Baker Hughes Incorporated

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BakerHughes Incorporated

StrategicPlan

Avision for progress through the future with Strategy

Spring2016

MGT508.01W – Strategic Plan, Texas A&ampM University – Texarkana

Jagdeep(Jay) Singh, Michael Munnerlyn, Nikishia Hollins, Pearlena Warren

BakerHughes Incorporated supplies oilfield services, products, technology,and systems to the oil and natural gas industry worldwide. Thecompany offers drilling and evaluation products and services, whichinclude drill bits for performance drilling, hole enlargement, andcoring conventional and rotary steerable systems used to drillwells measurement-while-drilling and logging-while-drilling systemsto perform reservoir navigation services drilling optimizationservices tools for coil tubing drilling and wellbore re-entrysystems coring drilling systems surface logging emulsion andwater-based drilling fluids systems reservoir drill-in fluids andfluids environmental services. Its drilling and evaluation productsand services also comprise wire line services, such as tools for openhole and cased hole well logging to gather data to perform petrophysical and geophysical analysis reservoir evaluation coringcasing perforation fluid characterization production logging wellintegrity testing pipe recovery and seismic and micro seismicservices. In addition, the company provides completion and productionproducts and services consisting of completion systems used tocontrol the flow of hydrocarbons within a wellbore wellboreintervention products and services to enhance the performance ofexisting wellbores intelligent production system products andservices to monitor and control the production from individual wellsor fields artificial lifts, such as electric submersible pumpsystems, progressing cavity pump systems, gas lift systems, andsurface horizontal pumping systems to lift oil and water chemicalsand chemical application systems and cementing, stimulation, andcoil tubing services. Further, it offers industrial products andservices to the downstream chemicals, and process and pipelineindustries. The company was founded in 1972 and is headquartered inHouston, Texas.

I. EnvironmentalAnalysis

A. SocialTrends – The developed nations of the world continue to demand themost significant portion of oil and gas production. Developing orunderdeveloped countries demand less oil and gas, but their demandcontinues to grow. For some countries, such as China and India, thisdemand grows at an exponential pace. China looks to become thelargest car market in the world over the next decade. This stands insharp contrast to a country still reliant on beasts of burden just 20years ago. The new development of nations creates new markets for oiland gas, which in turn changes worldwide supply and demand. Thesechanges in oil and gas demand keep prices high and in turn keep BakerHughes highly profitable. The process of oil tools, fracking andcementing carries break-even prices in oil around $50 per barrel.High demand keeps oil prices securely above this level.

a. Population– Population increases around the world keep a constant pressure onthe oil and gas industry. Population growth alone does not createpressure. But, growth within developed and developing countries thatdemand oil and gas creates pressure for ever increasing oil and gasproduction.

B. EconomicTrends – The natural rise and fall of the business cycle and theshocks from sudden events play a vital role in the oil and gasindustry. The business cycles through natural fluctuations due to thelong term economic expectations of consumers. If the market expectsthe long term prospects to be positive, it demands more supplies fromcorporations. If the market expects the long term prospects to benegative, it demands fewer goods. Baker Hughes must respond to thesefluctuations in the market. For example, if market prices fall onnegative future prospects, the company must alter spending andproduction to maximize profitability in a new pricing regime.

Theenergy market also responds drastically to any sudden world eventrelating to the use or production of oil products. For example, theevents related to 9/11 and the wars that followed sent shocks throughthe energy markets. The uncertainty due to terrorism and the offlineproduction due to war in Iraq limited supplies and shot pricesdrastically upward. Ultimately, oil and gas markets follow typicaleconomic trends, but also stand subject to energy specific shocks.Baker Hughes must have the flexibility to react to these suddenchanges. Because the company has a diverse portfolio, they are in areasonable safe position to keep low cost production online and delaymore expensive development projects.

C. PoliticalTrends (Federal/State/Local) – The government, at all levels, playsa large role in the oil and gas industry. The importance of politicalinvolvement grows in line with the growth of the company itself.Small independent operators must interact with state and localregulators. As an oil and gas company grows to a mid-size status, theability to lobby and understand the political process enters theradar. By the time a company reaches major and super major status,interacting with governments becomes an everyday occurrence necessaryto continue to do business. Bureau of Ocean Energy Management (BOEM)and Bureau of Safety Environment Enforced (BSEE) must keep all thecompanies in check in order to prevent future catastrophes.

Anotherfactor in political interaction relates to the domestic versusinternational status of the company. Domestic United States producersdeal solely with known entities. International producers must dealwith several countries, each with their own customs and laws.International oil and gas production exponentially increasespolitical interaction. This political interaction depends highly onthe trends within the United States and other hydrocarbon producingcountries. Baker Hughes represents a large-size internationalcompany. The company must interact with all levels of government inmany different counties. This interaction mandates that the companyhave field landmen to interact with local entities and a businessdevelopment division for state and international government. Theseinteractions create added complication to Baker Hughes business.

a. Regulations/Ordinances– Regulations and ordinances play a vital role in the success ofthe oil and gas industry. Energy industry companies create Health,Safety and Environmental Departments (HSE) in order to abide by theseregulations. These HSE Departments focus on complying with federal,state and local regulations. Local ordinances also play a key role inthe success of the oil and gas industry. Getting the buy in of thelocal population starts with complying with ordinances such as thoserelated to noise, light pollution, transportation, and working hours.Because of past inconsistencies and misconduct, the oil and gasindustry must follow the rules, regulations and ordinances set outfor them to the letter. Baker Hughes’s HSE Department plays a vitalrole in the success of the company because of the dangerous nature ofOil &amp Gas (CO2, Fracture fluids and multi-grade cements). BakerHughes has a zero tolerance policy which means if something is notsafe, anyone including the boss to an employee can stop work at anytime. Baker Hughes deals with many different chemicals in fracking,cementing, and in completions work so the company always abide by allthe regulations.

b. Taxes– The implications of taxes as they relate to the oil and gasindustry can become complicated. Strong accounting practices must bein place in order to keep track of production from every well. Taxesdirectly relate to the production from these wells. The complicationgets larger when considering different tax laws within localcommunities, states, or countries. Baker Hughes always account forthousands of tools across different states, along with any taximplications related to facilities and pipelines. One large tax issueBaker Hughes faces is relates to fracking permits with various fieldsin urban areas. These areas are high tax zones due to the limitedunderstand of fracturing by the locals. The question they must answeris how to educate the general public about different methods offracking and how it is done safely and it is not harmful for theenvironment.

c. Franchises– Franchises, in the sense of the licensing of a business model,does not play a role in the oil and gas industry. Franchising, in thesense of the right to use property, plays a vital role in theindustry. Oil and gas operators must negotiate property and mineraluse agreements with owners. Surface landowners hold land vital to thedrilling, producing and transportation of oil and gas products.Mineral owners hold the rights to the oil and gas producers wish toproduce for sale. Both groups hold a property that companiesnegotiate terms of use, including production profit sharing, time,remediation and countless other components, in order to make theindustry work.

BakerHughes creates relationships with both many major operators. SinceBaker Hughes does not own any oil &amp gas, they don’t’ have todeal with the property owners and the public as much as the majoroperators. Because of the nature of their business, operators musthave facilities, flowlines, and well heads placed throughout largeareas on the surface. This creates tension with landowners thatoperators such as Chevron or Shell must assuage.

D. TechnologicalTrends – Similar to the revolution in the electronics industry dueto the innovations in microprocessors, technology created arevolution in the oil and gas industry. Newtechnologies such as deep water drilling, tertiary recovery,horizontal drilling, and advanced completion design produced a NorthAmerican revolution in oil and gas production. Drilling evolvedslowly to the advanced state that the industry currently sits. Fromderrick design, drill bit technology, and drilling fluid composition,innovation in drilling comes together in its penultimate form bytaking it all to the water onto multi-million dollar offshoreplatforms. Baker Hughes utilizes these advanced drilling techniquesto create the best Drill Bits which are used at extreme temperaturesand depths. These drill bits are designed to withstand temperaturesand pressure of 400 plus degrees and 30,000 plus PSI.

Fromsurfactants, to polymers, to CO2 enhanced recovery, Baker Hughes alsoutilizes advanced reservoir technology to help expand production formany major operators. Baker Hughes uses surfactants in areas withmore surface population sensitivity because of its added safety. Theyalso use polymers to force CO2 into parts of the reservoir that wouldotherwise go unswept. Finally, CO2 EOR forms the basis for BakerHughes’s business. Using CO2’s beneficial properties in thereservoir allows for the extraction of hydrocarbons that wouldotherwise be impossible.

E. Competition– Competition is one of the biggest risks that any company willhave to face. Currently Baker Hughes is # 3 compared to itscompetitors. Number one is Stumberger and number two is Halliburton.Other risks are hostile takeover or mergers. In the past few monthsthere has been talks of a rival company Halliburton taking over BakerHughes or a merger. There are no clear details on that matter butmany articles give away many different stories. Until something isfinalized, no one can tell if the two companies will merge or if theywill continue to go their separate ways.

II. ResourceAnalysis (Self-Appraisal)

#

Risk

Challenges

Consequences

Solution

1

Impact of demand on world oil prices

Developing countries causes world-wide demand to increase

Declining oil prices negatively impact company’s profitability

Successful budget forecasting and Hedging

2

Maintaining compliance with regulatory &amp environmental laws

Since BP Oil spill, Increased focused on regulation &amp environment

BOEM &amp BSEE can shutdown projects &amp will institute fines

Baker Hughes has a HSE department to maintain good communication with regulators

3

Inability to keep up with technological advances

Investing in technology in order to stay competitive

Lagging performance of competitors

Baker Hughes utilizes advance drilling techniques to help extract Hydrocarbons for operators

4

Lack of liquidity needed to successfully compete in the industry

Companies are currently struggling due to the current price environment

Limited ability to fund projects &amp acquisition

Baker Hughes might be merging with Halliburton to keep their assets strong.

5

Properly Managing vendor relationships

Problems with vendors can negatively impact clients

Loss/delay of contacts with clients which can impact probability

Baker Hughes keeps extra equipment on hand and closely monitor vendors

  1. Human Resources – Baker Hughes has about 43,000 employees with just over 60% working outside of the United States. It is noteworthy that Baker did cut 18,000 positions in 2015 as a result of the impact of oil prices on the industry. Less than 10% of all employees work under a collective bargaining agreement. The Company is divided into four regions with each region having a President.These regions consist of: North America, Latin America, Europe / Africa / Russia Caspian, and Middle East / Asia Pacific. Baker takes pride in its “Best-In-Class Global Ethics and Compliance Program which covers a such topics as how payments are facilitated, employee travel &amp gift receiving, employee training programs, due diligence for commercial sales, and appointing a compliance governance committee (to name a few).

  2. Financial Resources – Baker had $2,324,000,000 in cash on their B/S as of 12/31/15 and working capital (defined as current assets – current liabilities) of $6,493,000,000.This represents a $584,000,000 increase in cash year over year despite the current environment that the Company operated in. The Company had just over $4B in outstanding debt as of 12/31/15 comprised mainly of senior unsecured notes along with $0 outstanding on a $2.5B revolving line of credit &amp commercial paper facility. The weighted average interest rate on all indebtedness at 12/31/15 was 12%. Baker did, however, generate a net loss of ($1,967,000,000) from revenue of $15,742,000,000 in 2015 as compared to net income of $1,719,000,000 from revenue of $24,551,000 in 2014.This is mostly a direct result of the massive decline in oil prices seen within the industry.

Despitethe loss, Baker did manage to generate $1,796,000,000 in cash fromoperating activities in 2015. They also reduced their CAPEX from$1,791,000,000 in 2014 to $965,000,000 in 2015.

  1. Facilities – Baker both owns and leases its offices in various locations throughout the world. It was noted in the 10K that none of the properties owned by Baker are encumbered.

  1. Product or Service Lines – Baker classifies their products and services into one of two categories: Drilling &amp Evaluation and Completion &amp Production.Drilling &amp Evaluation consists of the following products and services: drilling services, wireline services, drill bits, and drilling &amp completion fluids. Completion &amp Production consists of wellbore intervention, completion systems, pressure pumping, upstream chemicals, artificial lift, and intellectual production systems. Baker also has an extensive industrial services segment consisting primarily of their downstream chemical business and pipeline services business.

E. NaturalResources – Baker Hughes has no Natural Resources on their books. They offer services to customers who have obtained Natural Resourcessuch as oil and gas, but they have not acquired any of their own.

F. Contracts– Baker Hughes has contracts in the Oil and Gas industry at aglobal level. Being the third largest in their industry, theirclientele includes all of the major Oil and Gas Companies,Governments, and anyone with an ownership or a stake in OilProduction and Extraction. Because of the nature of the Oil and GasService Industry Baker Hughes retains contracts for all the servicesthey offer with clients.

G. Equipment– Baker Hughes has a large amount of Oil and Gas Extraction andProduction Equipment. In equipment, they have automated rotarysteerable directional drilling systems, high-performance drillingmotors and integrated logging-while- drilling assemblies.

III. Formulationof Assumptions and Criteria

Assumption:Baker Hughes may achieve larger profits by not taking on partners andfinding more sources of workover wells.

Criteria:Baker Hughes judges its decisions by their profitability for thecompany and how they fit into corporate strategy. These profitabilitymeasures include net present value, internal rate of return, andpayback time of potential projects. Corporate strategy includes afocus on secondary enhanced oil recoveries.

IV. Developa Mission Statement

BakerHughes mission is to develop solutions to the needs and requirementsof our customers in the Oil and Gas Industry. We strive to resolveany of our customer’s problems quickly and to compete on price andquality to differentiate ourselves from the competition. Our goal isto minimize costs, reduce risk and increase productivity for the oiland gas industry.

V. Determinationof Objectives and Goals

  1. OBJECTIVE

Ourfirst objective is to complete the merger with Halliburton. Thismerger will help sustain the company in the long term with anincreased production quantity. After the Merger, Baker Hughes willbe competing for the 1stand 2ndplace in the industry. This merger will increase our customer baseand help us to sustain a competitive advantage over our competition.

  1. GOAL – Our first goal will be to mitigate the hurdle of getting the merger approved. We will invest in Lobbyists, Public Relations, and other interest groups with a goal of establishing a “buy-in” from those in the decision making process. The merger began in 2014 and we would hope for it to completed and approved by close of Fiscal Year 2017.

  2. GOAL – Our next goal will be planning the merger. We hope to retain key staff in management to ensure our core values and production quality are not affected by combining the companies. Our first priority is to our shareholders and so we will focus on merging the companies in a stable and transparent fashion. The companies should communicate to ensure both parties agree on the terms of the Merger.

  3. GOAL – Our next goal after the Merger is concluded is to reach out to potential customers. We want to inform customers about the price, quality, and technical advantages we have achieved with the merger. Our goal is combine our current clientele and expand into our competition’s market share.

  1. OBJECTIVE

Oursecond objective is sustaining the company in the post-merger state. We wanted to keep customers, employees, suppliers, and stockholdersupdated as to how the merger will affect the way the company doesbusiness.

A. GOAL– Ourfirst goal in achieving this is to keep an open dialogue with allgroups (customers, employees, suppliers, and stockholders). We wantto build on our relationships with anyone that has direct contactwith the company. We need to allocate a fixed amount of resourcestowards a PR budget for communications.

B. GOAL– Ournext goal is to look for redundancy in operations between the tworecently merged companies. We need the assistance of independentauditors and consultants to help our merger be successful. Pensionsfor people in redundant positions should be offered as a way toincentivize staff to ascend into roles outside of the company. Also,we should incentivize “uniquely qualified” staff to stay with thecompany by offering bonuses and clear career track for promotions.

C. GOAL– Anothercritical goal to reaching our objective is increasing employeeinvolvement within the company. Staff at all levels should have theopportunity to make recommendations. Typically, assembly line crewshave the most insight into how a company can be more effective andefficient.

VI. Formulationof Strategy

1.Overhaulingthe acquisition and divestiture department stands as a vital part ofachieving limited partnership interference. Overhauling includeshiring new employees with added expertise in evaluating purchases andredefining the process of accessing fields. Hiring new employees mayturn into difficult and costly endeavor because of the limited marketfor experienced oil and gas professionals. Defining a new processentails the use of time, but should not include a large amount ofinvestment. Correcting the acquisition department limits the purchaseof “bad” fields with “bad” contracts. The term bad hererefers to the purchase of fields with overestimated reserves andunderestimated capital for development. It also refers to contractsthat do not enhance the profitability or limit the freedom of BakerHughes to practice their business.

2.BakerHughes needs to increase political action committee involvement andgovernmental lobbying. Increasing the political action involvementallows for larger contributions and funding of politicians thatunderstand the issues Baker Hughes deals with on a daily basis andwho are willing to help push the agenda of the company. Regulationslimit the amount of political contributions a company can make.Political action involvement help enhance these contributions.Increased lobbying helps persuade politicians and governmentaldepartments that the goals of Baker Hughes stand in line with thegoals of the county. Ultimately, making Baker Hughes visible topoliticians and getting the “green” story in their hands allowsthe company to work towards a carbon credit system. This systempushes the company into a new realm of possibilities andprofitability.

VII. Preparationof the Long-Range Plan(Up to 3-5 years).

Thecosts associated with implementing objective 1 include new hires andredefining a process. Making these changes should include hiring fivenew employees at approximately $150,000 per year. Redefining theprocesses include the work for one year of a person to the tune of$100,000. The savings include added value to new acquisitions. Forexample, one of our fields lost ~5% of its value after purchase.Baker Hughes paid $200 million for the field and lost $10 milliondollars after the devaluation. If you save $10 million per deal atone deal per year over the next three years, the potential savingscome to a realistic $30 million.

Thecosts for implementing objective 2 include political action andlobbying costs. Political action costs include a negligible amount ofan employee’s time. Lobbying costs should be regulated by potentialreturn. With the returns possible, it might make sense to invest $5million per year on lobbying. There will be no immediate return, butthe long term upside needs to be valued. Future income from lobbyingrelates to sequestration and carbon credits. If the company can takeon one extra field per year at an average of 250 million barrels oforiginal oil in place, the potential income per year would be on theorder of $150 million per year per field added. The capital cost forthese new projects would be on the order of $50 million per year perfield for the first 5 years.

Theresponsibility of these initiatives falls squarely on the president,vice presidents and advisors. They must lead the company into buyinginto these new programs and changes. They must continue to monitorthe progress of these initiatives also. Initiatives A and B may beimplemented over about a one or two year period. Monthly monitoringis necessary. Initiative C takes longer to implement. Lobbyingrequires communication, attention and monitoring over the next 5 to10 years to ensure constant momentum. Taking on the costs and effortfor these initiatives potentially adds multi-million dollars of valueto Baker Hughes Inc. (Figure 1).

Assets

2020

2019

2018

2017

2016

New Hires

$250,000

$250,000

$250,000

$250,000

$250,000

Redefining process

$10,000,000

$10,000,000

$10,000,000

Field Acq.

$150,000,000

$150,000,000

$150,000,000

$150,000,000

$150,000,000

Totals

$150,252,020

$150,252,019

$160,252,018

$160,252,017

$160,252,016

Liabilities

A&ampD Professionals

$1,000,000

$1,000,000

$1,000,000

$1,000,000

$1,000,000

Redefining Process

$100,000

$100,000

PAC Spending

$10,000,000

$10,000,000

$10,000,000

$10,000,000

$10,000,000

Field Acquisition

$50,000,000

$50,000,000

$50,000,000

$50,000,000

$50,000,000

Totals

$61,000,000

$61,000,000

$61,000,000

$61,100,000

$61,100,000

Net Long Range Changes

$89,252,020

$89,252,019

$99,252,018

$99,152,017

$99,152,016

Value Added (5 Years)

$476,060,090

Figure 1 – Long range planbalance sheet showing assets (value) added and the liabilities(costs) associated with adding that value.

VIII. Implementationof the Long-Range Plan and of the Short-Range Plan

Theshort term plan of the Baker Hughes company shall be implementedthrough a critical budgeting process. First, the company shallestablish the viability of the merger with Halliburton through a SWOTanalysis to identify the most appropriate way to approach thecompany’s shareholders. The potential benefits from the mergershall be communicated to the shareholders with an aim to win theiropinion before the merger is finalized in the year 2017 (Fubini,Price, &amp Zollo, 2007).

Thecompany shall enact a clear and transparent communication process forthe shareholders to follow up the entire merger transaction includingthe effect on their wealth and the strongholds of the company. Aconsultancy project composed of auditors and consultants shall beinitiated to evaluate possible changes in the structure of thecompany after the merger. The report from the evaluation shall form abasis to enact an explicit communication system for the employees tounderstand the benefits of the merger, communicate to employees thatwill be retained as well as initiate processes to handle employeeswhose positions shall be eliminated by the merger. Consequently, thecompany shall budget for the cost of eliminating affected positionsand create the new labor cost after the merger (Fubini, Price, &ampZollo, 2007).

Inthe long run, the company shall activate its lobbying plan toincrease its political involvement in pushing the company’sagendas. It shall evaluate the effect of the redefining process onthe financial position through a step by step approach beforeimplementation. Consequently, the human resource department shallbegin sourcing for the new five employees to be hired by advertisingfor the positions. The management shall critically evaluate theexperience as well as the suitability of the applicants for therespective positions before making its hiring decisions. Afteracquisition, a thorough monitoring and evaluation process shall beconducted regarding the budget, cost savings and value addition toidentifying deviations from expected results that require adjustments(Fubini, Price, &amp Zollo, 2007).

Theschedule for reviewing results from initiatives varies by the projectundertaken. Short-range initiatives need to come to a conclusionwithin one year of commencement. Monthly review ensures continualprogress. Long-term plan are to balance sheet improvement andleverage to commodity price recovery with excellent exposure variouscontracts.

References

Fubini,D., Price, C., &amp Zollo, M. (2007). Mergers:Leadership, performance and corporate health.Houndmills, Basingstoke, Hampshire: Palgrave Macmillan.