Introduction
It is argued that value-added rather profit shows the real wealth of the firm (1999 p. 1). Value-added approach uses the same financial accounts of profit accounting but highlights the capability of the company to perform its stakeholder (rather shareholder) responsibilities. In figure 1, capital (bought-in materials/ services) and constraint (depreciation) elements necessary to create the working environment are deducted to the outcome of operations (sales revenues). The net result, technically called as net value-added, is the amount distributable to all stakeholders including the firm itself which is represented by retained earnings. In this paper, the value-added approach will be critically explained and measured in the veil of purchasing function. The goal of this paper is to show the nature of the value-added approach in both quantitative and qualitative merits. Example organizations and their situations will be used in the presentation.
E-Procurement: Emphasis on Efficiency not Productivity
Until 1997, Massachusetts Institute of Technology (MIT) was adopting campus computer resale (1999 p. 68). However, as environment changed and competition intensified, problems of this operational scheme started to emerge. The organization was doing business with 14,000 suppliers, 7,000 requisitions were done annually, inventory costs rose to million, storefront manpower requirement was 19-fulll time employees and 80% of the paperworks were orders under 0 at a cost of 0 per paper transaction. As margins decreased and overhead increased, MIT had to use a different purchasing model to fit the current competitive environment. MIT teamed-up with NECX, a vendor with e-commerce and Electronic Data Interchange (EDI) capabilities. The partnership created an online catalog where the former recommended-products and the latter pre-sales information were viewable. In 1997 and 1998 operations, the e-procurement purchasing model had provided several benefits which can be discussed suing value-added equation (refer to figure 1).
The right hand side of the value-added equation is largely affected. S increased as 1997 sales reached .8 million while 1998 sales rose by 44% up to .8 million (p. 68). On the other hand, B decreased as cost of good sold was reduced to 0,000 in 1997. The pressure to S was also lessened as inventory and carrying cost were eliminated while paper procurement process was reduced up to a level where it was regarded as the most significant cost saving. DP was also trimmed down when the floor space of the store was transformed to a mere showroom for the display of MIT selected and largely recommended computer products. However, there is an obvious adverse effect to the left hand side of the equation when employees were downsized to only four from the original nineteen. This is a scenario when one major stakeholder was undermined in favor of operational efficiencies.
The increase in S, decrease in B and DP as well as other costs aggregately increase value-added distributable to stakeholders. The revitalized purchasing strategy generated by MIT led to this favorable state. Through e-procurement, individual and departmental customers that use the institution’s network can readily check the availability, price and specifications of the recommended products (p. 68). MIT and NECX only included in the electronic catalog computer products compatible within the network. When customers order, the 30,000 suppliers and EDI capability of NECX will efficiently ship and provide after-sales service to end-users. On the other hand, MIT was responsible for consultancy (with four showroom employees) regarding the future status of compatible hardware, software and other accessories for the network. This, however, beat employee welfare as the adverse effect to the right hand side is isolated to W which in turn benefits other stakeholders.
Value-added was derived in the increase in S due to faster response to orders as MIT purchasing activities was relieved and passed to NECX. MIT was able to focus its core competencies in improving the network environment and making the products of NECX buyable. MIT did not led to complex operation as the partnership developed 30,000 from 14,000 suppliers. This advent even increased product differentiation, order availability and customer convenience. B is deducted with academic discounts aside from operation efficiencies and reduction in overhead from the former resale store. Consequently, the absence of resale store resulted to lesser DP in inventory, delivery vans, building use and other assets. The right hand side is maximize while deductions were minimized leading to optimal value-added outcome. Obviously, wealth distributable to stakeholders will be in better amounts except to MIT employees.
The interesting point here is that the supposedly increased in wealth of MIT could be in doubt as they downsized employees from 19 to 4 after e-procurement. This would mean that the contribution of employees was paid without regards to positive value added phenomenon ( 1999 p. 29). It can be argued that by efficiency or automation other stakeholders can benefit from reducing the workforce as long as one right hand side factor will be undermined before distribution. Clearly, the bold demarcation of value-added and profit accounting can be derived. Profit equation (see figure 1) does not highlight the impact of the net result of operations to all major stakeholders. In the contrary, value-added equation separates the beneficiaries of wealth (the right hand side) from the catalysts of wealth (the left hand side elements). This implicitly indicates that the right hand side is untouchable or not responsible to any stakeholder welfare.
The value-added statement in Britain referred its profit-undermining concept as a part of social responsibility reporting (p. 30). With this reference, authorities can question MIT about its workforce reduction as value-added reporting shows how productive (p. 39) not how efficient an organization is in using its resources. Efficiencies in paperwork, inventory costs, supplier communication, among others are in doubt if such were eliminated in a productive manner. Productive in the sense that they are managed to positively affect value-added attributable to stakeholders and not to prevent MIT responsibility on stakeholders. In this case, the net value-added is overstated (if not, distorted) because the operation failed to sustain the productive capacity of these purchasing activities to sustain the social responsibility of the organization particularly to its employees.
As the left hand side of the equation is the catalysts of value, the right hand side should be static at the end of the operation. In addition, the latter should not be responsible to other corresponding elements or other stakeholders. Value-added reporting concerns social responsibility and not the isolated welfare of shareholder, government, creditor or the firm. Further, the operation cycle of an organization is reflected in the equation. As pre-operation requirement, the organization employs labor, borrows money to creditors when financing fall short of budget, gets shareholder support for continuing the business or expansion, uses government roads and other infrastructures and involves its internal funding (W + I + DD + T + R). At the end of the productive operations, the organization results to a level of gross productive outcome deductible by input payments and asset reconciliation (S – B – DP). The residual or the level of the net productive outcome will be evaluated based on its ability to repay stakeholders.
When analyzed, MIT has became efficient rather productive during the adoption of e-procurement. Profit model rather value-added can best highlight this evolution. Since at the end of the operation, W in the right hand side is reduced, the contribution of W during the non e-procurement years (like friendship of sales people with customers) is undermined and extracted by automation. In addition, the marketing contribution of the former campus computer resale store was undermined and extracted by virtual environment. This made the distorted rise in the wealth of MIT as the accumulated contribution of W and store are passed to e-procurement as there was a pick-up of S and cost-efficiencies in B and DP. MIT should had paid for W or DP specifically at the end of operations but e-procurement made the organization efficient that enabled them to avoid the payment, thus, seemingly led to increase in wealth.
Design-Build (D&B) Procurement: A Curtain against Stakeholder Liability
The D&B concept has long been used by the United States and United Kingdom but already gaining popularity in Hong Kong ( 2004 pp. 387+). It is a procurement method where one entity, usually a contractor, is accountable to the contract of design and construction (pp. 387+). Since the concept is widely used by public offices, replacing the traditional design-bid-build model, four advantages are eminent. The risk is transferred to the contractor, the resources and competencies of contractors are maximized, improved resolution for reflecting public accountability and lesser inconsistency between designs to actual construction.
D&B first advantage makes the public office (the client) operation risk-free without submission to risk-return trade-off ( 1999 p. 185). This means that the client can execute its social responsibility goal without the monetary and social costs associated in the future of the contract. This connotes that the B that is deductible to S (assuming that S passes value-added definition of non-for-profit organization) has lower net present value (NPV) as the contactor already shouldered deviations from the expected B. As the construction industry is sensitive to price fluctuations particularly in raw materials like steel, cement and timber ( 2002 pp. 23-24), the risks of future changes of these inputs are avoided by the client. Hence, there is value-added created for the right hand side of the equation due to the absence of coordination and contingency costs which can be diverted to other socially beneficial allocations. In this respect, value-added does not merely increased but even expand to other worthwhile projects due to the significant residual in S.
However, Hong Kong clients are expecting “all in-service” ( 2003 pp. 419+) to contactors from the time the contract is agreed. In view of employee accidents or even fatalities, the value-added approach cannot reflect looses of value that should have been shouldered by a socially-oriented client. In addition, the ability of the client to change the design of the contractor and dictate several aspects of actual construction with the aid of consultants (pp. 419+) serve as further value-added with respect to B. DP is also minimized as the duration of the construction is bound to early finish due to political pressures (pp. 419). The high bargaining power of the client put the left hand elements to minimal levels despite the maximization efforts applied in the S. As these clients are not responsible to the contractor, value-added equation has many qualitative factors to consider in arriving at the net value- added distributable to stakeholders. With this, the second advantage of D&B has already been accounted.
With this admission, value-added approach is doubted to reflect the performance of Hong Kong public office. The presence of many qualitative pressures in the left hand side of the equation and little impact to the right hand side is a clear manifestation of the deficiency. In addition, explaining the third and fourth advantages within the value-added veil would only lead to inconsistencies in the preceding advantages. How would improvement in public accountability be reflected if the client merely passes the burden to the contractor? If any, financial records will be more transparent for allocation scrutiny due to private entity intervention in both the design and construction stages. Further, how can design inconsistencies be minimized if there are consultants (client representatives) guarding the construction? Would this practice only increase B due to consultancy fees?
Automation: The Stakeholder Retaliation
In its endeavor to reduce designing costs and increase productivity, the purchasing department of Bavarian Motor Works (popularly known as BMW) bought a technology to replace manual crash-testing of cars by machine-operated procedure ( 2003). In the process, B is increased as well as potential DP due to declining valuation of machines in the future. However, the thinking of efficiency and productivity was reached because of the distortion earlier identified in MIT case. The deduction pressure and supposedly value-added was gained from the right hand side of the equation, which in our MIT discussion, should not be. BMW engineers were possibly bargained to “do less for less pay”. However, an organization cannot undermine the power of initiative, creativity and uniqueness of human resources (represented by W in the equation) in favor of efficiency.
As soon as BMW generated the noise of the new technology, competitors bought the same package from hi-tech vendors. Differentiation strategy was easily diminished and BMW’s design was practically devalued. In effect, the S in BMW value-added equation plummeted which aggravated the B and DP rise, and more importantly, distortion in the right hand side of the equation particularly W. The error was later identified wherein purchasers excluded the complex intangible resource (the interactions among design engineers) in automation decision. This incident clarified that both efficiency and productivity theories present in automation of BMW design stage were misleading.
The value-added approach clearly showed that BMW erred in automation strategy because it threatened employees (a major stakeholder) to satisfy R or other right hand side elements. In this view, our finding in MIT case (that the right hand side should be static to avoid value-added distortion) is enforced. In addition, stakeholder elements should be maintained, or better increased, to assure that differentiation strategy or simply quality is present in the production or service provision. This can have merit in terms of competitiveness. For example, if taxes are not evaded, no litigation will be applied to the firm that could even lead to stronger political lobbying and public image.
Conclusion
We have discussed value-added approach in terms of different kinds of organization (educational – MIT, public – Hong Kong clients and private – BMW). The MIT case is an eye-opener as it outlays the inherent features of the approach as well as directly denouncing that mere efficiency is beneficial to society in strict manner. The analysis highlights that procurement activities can distort the equation as the approach only merited productive capabilities of an organization. In effect, it suggests that social stakeholders should be favored over technological breakthroughs which only serve to eliminate social responsibilities. On the other hand, the Hong Kong case reveals that the approach is not conducive in situations where there are too many qualitative factors involve. Subsequently, this shows that D&B procurement of public clients does not indicate greater social accountability rather anxiety from the risk of failure in meeting the project due constraints in budget, time and quality. Lastly, the BMW case is a confirmation of MIT finding. However, this particular discussion led us to emphasize the importance of human resources against technology. In the MIT case, we have a hard time validating this because the e-procurement resulted to seemingly positive outcomes.
Appendix
Figure 1: Value-Added Equation
Profit accounting is R = S – B – DP – W – I – DD – T (with little mathematical manipulation) value added equation will be S – B – DP = W + I + DD + T + R.
Where,
R = retained earnings
S = sales revenue
B = bought-in materials and services
DP = depreciation
W = wages
I = interest
DD = dividends
T = taxes
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