December 2017 Special Report: Saudi presents ideal localisation model
The kingdom's nationalisation doctrine has clearly set out objectives that are not just promoting the development of local entities, but also attracting foreign investment
A recent study by global management consulting firm Strategy&, part of the PwC network, has highlighted that multinational corporations (MNCs), and their local partners, operating in the Saudi oilfield services and equipment sector must review their strategies and approaches to partnerships in order to continue to thrive.
Partnerships between MNCs and local companies dominate the oilfield services and equipment sector in Saudi Arabia. MNCs initially acted alone until changes in local regulatory requirements required the participation of local companies. To meet these requirements, many MNCs that entered the market in the 1970s did so in partnership with strong, family-led industrial conglomerates, with the local firms acting as the agents and distributors for goods manufactured overseas.
Recent moves to increase transparency and encourage foreign investment via the revision of key pieces of legislation are making it easier for MNCs to do business in Saudi Arabia without local partners. The kingdom has stated its desire to reform and liberalise its economy. This is evidenced, in part, by the creation of the Saudi Arabian General Investment Authority (SAGIA) and, in 2005, their accession to the World Trade Organization.
On the role of partnerships, Georges Chehade, partner with Strategy& Middle East and a member of the Energy, Chemicals and Utilities practice said, “Partnerships still remain an important option for smaller foreign companies that have less international experience or for new entrants to the Saudi market. For such companies, the establishment of an agency or distributorship allows them to understand market dynamics and mitigate risks.”
Saudi Arabia has long had a policy to localise manufacturing activities and create employment, a policy whose recent renewal provides an incentive for MNCs to seek local partners or for local firms to become independent oilfield services and equipment suppliers. There have been previous initiatives, such as ‘Nitaqat’ from the Ministry of Labour, which was introduced in 2011 to encourage the employment of Saudi nationals through incentives and penalties. However, official efforts at localisation have often met with limited success because of the absence of a cohesive national strategy for local content development; uncoordinated local content development efforts lacking a single coordinating entity driving the agenda; incomplete monitoring, regulations, and enforcement of local content objectives; and, procurement practices that limit the ability of local companies to participate and compete.
The decline in oil prices since mid-2014 has provided a new urgency to diversify the Saudi economy away from oil. Saudi Vision 2030, announced in April 2016, emphasises the maximisation of local content, job creation, and private-sector participation. To support these objectives, a Local Content and Private Sector Development Unit was formed within the Council of Economic and Development Affairs in December 2016. This unit’s task is to increase local content, support the development of the non-oil private sector, and improve the balance of payments. The unit plays an important role addressing barriers to localisation across different industries, such as through the establishment of industrial zones and reviewing import tariffs.
For oilfield services and equipment specifically, the key localisation initiative is Saudi Aramco’s In-Kingdom Total Value Add (IKTVA) programme, launched in December 2015. IKTVA is solely focussed on the oil and gas sector and so can have an important effect on oilfield services and equipment partnerships. As the sole buyer for the majority of oilfield services and equipment, Saudi Aramco is in a unique position to directly influence the localisation strategies of key suppliers.
IKTVA’s objectives can be summarised to reflect the following:
• Double the percentage of locally produced energy-related goods and services from 35% in 2015 to 70% by 2021
• Export 30% of output from the local energy goods and services industry
• Create half-a-million direct and indirect jobs for Saudi nationals.
Saudi Aramco is placing increasing emphasis on IKTVA in the award of major contracts. The company’s top 100 suppliers are subject to an audit procedure that generates an IKTVA score based on measures of current localisation (expenditure on local goods and services, and salaries paid to Saudi nationals) and forward-looking measures that demonstrate how the supplier is supporting future localisation (training and development of Saudi nationals, supplier development, and local research and development). Aramco works with suppliers to ensure that actions taken are aligned with national objectives. The resultant IKTVA score is used to determine the contract award.
Although the IKTVA programme is still developing, it is already having an impact. Saudi Aramco reports that locally produced energy-related manufacturing accounted for 43% of the total in 2016, up from 37% in 2015. In addition, the IKTVA score was a key component in the process to select suppliers for contracts that could total over SAR 60bn ($16bn). Meeting IKTVA targets to remain competitive is forcing MNCs to rethink their supply chain operations so that they switch to local suppliers and develop the local supply chain wherever economically justified.
The changed environment provides an opening for local companies that proactively develop and adapt their capabilities to support MNC localisation to be positioned to retain their existing partnerships and attract new MNC partnerships.
Dr Yahya Anouti, principal at Strategy& Middle East and a member of the Energy, Chemical and Utilities practice, remarked, “The changing environment offers important opportunities to those local companies that proactively align their strategy and capabilities to meet the new requirements of localisation. Local companies that succeed in developing their capabilities will emerge as partners of choice for MNCs or as independent local suppliers.”
To achieve future success MNCs will need to significantly improve how they interact with local partners, specifically in areas such as finance, technology, operations, shared services, localisation, public affairs advocacy, marketing and the supply chain.
David Branson, executive advisor at Strategy& Middle East and a member of the Energy, Chemical and Utilities practice, commented, “Although the investment landscape in Saudi Arabia may seem of concern for local companies, the current changes herald the start of the next phase of development of the oilfield services and equipment sector. In this new era for partnerships, success will come to MNCs that can leverage local partnerships to drive increased localisation, and to those local companies that can offer the capabilities to support this process.”