Landdox Team

May 19, 2020

Thinking About Digital Transformation? Better Brush up on Econ 101.

sunk-costs-digital-transformation-land-management-software

Increasingly E&P CEOs and CIOs are tapping ‘Digital Transformation’ czars and mandating Cloud-first strategies in order to slash G&A, improve decision-making, and boost operational resilience..

In a March 2020 study, McKinsey & Co. reported that more than 70% of companies undertaking digital transformation initiatives have seen their projects stall out at some point along the way.

The good news for E&Ps, according to McKinsey, is that market disruptions (like, say, a price war and a 30% overnight drop in global demand for your products) do not typically derail technology modernization projects.

McKinsey found that factors within a company’s control -- internal resources, misalignment and poor digital strategy -- prevent successful technology pilots from becoming full-blown successes.

At Landdox, we spend significant time with E&P leaders who are responsible for leveraging technology to improve their company’s bottom line.

Based on our observations, we’d like to offer E&P CEOs frustrated by slow progress against a clear and urgent modernization mandate an alternative explanation for the bottleneck.  

The solution, we believe, has more to do with human psychology than information technology.

Ready to schedule an intro call? Contact Us »

Econ 101

Let’s first start with a refresher from your Intro to Economics class.

A sunk cost is an investment of money or time that can never be recouped. Companies incur sunk costs every day in the ordinary course of business. Sunk costs aren’t necessarily bad or good, they’re simply a fact of life.

For example, the dry hole cost of an uneconomic well is a sunk cost.  

Was it a bad idea for the E&P to drill the well?  

Not necessarily. Reservoir and geology could have been in unanimous agreement about the well’s prospects, and the drilling team could have executed flawlessly. Nonetheless the well was a duster. And nothing can be done to recoup the time and money spent planning, drilling, casing and logging it -- they’re all sunk costs.

Sunk costs are only problematic to the extent they influence our decisions about what to do next. That’s because, as every college freshman learns in Econ 101, you must ignore sunk costs when deciding how to invest your time and money going forward.

Behavioral Economics

If everyone acted according to the principles you studied in Econ 101, that would be the end of the story.

To stick with our oil & gas example, you would never expect the E&P CEO to green-light an expensive completion of the dry hole just because her team had already sunk a lot of time and money into leasehold, well planning, and drilling.

Instead you would expect her to re-direct the budget originally earmarked for the completion toward a project that had a better chance (or any chance) of generating a profit.

However, it turns out that companies and people “complete dry holes” all the time. In fact, economically irrational behavior is so pervasive in business and life that there’s a whole academic field dedicated to studying it.

Behavioral Economics -- a mash-up of psychology, finance, and economics -- seeks to explain empirically how people make decisions. The field has produced several Nobel Prize winners and New York Times best-sellers in recent years.

We believe Behavioral Economics offers the best explanation for why so many E&P digital transformation projects fail to gain traction.

The Sunk Cost Fallacy

The Sunk Cost Fallacy is the mistaken tendency to continue in an unprofitable endeavor because of previous investments of time and money into the project. In other words, continuing to throw good money after bad rather than cutting one’s losses and moving on.

Why does the Sunk Cost Fallacy regularly trap people?

Evolutionary biology, according to Nobel Prize-winning behavioral economist Daniel Kahnemann, author of Thinking, Fast and Slow.

Human beings are hard-wired to place far more weight on losses than on gains of equal value, Dr. Kahnemann observed over decades of psychological studies.

As a result, people will do just about anything to avoid chalking up a loss -- even if it means continuing to sink money into a losing proposition at the expense of pursuing a better path forward.

Learn how going digital helped Venado Oil & Gas. Download our Case Study »

Dry Holes in the E&P Tech Stack

The oil & gas industry will spend $13 billion on traditional enterprise software in 2020, according to Bloomberg NEF.

How can an industry spend $13 billion per year on enterprise software and still need a digital transformation?

Recent conversations we’ve had with some of the world’s largest oil & gas companies’ digital transformation leaders offer insight.

In independent conversations, each company described the horrible situation they were in after having invested millions of dollars and multiple years to implement land management software that simply didn’t work.

One of these operators currently employs six internal IT teams and a squad of costly outside consultants simply to maintain enough system uptime to keep up with lease expirations, payments, and obligations.

Another operator described ongoing lost productivity as their busy employees experienced a 15-minute wait time to edit records and had to hand-key the details of thousands of recently acquired oil & gas leases into the system. And that was after investing millions of dollars on the land software’s maintenance and upgrade costs in the prior year alone.

Still, despite the significant opportunity cost of lost productivity and the higher G&A associated with the status quo, both companies wrestled with how to build a “business case” for making a change that would entail writing off millions of dollars of software licensing and implementation costs.

The Sunk Cost Fallacy had paralyzed both companies’ digital transformation efforts even before their pilot projects got under way.

When it comes to their land software, they’ve both drilled dry holes. But, instead of acknowledging the sunk cost and re-allocating their budget, their Land and IT teams are continuing to complete, re-complete, and perform workovers on the same dry holes.

In the process, these companies are missing out on the opportunity to reduce G&A, improve their team’s visibility into the land position, and boost employee morale.

How Do You Empower Digital Transformation?  

Another way of saying ‘Digital Transformation’ is technology change.

If you want a culture that embraces change you must first de-stigmatize sunk costs.

That means putting an emphasis on what’s best for the company going forward rather than second-guessing decisions made in the past and the people behind those decisions. Empower your team to cut their losses and focus on optimizing for the future.

Give your team permission to ignore the sunk costs.

Let Landdox Help.

Landdox is a cloud-based land platform that features every tool your entire land team (land - land administration - division order - owner relations) needs to do their work within one fully integrated application.

"We have converted so many data sets from legacy land systems into Landdox that we now have processes and a team that can convert most data sets in days -- not weeks or months -- at a price that makes ignoring sunk costs extremely palatable."

The large oil & gas companies mentioned above are making the switch to Landdox.

Ready to ignore your own sunk costs? Please call us to see how easy Digital Transformation can be.

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