Our business decisions have been overly influenced for decades by the theory of the Invisible Hand. The Invisible Hand is a concept coined by Scottish economist Adam Smith over two hundred years ago. The basic premise is that people will do business with each other in a free market that best decides the price of goods and services. An unfettered free market would not want any government intervention. This concept upheld the idea that when everyone works for their own self-interest, we will collectively be better off.
We can now see the shortcomings of the Invisible Hand, which operated in a time with slave labour, a privileged few controlling commerce, harsh working conditions, child labour practices, and an absence of environmental responsibility. Natural resources were seen as being infinite but also worth fighting over. The Invisible Hand directed the growth of the Industrial Revolution.
Fast forward to today. In Canada, many of the shortcomings of the Invisible Hand have been eradicated in the marketplace – but not all. We acknowledge that government intervention is necessary to enforce responsible business practices. We complement the Invisible Hand with a term this author refers to as the Indivisible Hand of government. The Indivisible Hand guides and, out of necessity, monitors the Invisible Hand to ensure social and economic interests are realized in a sustainable manner.
Any model which is primarily profit-based from a Supply side needs to be effectively balanced by the Demand side. Procurement practices, built on the Invisible Hand values, were aimed at attaining the lowest cost. This theory seemed to make sense until we looked deeper into the supply chain and found that the lowest cost came at the expense of social values and the erosion of long-term economic development.
Until more recently, business management training was primarily based on Smith’s theory that as long as a product was legally sold, the market would set the price and should not concern itself with the public welfare – that was the job of government. Public sector procurement also followed the Smith theory, where the lowest cost from a tendering process must deliver the best value. Procurement decisions were largely one-dimensional – with economic interests first.
However, quality management started to drive value, which in turn affected costs. Investing in quality management was primarily a means to ensure economic benefits would accrue. Environmental interests followed quality management rather reluctantly – until we could connect environmental benefits with sustaining profits. Social procurement didn’t hit the procurement radar until the early 2000s.
Procurement, which is a transactional tool of the Demand side, needed to redefine the value proposition to go beyond the lowest cost and be based on values of a larger stakeholder base. Procurement in private and public sectors began realizing that the lowest cost was not a sustainable model. The Indivisible Hand, through legislation and by supporting international standards, has been transformative in affecting how we think of value. We need a three-dimensional model with economic and environmental interests meeting the expectations of stakeholders.
This has led to the emergence of value-based sourcing. Value-based sourcing is a more comprehensive decision-making approach that goes beyond the out-of-pocket costs. Where the objective of competitive bids has traditionally been focused on the lowest cost, the value-based approach is inclusive of other direct and indirect factors that influence value.
If we get the lowest cost from buying imported clothing and uniforms for our park staff, a city budget may see a savings on a line in their budget. What is not seen is the potential exploitation of the individuals who made the uniforms or the environmental degradation in the country of source through the discharge of chemicals to dye the uniforms. Value-based sourcing, or social procurement, requires that other factors be addressed, such as a requirement that the uniforms are sourced from a supplier audited for compliance with ISO 20400 social procurement standards and / or ISO 14000 environmental standards.
The price line in the park’s budget may reflect a higher out-of-pocket cost, but that price will be value-based. If we shop closer to home, we can see similar outcomes. If we source custodial services following the Invisible Hand model, we will identify several suppliers offering competitive prices and we can find one with the lowest cost. If, under the Indivisible Hand model, we as buyers set higher standards such as ensuring fair or living wages are paid to the employees of potential custodial suppliers, a competitive bid will be awarded but the price will also be value-based. Stakeholder expectations are still being met. We know that the economic multiplier effect redistributes the revenues within the local economy.
Value-based thinking is critically important for government spending. With the billions of dollars spent annually for goods and services by various governmental departments, we need to ensure that a common set of values or principles are reflected in the award criteria. The message sent out in the tender criteria and weighting is reflected in the competitive responses. Awarding large contracts on a consolidated commitment, where only a handful of large multi-national corporations can supply, negates the opportunity for small medium enterprises and social enterprises to compete. This opportunity is enshrined within the Canadian Competition Act as follows: ensure that small and medium-sized enterprises have an equitable opportunity to participate in the Canadian economy. While a large bundled contract may arguably yield the lowest cost, the dimension of social development will offset the out-of-pocket savings in the long term.
Having procurement engage with social enterprises to create meaningful jobs for people facing barriers contributes greatly to economic and social development. Ensuring that small-to-medium businesses are economically viable in local communities builds social capital. Changing the idea from providing public welfare to supporting public well-being is facilitated through social procurement practices.
The Invisible Hand favoured unfettered market transactions that benefited a small group of stakeholders. This led to the idea that profits should trump principles. The courts had to intervene to establish laws on conducting business. Business ethics and codes of conduct emerged to signal a change in behaviour and practices. The Indivisible Hand favours a market transformation that reflects the values of the majority of its stakeholders. The latter theory does not compromise principles or budgets. It does provide a better answer to the question: Why did we buy that?
Larry Berglund | SCMP | MBA | FSCMA
Larry Berglund has been a lecturer for United Nations staff and advocates on the role of social enterprises as being an integral part of the supplier community. Larry drafts public sector procurement policies which address social and economic development opportunities, as well as assists social enterprises to successfully win competitive bids. He was involved in drafting the first social and ethical procurement policy for a municipality in Canada. He also created and now facilitates the SCMA Ethical Behaviour & Social Responsibility Workshop. Larry was recently awarded a contract to facilitate the expansion of social procurement strategies within government entities, increase the understanding by elected officials and suppliers, and to develop social procurement skills with procurement professionals. Larry’s recent book is Good Planets are Hard to Buy.
Readers are cautioned not to rely upon this article as legal advice nor as an exhaustive discussion of the topic or case. For any particular legal problem, seek advice directly from your lawyer or in-house counsel. All dates, contact information and website addresses were current at the time of original publication.