by manufacturing.If the main resource used is physical or intellectual energy,with a minimum of raw materials, we call it a service. The word process describes the flow of work, which enables production of goods or provision of services. In every commercial or industrial venture there is a flow of work, or Business Process. The business can vary widely; from a firm of accountants to a manufacturer of chemicals to a courier service.
In the case of many service industries, the output is information.Lawyers and financial analysts apply their knowledge, intellect, and specialized experience to process data and advise their clients. Management consultants advise businesses, and travel agents provide itinerary information, tickets, and hotel reservations. In all these cases, the output is information that is of value to the customer.
1.1.1 Criteria for assessing efficiency
In any process, we can obtain the end result in one or more ways. When one method needs less energy or raw materials than another, we say it is more efficient. For a given output of a specified quality, the process that needs the least inputs is the most efficient. The process can be efficient in respect of energy usage, materials usage, human effort, or other selected criteria. Potential damage to the environment is a matter of increasing concern, so this is an additional criterion to consider.
If we try to include all these criteria in defining efficiency, we face some practical difficulties. We can measure the cost of inputs such as materials or labor, but measuring environmental cost is not easy. The agency responsible for producing some of the waste products will not always bear the cost of minimizing their effects. In practical terms, efficiency improvements relate to those elements of cost that we can measure and record. It follows that such incomplete records are the basis of some efficiency improvement claims.
1.1.2 Improving efficiency
Businesses try to become more efficient by technological innovation,business process re-engineering, or restructuring. Efficiency improvements that are achieved by reducing energy inputs can impact both the costs and undesirable by-products. In this case, the visible inputs and the undesirable outputs decrease,so the outcome is an overall gain. A similar situation arises when it comes to reducing the input volume of the raw materials or the level of rejections.
When businesses make efficiency improvements through workforce reductions, complex secondary effects can take place. If the economy is buoyant, there may be no adverse effect, as those laid-off are likely to find work elsewhere. When the economy is not healthy, prevailing high unemployment levels will rise further. This could perhaps result in social problems, such as an increase in crime levels. The fact that workforce reductions may sometimes be essential for the survival of the business complicates this further. There may be social legislation in place preventing job losses,and as a result, the firm itself may go out of business.
1.1.3 Cost measurement and pitfalls
There are some difficulties in identifying the true cost of inputs. What is the cost of an uncut piece of diamond or a barrel of crude oil? The cost of mining the product is all that is visible, so this is what we usually understand as the cost of the item. We can add the cost of restoring the mine or reservoir to its original state, after extracting the ores that are of interest, and recalculate the cost of the item. We do not calculate the cost of replenishing the ore itself, which we consider as free.
Let us turn to the way in which errors can occur in recording costs. With direct or activity-based costing, we require the cost of all the inputs. This could be a time-consuming task, and can result in delays in decision making. In order to control costs, we have to make the decisions in time.
Good accounting practice mandates accuracy and, if for this purpose it takes more time, it is a price worth paying. Accounting systems fulfill their role, which is to calculate profits, and determine tax liabilities accurately. However, they take time, making day-to-day management difficult. Overhead accounting systems get around this problem by using a system of allocation of costs. These systems are cheaper and easier to administer.However, any allocation is only valid at the time it is made, and not for all time. The bases of allocation or underlying assumption schange over time, so errors are unavoidable. This distorts the cost picture and incorrect cost allocations are not easy to find or correct.
Subsidies, duty drawbacks, tax rebates, and other incentives introduce other distortions. The effect of these adjustments is to reduce the visible capital and revenue expenditures, making an otherwise inefficient industry viable. From an overall economic and political perspective, this may be acceptable or even desirable. It can help distribute business activity more evenly and relieve overcrowding and strain on public services. However, it can distort the cost picture considerably and prevent the application of market forces.
We have to recognize these sources of errors in measuring costs. In this book we will use the concept of cost as we measure it currently, knowing that there can be some distortions.
1.2.1 Mechanization and productivity
When we carry out some part of the production or distribution process, we are adding value by creating something that people want.We have to measure this value first if we want to maximize it. Let us examine some of the relevant issues.
In the days before the steam engine, we used human or animal power to carry out work. The steam engine brought additional machine power, enabling one person to do the work that previously required several people. As a result each worker’s output rose dramatically. The value of a worker’s contribution, as measured by the number of items or widgets produced per hour, grew significantly. The wages and bonuses of the workers kept pace with these productivity gains.
1.2.2 Value added and its measurement
We use the cost of inputs as a measure of the value added, but this approach has some short comings. Consider ‘wages’ as one example of the inputs. We have to include the wages of the people who produced the widgets, and that of the truck driver who brought them to the shop. Next we include the wages of the attendant who stored them, the salesperson who sold them, and the store manager who supervised all this activity. Some of the inputs can be common to several products, adding further complexity. For example, the store manager’s contribution is common to all the products sold; it is not practical to measure the element of these costs chargeable to the widgets under consideration. We have to distribute the store manager’s wages equitably among the various products, but such a system is not readily available. This example illustrates the difficulty in identifying the contribution of wages to the cost. Similarly, it is difficult to apportion the cost of other inputs such as heating, lighting,or ventilation.
We can also consider ‘value’ from the point of view of the customers. First, observe the competition, and see what they are able to do. If they can produce comparable goods or services at a lower price than we can, customers will switch their loyalty. From their point of view, the value is what they are willing to pay. The question is: how much of their own work are they willing to barter for the work we put into making the widgets? Pure competition will drive producers to find ways to improve their efficiency, and drive prices downward. Thus, another way is to look at the share of the market we are able to corner.Using this approach, one could say that Company A, which commands a larger share of the market than Company B, adds more value. Some lawyers, doctors, and consultants command a high fee rate because the customer perceives their service
