “We are moving forward briskly into the fog.”

REPORTER ASSOCIATE Wilton Woods

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