Private and public sector perspectives on the term ‘value added’

The term “value added” has become a near-meaningless phrase that occurs throughout business writings.

As originally conceived, value added was defined as the surplus of sales over cost of bought-in goods and services. It was a measure of how much value a company added to its products by its own efforts (even if those “efforts” amounted to no more than passively holding the goods in question until a buyer wandered along).

This definition of value added is closely related to the definition of Gross National Product. However, in recent years, the term has been used so generally that it now lacks any precision at all.

For a private business, value added may be defined as sales less bought-in materials, components and services.

It can be calculated from profit before interest and tax by adding back employee costs, depreciation and amortization.

It is thus a measure of the wealth created by a business activity, which is available for distribution among the providers of capital (whether in the form of debt or equity), to workers (as salaries, wages and pensions), to governments (as taxes) and for internal investments by the business itself to sustain, grow and develop.

When considered from the perspective of an individual aspect of any organization, conceptually, it describes the following types of contribution to the production or service operations of the organization:

• The positive difference between a statistically predicted performance (based on prior attainment and the general pattern in the data) that would likely be encountered if a measure or process was not put into place, and the actual performance after that process is put in place;
• the extent of relative progress achieved in the value of each key stage of production or delivery process; and
• the contribution of innovative ideas and other forms of technical assistance that improve the efficiency of an operation, i.e., increase its income earning potential or improve the amount of utility derived from the same amount of expenditure. Alternatively stated, it includes any technical or professional support provided to an organization which enhances its ability to capture, derive or create a net gain in value from the assets at its disposal.

As should be clear from the discussion so far, there are several ways in which a purchasing department can add value to the operations of any organization, including a municipality.

I would consider such added value services as performance improvements, supplier assessment, streamlining the procurement process and project management.

There is also value added benefits in monitoring the internal process of supply with a view towards effecting improvements whenever possible.

The general goal is to cut both the time and cost involved in sourcing necessary supplies.

I have talked about benchmarking in previous articles and believe it is still one of the more popular techniques for measuring the extent of acceptable performance.

It is a highly respected practice in the business world and can be considered as a value added process in the long-term. Any company or public sector organization should look both inward and outward to find best practices and high performance and then measure actual business operations against those goals.

Both external and internal benchmarking can be used in conjunction with other improvements tools.

Under an internal program of benchmarking, performance targets are fixed, current performance is assessed, methods are devised for improving the standard of performance to a target level, and then a measurement is taken after a reasonable period to determine whether progress has been made towards reaching those targets.

Under external benchmarking, the performance of an organization in key areas is compared with that of its principal competitors. The goal of external benchmarking to add value is to bring about continuous improvements in service delivery.

Stephen Bauld is a government procurement expert and can be reached at swbauld@purchasingci.com. Some of his columns may contain excerpts from The Municipal Procurement Handbook published by Butterworths.