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Getting smart about capital spending

An energy company transforms how it plans capital projects, freeing up billions to enter new markets.

Challenge

A major energy company was spending billions of dollars each year on capital projects, just to stay in business. Its executives were unsure if they were getting sufficient value from that investment, because projects typically lacked clear business cases. The executives also wanted to free up capital to fund ambitious growth objectives in new markets and to expand production capacity to increase volume.

But a new approach to capital allocation would require a change in corporate culture. Given the company’s proud tradition of engineering excellence, managers were skeptical about reducing spending, thinking it might lead to cutting corners. Historically, business units had had some flexibility in how they spent their capital budgets, and managers were wary of losing it.

The company’s leadership asked McKinsey to gauge the opportunity to get greater value from the company’s capital investments. They also requested recommendations of practical ways to prioritize capital projects better, deliver them at lower cost, and build buy-in from managers to sustain the change.

Discovery

Our first objective was to convince skeptical managers that they could find better ways to design, select, and fund capital projects. We helped create a “capital-effectiveness team,” drawn from the company’s best talent, to review each project valued at $5 million or more, starting in just one business unit. With strong support from that unit’s top executives, the team designed and deployed a suite of best-practice capital-optimization tools, including standardized economic models to apply to each project, and a new way to rank and prioritize capital projects across the portfolio.

In the pilot business unit, we worked alongside the capital-effectiveness team and with managers to create business cases for each project. Then we conducted a thorough “scrubbing” exercise on each one to verify the business need, test economic assumptions, and assess whether the project was a priority for the company. As a result, 10 percent of the proposed projects were canceled, as they lacked a true business rationale. In many others, the team helped identify lower-cost solutions or ways to reduce the project scope where it exceeded the company’s requirements. The team also pinpointed several high-priority projects and helped accelerate their implementation.

In parallel, we introduced processes to build capabilities and shift mind-sets. We created immersive training programs for more than 200 project staff across the business unit and also rotated a new group of high performers into the capital-effectiveness team every few months. Building on this programs, the company’s executives later rolled out the new capital-optimization approach to the entire organization. The capital-effectiveness team took on an expanded role in the central corporate-finance function, which allowed for sustainable and continuous improvements in capital allocation across the business.

Impact

The new capital-effectiveness approach delivered rapid and remarkable financial impact. The pilot business unit reduced its capital expenditure on the evaluated projects by 30 percent, while the net present value of the projects increased by more than 70 percent. This impact garnered attention across the company and made it easier to roll out the new approach to other business units.

Four years into the rollout, when the new methodology had been embedded consistently across the organization, it delivered a 12 percent reduction in the company’s total capital expenditure—freeing up billions of dollars to invest in expansion and acquisitions in new markets.

Just as important, the strong focus on capability building provided the company with a cohort of capital-optimization experts who were energized to share the new approach with their colleagues—and coach them to deliver greater value from their own capital projects. The company continued to build this core of talent, introducing a yearlong certification program in which team members progressed from observing, to supporting, to leading efforts at capital scrubbing and optimization.

FEATURED EXPERTS

Filipe Barbosa

Senior Partner, Houston

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