1. Why are big oil companies vertically integrated?

Ans There are five major reasons for big oil companies to vertically integrate:

Steady supply
The oil embargo and the consequential scarcity and price increase in 1973 (see exhibit 6)
resulted in a crisis for the big oil industries. Since they were dependent on their oil suppliers,
they had to deal with the price increase. Vertical integration assures the steady supply of oil
and minimises the level of dependency. Not only the amount but also the quality of the supply
can be controlled in big, vertically integrated oil companies.

Avoidance of new entrants

Since the supply chain of oil is quite complex and requires big companies to be vertically
integrated, it takes a great financial effort to enter the market to compete on a same level.

Increase of profitability
Improvement of coordination of upstream (production) and downstream (distribution) will
lead to synergies and an increase of profitability.

Technological economies
As integrated oil companies handle the whole supply chain, they will have more opportunities
to increase value to the product by developing new technologies. Especially, in the upstream
process it can help to decrease the required input to produce a given output.

Cost reduction
Integrating up- and downstream can save time and costs of the selling and buying process that
usually occurs between two different companies. In particular, market research, advertising,
and sales promotions.

In conclusion, incomplete markets, transportation shortages, and unstable relationships

between firms gave oil companies the incentive to integrate vertically, matching the capacities
of their production, refining, and marketing operations. BP in particular, saw the advantages
coming from unpredictable regulated markets. Thus, they use the integrated structure to
expose interbusiness subsidies, and to force businesses to perform more competitively.
However, the amount of vertically integrated oil companies decreased from 1979 to 1999,
while the non-integrated companies decreased (see exhibit 7).
 How favourable were the economics of the oil and gas industry before the BP-Amoco
merger? What were the effects of the recent mergers on industry structure and on BP’s
profitability?

Ans As prices were on a minimum in 1998 (see exhibit 6) the former industry structure could
not persist. The economy of the oil and gas industry was struggling. Especially, the lack of
returns compared to other industries and the fact of continuously dropping oil prices forced
BP to respond.

Moreover, most of the expansion opportunities were already maxed out. Oil had been
discovered in more than 80 countries. Oil and gas field became more challenging to access
and to develop efficiently. Thus, gaining profitability was the major driver for further growth.

1. How will the structure of the industry evolve? Do you expect more mergers among the
largest oil companies?
2. Consider the four alternative courses of action that Lord Browne was contemplating at the
end of the 2002 case: acquisition, internal growth, divestiture, and diversification. Did he
choose the right ones? Could he have done better? What should he do now?
Ans BP has four strategy options for growth in future:
1. Acquisition
2. Internal growth
3. Divesture
4. Business diversification
In our opinion, the company should follow a mix of internal growth and business diversification
strategy

RATIONALE:
1. Internal growth
In past years, BP has only focused on cost reduction (through acquisitions). However, for
sustainable growth, company needs to focus upon the productivity. This is only possible
through internal/organic growth.

2. Business diversification
In order to remain relevant in the changing times for energy sector, BP needs to diversify
into fields like Renewable energy segment (Solar, wind), B2B energy services like
consulting.
Advantages of Internal growth strategy:
1. This strategy involves less risk than the external growth
2. Growth can be financed through internal funds
3. This approach allows business to grow at a more sensible rate