The recent oil price downturn continues to force companies to rethink their business models. As a strategy to stay a float, players in the upstream oil industry – oilfield service companies in particular – continue to engage in activity cutbacks, service price renegotiations, cancellations, and postponements of future service commitments. Left unchecked, heuristics may continue to undermine strategic decision-making.

Many of the factors that explain how oil prices fluctuate are interconnected. The fall from a peak of $115 per barrel in mid-2014 by more than 70 percent at some point – compared with the June 2014 levels – remains one of the most important international macroeconomic developments of the last two and a half years. Energy economists explain this in terms of the shocks to demand and supply arising from the complex interplay of geopolitics, economics, and technology. Considering the excess supply and inventories that have built up in the market, lower prices continue to force producers to adjust supply, stockholding, and investment flows. As we head into 2017, uncertainty around what oil prices might look like in the future weighs heavily on operators, contractors, investors, and regulators.

On the true relationship between the price of oil and the cost of production per barrel, classical economic thinking posits that in a competitive industry, the cost of producing an additional unit of output – i.e. marginal cost – determines price. In the same vein, traditional management and economic theories suggest prices should reflect value. The tough challenge, however, is figuring out the precise value prices represent. Perhaps even tougher is the question of whose judgement should be relied on in arriving at the perceived or estimated value of the particular good or service in question. To the extent that oil prices drive costs, it is often expected – on the supply side – when oil prices fall, a corresponding cost deflation will be required to ensure profitability. The corporate decision-making process often hinges on value maximization. In the realm of supply chain management, this implies finding the lowest-cost suppliers that meet certain minimum quality standards.

While sound economics and business analytics remain vital, it is equally very important industry executives focus on behavioural and cultural change as a tool for engineering key players to deliver leaner, fitter, and efficient operations under a continued low-oil-price regime. Industry operators need to rethink their contract management and supplier relationship management strategies. While it remains a fact that it will take time to achieve significant efficiency improvements, companies need to carefully weigh the costs of short-term cost-reduction strategies against the benefits of deploying long-term supply chain best practices in the most optimized way. This is in addition to managing expectations and reaching a consensus with suppliers with regard to the important – and often complex – issues of safety, training, and equipment specifications.

In closing, beyond budgets and costs, firms should be lean, competitive, and continually attract investments. Because price shocks affect firms in an industry differently, companies need to critically examine their changing cost economics, in addition to long-run shifts in the cost position of competitors. These combined will provide the necessary ingredients to craft an effective strategy to help avoid the competitive pricing trap. And, of course in addition to economics, strategy, analytics, marketing, and sales, greater attention should be paid to the behavioural science of forecasting and decision making.