Our business decisions have been overly influenced for decades by the Invisible Hand theory. The Invisible hand is a term coined by Scottish economist Adam Smith over 200 years ago. The basic premise was that people will do business with each other in a free market which best decides the price of goods and services. An unfettered free market did not want any government intervention. When everyone works for their own self interests, we will collectively be better off, was the thinking behind the Invisible Hand.
We can 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 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 erosion of long-term economic development.
Business management training, until more recently 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 government’s job. 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 – economic interests first.
Quality management started to drive value which 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 which 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 which influence value.
If we get the lowest cost from buying imported clothing and uniforms for our civic park staff, a city budget may see a savings on a line in their budget. What is not seen, may be the exploitation of the individuals that made the uniform 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. Factors which require that the uniforms are sourced from a supplier which is audited for compliance with ISO 20400 social procurement standards and / or ISO 14000 environmental standards.
The park’s budget for clothing may reflect a higher out-of-pocket cost but the 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 which will offer competitive prices and we can find one with the lowest cost. If, under the Indivisible Hand model, we set higher standards such as ensuring fair or living wages be paid to the employees of potential custodial suppliers, as buyers, 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 arguably, a large bundled contract may yield the lowest cost, the other 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 with barriers, contributes greatly to economic and social development. Ensuring that small 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 which 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 which 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?