The Role of the Management in Kosovo SME's,the Help they need to overcome the Economic Crisis

Biannually Volume I

Issue 2(2)

Winter 2010

ISSN 2068-7532

J

AS

ER

S

ournal of Advanced Research in Management

Journal of Advanced Research in Management

92

Contents:

1

Return Migration in Italy: What do we know? Alessio Emanuele Biondo University of Catania Simona Monteleone Parthenope University of Naples …94

5

Vertical Integration in High-Transaction Cost Sectors: The Case of the Bulgarian Pharmaceutical Industry Tamara Todorova American University in Bulgaria … 127

2

Basic Concepts of Change Management of SMEs Elena-Oliviana Bold University of Craiova … 102

6

The Role of the Management in Kosovo SMEs, The Help They Need to Overcome the Economic Crisis Fatos Ukaj Faculty of Applied Science in Business, Pejë, Kosovo … 139

3

ISO14001 EMS’s Impact on Employee Attitudes: A Review of the Literature Harjeet Kaur DBA (UniSA), HELP University College Malaysia … 112

7

Enterprise Modelling Based on Combination of Process and Rea Value Chain Perspective Dominik Vymetal Silesian University Frantisek Hunka University of Ostrava Miroslav Hucka VSB-Technical University Josef Kasik VSB-Technical University … 145

4

Economic Feasibility of the Reengineering Projects Laura Ştefănescu Spiru Haret University Andy Ştefănescu University of Craiova … 120

Winter 2010 Volume I, Issue 2(2)

Editor in Chief Andy Stefanescu University of Craiova, Romania

Co-Editors

Rajesh H. Pillania Management Development Institute, India

Editorial Advisory Board

Huseyin Arasli Eastern Mediterranean University, North Cyprus

Madalina Constantinescu Spiru Haret University, Romania

Jean-Paul Gaertner Ecole de Management de Strasbourg, France

Harjeet Kaur, HELP University College, Malaysia

Rita Yi Man Li University of Hong Kong, Hong Kong

Piotr Misztal Technical University of Radom, Economic Department, Poland

Russell Pittman International Technical Assistance Economic Analysis Group Antitrust Division, SUA

Chuen-Khee Pek Nottingham University Business School, Malaysia

Rachel Price-Kreitz Ecole de Management de Strasbourg, France

Laura Stefanescu Spiru Haret University, Romania

Laura Ungureanu Spiru Haret University, Romania

Sumati Varma Delhi University, India

Hans-Jürgen Weißbach University of Applied Sciences – Frankfurt am Main, Germany

ASERS Publishing http://www.asers.eu/asers-publishing ISSN 2068-7532

Volume I Issue 2(2) Winter 2010

93

The Journal aims to serve researchers, scholars through prompt publications of significant advances in any branch of management science, and to provide a forum for the reporting and discussion of news and issues concerning management science. The editorial objective of the journal is facilitation of knowledge enhancement related to studies in the following fields, but is not limited to these:

Organizational Studies; International management issues; Knowledge management; Reengineering organizational; Entrepreneurship in the global marketplace; Business internationalization/globalization; Strategic alliances, partnerships and networks; Global strategies for cooperation and competition; Financial management; Supply chain management; Information systems, technology, innovation and operations management; Educational management and leadership; Total quality management; Management/business information systems; International Project Management; E-Business Innovation and Process Management; ……..Any other related topic.

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variety of international issues, empirical research and other matters of interest to researchers and practitioners in a diversity of subject areas linked to the broad theme of management.

All papers will first be considered by the Editors for general relevance, originality and significance. If accepted for review, papers will then be subject to double blind peer review.

Deadline for Submission: 5th June 2011 Expected Publication Date: June – July 2011 Web: www.asers.eu/journals/jarm/ E-mail: [email protected] To prepare your paper for submission, please see full author guidelines in the following file: JARM_Full_Paper_Template.doc, then send it via email at [email protected].

Call for Papers Summer_Issue 2011


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mailto:[email protected]

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94

RETURN MIGRATION IN ITALY: WHAT DO WE KNOW?

Alessio Emanuele BIONDO

University of Catania, Italy [email protected]

Simona MONTELEONE Parthenope University of Naples, Italy

[email protected]

Abstract Return migration is the positive counterpart of brain drain. Human capital accumulation increases in a country if

skilled agents go back home after a period spent working abroad. Effects of brain drain in Italy could be negative as highly skilled migrants decide not to come back to their native country. Our simple model shows that if preference for home consumption is balanced by career opportunities and life-style conditions, agents leave Italy and prefer to remain abroad. Data support and policy implications are provided.

Keywords: return migration, brain drain

JEL Classification: F22, J24

1. Introduction Return migration is the flow of migrants who come back to their home country after a period spent in a

foreign country for activities usually related to job or human capital accumulation. When it occurs as the resulting phenomenon from a brain drain migration, human capital accumulation of the country of origin increases in time as highly skilled agents come back and import their abilities.

The propensity to return in the country of origin after a period spent abroad varies among countries, and the percentage of migrants who return within 10 to 20 years is between 25% and 30% of the initial group (Borjas, and Bratsberg 1996; Dustmann, and Weiss 2007). This kind of migration is especially concentrated among the highly educated agents, who are often among the most successful of them (Johnson, and Regets 1998; Luo, and Wang 2002; Commander, et al. 2004; Gundel, and Peters 2008; Batista, et al., 2007; Zucker, and Darby 2007).

Propensity to return of Italian highly skilled workers has been revealed very low as results from empirical findings reported in a statistic investigation by Monteleone, and Torrisi (2010). This paper builds a theoretical model which fits this evidence, showing that Italian return migration suffers because of certain structural conditions of the labor market. The provided explanations of these results suggest policy implications in sight of more adequate human capital accumulation.

The paper is organized as follows: Section 2 gives a brief overview about return migration literature; Section 3 presents the model which shows theoretical support of low propensity to return of Italian agents; Section 4 provides some policy implications and Section 5 provides conclusion.

2. Return migration

Effects of brain drain are described in literature either as negative or positive according to the highlighted prevailing factors of this phenomenon. In fact, some prefer to consider only effects on labor market, giving insights of negative impact. More recent contributes suggest, instead, to give more weight to human capital accumulation, underlining positive aspects on economic growth (Carrington, and Detragiache 1998; Bein, et al., 2003; Commander, et al. 2003; Giannoccolo 2006; Monteleone 2010).

Bhagwati and Hamada (1974) explain that economic integration of markets and consequent migration implies a net loss for poorer countries, both in productive and in fiscal terms, given that more specialized workers (and therefore those with higher potential salaries) move away.

Haque and Kim (1995) suggest that brain drain affects negatively long-term income, given that reduces the internal human capital accumulation rate and increases migration rates from countries that remain unproved of qualified workers.

Mountford (1997) acts as a watershed between supporters and opponents of brain drain. In fact he highlights how positive on economic growth the chance to gain higher wages for workers can be: because of uncertainty he holds that emigration rates would remain within an acceptable range, giving the chance to




95

stimulate education diffusion. This stream of literature assumed in years increasing weight, as demonstrated considering Vidal (1999), Bein, Docquier, and Rapoport (2001), Docquier, and Rapoport (2009), among others.

Therefore return migration is the main positive consequence of brain drain. The return gives, on one hand, to an agent the chance to improve skills and to gain higher wages; on the other hand, to the country of origin, the possibility to increase its stock of capital accumulation and to ignite educational externalities which lead to a more specialized work force.

As a matter of fact, who migrates aiming to return, has the opportunity to accumulate human capital in the host country during the period of emigration, through a process of learning by doing, and then disseminate this new knowledge in the country of origin (Dos Santos, and Postel-Vinay 2003).

Mayr and Peri (2008), note that agents from richer countries (East Europe, Asia and Latin America) have a greater tendency to migrate and to return home compared to ones from poorer countries (Africa). The same view is suggested by Dustmann, and Weiss (2007), who argue that agents emigrated from countries in EU, America, Australia and New Zealand, mainly return home after a period, while emigration from India and Africa assumes substantially permanent characterization. In particular, they focus on migrants from UK and say that migration is temporary: strongly temporary among highly skilled workers.

Return migration seems valid for most European countries but Italy. Because of the lack of statistic observations about Italian brain drain (and therefore about the potential return migration associated to it), our model tries to fit empirical findings of Monteleone, and Torrisi (2010) who provide important empirical result about brain drain in Italy. Italian highly-qualified agents show a very low propensity to return back home. In their empirical work, these authors build a sample of 350 highly-skilled academic qualified Italian agents who decided to migrate to follow job opportunities. Responses from the interviewees give an interesting profile of the agents who leave Italy: they are aged between 31 and 40 years, mainly they are assistant professor and work in public universities. An important finding is a sort of „delay‟ suffered by Italian agents compared to their colleagues in developed countries with regard to age related to career progression. Over 70% of interviewed revealed a low or no propensity to return to Italy. This result confirms the intuition stated above about the permanent character of Italian emigration: who migrates is not willing to return to Italy after a period spent abroad. Reasons behind migration and no return propensity have revealed to be mainly:

scarce availability of research funds; either scarce or not meritocratic career opportunities; lack of adequate infrastructures; very low wage structure and therefore life-style limitations; Environment not sufficiently stimulating. The model will show that with these characteristics in the academic job market, return migration to Italy is

absent.

3. A simple model with no return migration We consider the productive life of an agent, and for sake of simplicity we neglect uncertainty about future

wages and costs of migration. There exist two countries in the world, Italy (Home country – H) and the destination

country (Foreign country – F). Time )(t is assumed to be continuous between 0t (moment of decision to

emigrate) and Tt (moment of death): therefore we neglect retirement issues, because agents will work all life

long. Wages in home and foreign countries are denoted by Hw and

Fw . Wages are function of time spent

working in a country. It is realistic that workers earn increasing salaries, as time passes. Wage in host (home)

country is a function of time spent working abroad, (at home, T ). We assume that )(FF ww

with 0)( ddwF, and )(HH ww with 0)()( ddwH

. As the sample revealed, we consider

that the initial condition which inspires the migration decision is that )0()0( HF ww . Interviewed sample

reveals that, at least as perception, high-skilled post graduate workers find

that ddwddw HF )()( . This is associated with the idea of a true and very strong correspondence

between effort and wage dynamics of foreign careers in the academic sector, which inspire much of the reduction of Italian migrated workers‟ propensity to return.

Worker‟s lifetime utility function is


96

dttcudttcuU HT

HFF )]([)]([0

(1)

represents a preference weight between home and foreign consumption. Interviewed workers of the

sample propend to show a value of less than one. This descends from the feelings that high skilled Italian

academic workers showed: they think their foreign life-style and job-conditions are better than those they had in Italy.

This makes life (i.e. consumption and therefore utility) abroad preferable if we have to compare with the domestic one, even those among them who previously worked in Italy, and found opportunity to leave, left. This proves that there exists a basic reason of little satisfaction in domestic job condition, along with the case that the interviewed people face scarce possibility of career and too little evidence of skill/productivity-based careers in Italy. Furthermore, given the greater human capital accumulation of individuals in the sample, it is reasonable to expect that these persons are more open-minded and thus less reluctant to build their lives in a foreign country. Generally speaking, the stronger the opportunity on foreign job market – relatively to the domestic one, the higher the life-style attainable abroad, the lower the appreciation for consumption at home, the lower the propensity to

return. All of this explains why eventually represents the propensity to return. Imposing that 1 would

explain strongly why workers prefer not to return. We assume that 1 . However, will not drop out the

formulas because a general implication even for 1 will be provided. Since we assume no discount for sake

of simplicity, and considered that marginal utility of consumption is assumed to be decreasing, this implies that during both sub-periods of time (time spent abroad and time spent at home) consumption levels will be constant. Thus, Equation(1) can be written as

)()( HF cucuU (1‟)

where Hc and

Fc are the optimal constant flows of consumption, at home and abroad, and therefore

lifetime utility of agents is determined as the sum of two products, each referred to the period of time spent abroad and in the home country.

Utility function in each sub-period is assumed to be

1)(

1ccu j

(2)

with 1 , HFj , .

The lifetime budget constraint is

HFT

HF pccdttwdttwY

)()()(0

(3)

)(Y is the lifetime income and p is the home to foreign consumption relative price,FH ppp . The

decision of migration is inspired by the occurrence of a lower or no wage in the home country. The maximization of (1‟) subject to (3) leads to

)(')(' HF cup

cu

Moreover, posing that 1p (considering the case of Italians going in other industrialized country, the

hypothesis that home consumption is cheaper/more expensive than foreign one would not be always realistic), one could get:

)(')(' HF cucu (4)


97

Immediately, from Equation (4), and given the Equation (2), it results:

FH cc 1 (5)

Solving Equation (5) and Equation (3) we gain the optimal values of consumption:

1

)(

YcF

and

1

1 )(

YcH

(6)

The sample reveals that initial hypothesis [ )0()0( HF ww ] explains why high skilled workers move

away. This explanation is supported by the comfortable feelings in reaching job opportunities. High skilled Italian academic workers enjoy abroad chances that in Italy they did not find. First of all, in order to check if they prefer not to return, consider how lifetime income evolves with respect to . It means to evaluate the first derivative of

Equation (3) w.r.t. :

dtt

tdwww

d

dY TH

HF

)(

)()0()(

)( (7)

Consider Equation (7) for how it evolves while tends to T: i.e. if agents decide to remain abroad.

Assuming that wage dynamics is constantly increasing in time, at home and abroad, i.e. kdttdw ])([ (as

widely found in literature, for example in Jacobson, et al., 1993 and in Ljungqvist, and Sargent 1998) the integral in the r.h.s. of Equation (7) becomes

)()(

)(

Tkdt

td

tdwTH

whose limit for approaching T is zero

0)(lim

TkT

As initially assumed, )0()0( HF ww , and given 0)( ddwF, then 0)0()( HF ww and

thus, Equation (7) is increasing in and positive. The latter conclusion is immediately verifiable as one that can

show that

0)0()()()0()( kTkwwTkww HFHF (8)

since

Tkkww HF )0()(

Lifetime income then rises as grows: this represents the income incentive for no return.

Secondly, we question how lifetime utility is affected by time spent working abroad. Differentiating Equation (1‟) w.r.t. yields

)(')(')1)(( 1

Ycucud

dU FF (9)

which is positive if 10 . It still remains positive for some positive (not „too big‟) values of and

further research will be conducted to show the turning point.


98

Thus, we can conclude that time spent working in the foreign country not only does provide higher wage from the beginning, but also increases utility, and thus reduces propensity to return as time passes.

This model explains evidence of data from a theoretical perspective. Of course, results would be reversed if conditions of preference about location of consumption or purchasing power of income were changed.

Abandoning features of the Italian sample, and more generally, for higher positive values of , the model does

not describe the experience of individuals in the sample, who expressed feelings of satisfying life-style and job conditions. In this case, the model would vest in more weight to consumption at home. The same rationale is behind the assumption that wage in Italy does not depend on foreign work experience. This condition has been imposed because it is typical for Italian academic job market: there is not any additive merit to those who started working abroad. Another important issue is that this model can explain exceptions derived from any form of

„patriotism‟: very high values of can revert results even for extremely advantageous foreign wage dynamics.

4. Some policy implications

Italian brain drain phenomenon appears to be a consequence of a structured set of problems which engrave on the Italian scientific research. Among the causes, there exists a severe lack of infrastructures and adequate equipments, scarcity of funds for research (which sometimes appear to be assigned in a non meritocratic way), and the extremely low wage level compared to standards in other countries. Responsibilities of this situation are eventually due to the extremely low attention that many Governments (independently of any political orientation) dedicated to Italian Academic system and to public research development, which did not assumed any strategic role in the long term path of the country. A part of the responsibility lies also on the private sector of firms and entrepreneurs, because they did not show to understand the relevance of investments in public research as well. Consequences of this state of the art are, first of all, the loss of prestige and competitiveness at international scale that Italy risks to face, secondly the impoverishment in terms of human capital. As a third aspect, the country could become less attractive in terms of scientific careers for distinguished foreign researchers who could give important insights to the domestic academic sector. Fourthly, courses and educational supply of universities could reveal neither attractive nor competitive for international students.

In order to avoid the realization of these predictions some attempts have been done in 2001 with the creation of the first program for „brains return‟, which established some advantageous novelties in stipulating academic contracts with Italian scientists who had been working abroad for at least three years. One of these novelties was the commitment for a strong correspondence between salaries given in Italy and European standards; another was the appointment for more advanced infrastructures dedicated to those who would accept to return. Unfortunately, as Ziguras and Law (2006) showed, this kind of policy does not seem effective, and the Italian case did not represent an exception to their conclusions. Furthermore it must be noted that since 2006 the program has been stopped due to the lack of funds. Moreover, one should argue that if return policies are not associated to sector-specific development policies, there exists the chance to attract just less active researchers which could find convenient to return for familiar or personal reasons.

In 2003, guidelines for the foundation of the Italian Institute of Technology (IIT) were given. This institute should have been dedicated to the applied research in technology, mainly for industrial applications. But, as Saxenian (2001, 2002 and 2005) underlined for Taiwan, China, and India, the creation of a national research bureau requires important investments. Eventually these funds were absent in the Italian case.

More recently, the situation of Italian Universities has worsened. The percentage of GDP dedicated to research has not been increased. Government has rather chosen to strongly reduce public spending for research and investment in the academic sector. This, again, amplifies brain drain instead of reducing it. There is not a unique magic recipe to solve once forever the problem. But a way out can be depicted as a process.

First of all a new framework in educational system can be desirable as students could enter faculties with more basic knowledge, leaving the academic sector the role for giving them applications and scientific attitudes, instead to strengthen previous weak scholastic curricula. This aspect is particularly relevant because otherwise young Italians will not be competitive in an always more educated European job market. Secondly, enrolment procedures for academic careers may find new solutions to select more profitable work force. Thirdly, research needs experience but also young force and enthusiasm. Therefore, the incentive to focus on the lowering of the average age for academic personnel is strong: usually the more experienced agents can cover leading roles, but the younger can hold more dynamic and well-paid positions. Fourthly, the existence of a strong and well visible link between academic research and firms‟ innovation appears to be widely desirable. This could guarantee the


99

existence of funds for research for technical sciences as much as the possibility to raise funds for humanistic research, necessary for other none applied purposes.

Last but not least, economic treatment of professors is a key note in this entire framework. Academic personnel are often made by people who severely dedicated their younger years to study. These individuals must find opportunities to gain what they deserve: chances to demonstrate their value before entering; chances to grow in their career after they find their job. Productivity-measurement system must be implemented to make Italian academy more efficient and profitable at the same time, both for researchers and society.

There is the need to build a new incentive structure for academic workers and a more stimulating environment to ensure that Italian possibilities to express scientific excellence return to be the basis of economic growth and social development.

5. Concluding remarks This paper aimed to provide a general theoretical model to explain empirical findings by Monteleone, and

Torrisi (2010), of a low propensity to return for Italian brain drain. Basic reasons are related to the structural form of academic labor market in Italy. The idea that wage and job opportunities in this sector are not affected by time and human capital improvements gained abroad is the deep reason for no return. Emigrants experience highly productive job environments, career opportunities and better wages. Such aspects abate utility from home consumption, and are so strong and so deeply felt to induce Italian academic workers‟ commitment in fading out their propensity to return.

References:

[1] Batista, C., Lacuesta A., and Vicente, P. 2007. Brain Drain or Brain Gain: Evidence from African Success Story, IZA discussion paper 3035, Bonn, September.

[2] Bhagwati, J., and Hamada, K. 1974. The brain drain. International Integration of Markets for Professional and Unemployment. Journal of Development Economics vol.1.

[3] Bein, M., Defoort, C., and Rapoport, H. 2006. Brain drain and human capital formation in developing countries: winners and losers, IRES Discussion Paper n. 2006-23, May.

[4] Bein, M., Docquier, F., and Rapoport H. 2003. Brain drain and LDCs‟ Growth: Winners and Losers, IZA Discussion Paper n. 819, July.

[5] Bein, M., Docquier, F., and Rapoport, H. 2001. Brain drain and economic growth: theory and evidence. Journal of Development Economics 64 (1): 275-89.

[6] Borjas, G., and Bratsberg, B. 1996. Who Leaves? The Out migration of the Foreign-Born. Review of Economics and Statistic 78 (1):165-176.

[7] Carrington, W.J., and Detragiache, E. 1998. How big is the brain drain?, IMF Working Paper n.201.

[8] Commander, S., Kangasniemi, M., and Winters, L.A. 2003. The brain drain: Curse or Boon?, IZA Working Discussion Paper n. 809.

[9] Docquier, F., and Rapoport, H. 2009. Quantifying the Impact Highly-Skilled Emigration on Developing Countries. CEPR project, Fondazione Rodolfo Debenedetti.

[10] Dos Santos, M., and Postel-Vinay, F. 2003. Migration as a source of growth: the perspective of a developing country. Journal of Population Economics 16(1):161.

[11] Dustmann, C. 1996. Return migration. The European Experience, Economic Policy 22.

[12] Dustmann, C., and Weiss, Y. 2007. Return migration: Theory and Empirical evidence, CReAM, CDP n. 02/07 London.

[13] Giannoccolo, P. 2006. The Brain Drain. A Survey of Literature, Working Paper n. 526.

[14] Gundel, S., and Peters, H. 2008. What Determines the Duration of Stay of Immigrants in Germany? Evidence from a Longitudinal Duration Analysis. DIW Berlin, The German Socio-Economic Panel (SOEP).

http://ideas.repec.org/p/diw/diwsop/diw_sp79.html

http://ideas.repec.org/p/diw/diwsop/diw_sp79.html


100

[15] Haque, N.U., and Kim, S-J. 1995. Human capital flight: impact of migration on income and growth, IMF Staff Papers (42):577-607.

[16] Jacobson, L., Lalonde, R., and Sullivan, D. 1993. Earnings Losses of Displaced Workers. American Economic Review. (83): 685-709.

[17] Johnson, J.M., and Regets, M.C. 1998. International mobility of scientists and engineers to the U.S.: Brain drain or brain circulation?, National Science Foundation Issue Brief: 98-316.

[18] Ljungqvist, L., and Sargent, T.J. 1998. The European Unemployment Dilemma. The Journal of Political Economy vol. 106 (3): 514-550.

[19] Luo,Y.L., and Wang, W.J. 2002. High skilled migration and Chinese Taipei‟s industrial development. International mobility and the highly skilled. OECD editions, Paris.

[20] Mayr, K., and Peri, G. 2008. Return Migration as a Channel of Brain Gain, NBER Working Paper n.14039, http//www.nber.org/papersw14039.

[21] Monteleone, S. 2010. Brain Drain e Crescita Economica: Una rassegna Critica Sugli Effetti Prodotti, QA – Associazione Rossi Doria (forthcoming).

[22] Monteleone, S., and Torrisi, B. 2010. A Micro Data Analysis of Italy‟s Brain Drain, University of Naples ‘Parthenope’, Discussion Paper.

[23] Mountford, A. 1997. Can a brain drain be good for growth in the source economy?. Journal of Development Economics (53):287-303.

[24] Saxenian, A.L. 2001. Bangalore: The Silicon Valley of India, Center for Research on Economic Development and Policy Reform, Working Paper, 91.

[25] Saxenian, A.L. 2002. Transnational Communities and the Evolution of Global Production Networks: The Cases of Taiwan, China and India. Industry and Innovation 9 (3): 183–202.

[26] Saxenian, A.L. 2005. Brain Circulation and Capitalist Dynamics: Chinese Chipmaking and the Silicon Valley-Hsinchu-Shangai Triangle. in Nee, V., and Swedberg, R. (eds.). The Economic Sociology of Capitalism, Princeton NJ, Princeton University Press, pp. 325-351.

[27] Vidal, J.P. 1998. The effect of emigration on human capital formation. Journal Public Economics, vol.11.

[28] Ziguras, C., and Law, S.F. 2006. Recruiting international students as skilled migrants: the global „skill race‟ as viewed from Australia and Malaysia. Globalisation, Societies and Education 4 (1): 59-76.

[29] Zucker, L., and Darby, M. 2007. Star Scientists, Innovation and Regional and National Migration, NBER Working Paper. n.13547, Cambridge, Ma.


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APPENDIX

A - OPTIMAL CONSUMPTION VALUES:

From FH cc 1 and )()( YcTc HF , by simple substitution we gain:

)()1( 11 YcTc FF , and finally, )(

)(1

T

YcF .

Similarly, it results )(

)(1

1

T

YcH

B - DIFFERENTIATION OF UTILITY W.R.T.

From

1

)()(

1

)()]([)()]([

11 HFHF c

Tc

cuTcuU

d

dccT

d

dcc

cc

d

dU HH

FF

HF

)()()(1

)(

1

)( 11

d

dccT

d

dcc

cc FF

FF

HF

)()()(1

)(

1

)( 111

])([)(1

)(

1

)( 111

Td

dcc

cc FF

HF

(remember that )(

)(1

T

YcF ,

therefore 21

11

])([

)()1(])()[('

T

YTY

d

dcF

)

FFFHF

ccYccc

)1()()(')(1

)(

1

)( 111

)(')(])(1

)([)(

1

)( 11

Ycccc

ccc FHH

HFF

F

)(')(1

1

1)(1

1

1)( 11

Yccc FHF

)(')(1

)(

1

)( 11

Yccc F

HF

)(')(')]()([ Ycucucu FHF

)(')('1

)(

1

)( 11

1

Ycucc F

FF

)(')(')1)(( 1 Ycucu FF which is Equation (9).


102

BASIC CONCEPTS OF CHANGE MANAGEMENT OF SMES

Elena-Oliviana BOLD University of Craiova, Romania

[email protected] Abstract

Change is the only constant. The only difficulty is to follow it. The last decade was a period of unprecedented transformations. In all industries, SMEs are in process of transformation. The change is occurring increasingly rapidly and it is a fundamental problem.

To maintain an organization running efficient and to increase performance, adaptation to the changes occurring in the environment in which it operates is needed.

Elements of the past are no longer valid today. An organization's most precious resource for tomorrow is the ‘technical information’ (the know-how) and the main difficulty is to transfer the most important ‘raw material’ – human-resources – beyond products, countries, markets and functions. For this purpose, a new type of organization is needed, one which is capable of maximizing the core competencies and core activities. Human capital is an active element. (Nistorescu, and Constantinescu 2009, 33).

Keywords: change, management, organization, human resources, SMEs, organizational culture, strategy, resistance JEL Classiffication: M13, O32

1. The concept of organizational development Organizational development is defined (Burduş E. and others, 2008, p.18) as a set of actions to design

and to implement measures to improve the management system components (strategy, structure, information system, decision-making system, methodological system), aiming at increasing performance and competitiveness of the organization.

Several characteristics of organizational development follow from the aforementioned definition: applying measures to improve the entire management system or a component thereof for the entire

organization or only a subdivision; using a wide range of methods and techniques that are specific to the whole system of management or

to a specific problem (strategy, leadership, decisions, etc.); implementing, by all measures, the changes related in general, to human behavior,;

- organizational development involves both the implementation of change, as well as further improvements; organizational development aims at increasing efficiency, therefore a wise use of resources will mount

the quality of products and services, labor productivity and will improve working conditions within the organization.

1.1. Adapting to the environment SMEs, especially those based on knowledge, are the main vector of development. (Nicolescu 2001, 30). The starting point is adapting to external factors, which should be monitored and analyzed by SMEs at all

times. If the organizational transformation does not correlate with the changing market realities, the improvements will last only limited periods of time. Also, stability is an illusion. If customers cease to buy products, even for a short period of time, the biggest corporate companies will begin to falter. A new rival or a new technology can quickly destroy even the foundation of the most well established companies. Their most striking feature isn‟t the longevity, but their impermanence.

Figure 1.The analysis of business environment

Shareholders Markets/ Technology Customers SMEs Employees Economy Social Suppliers trends Source: Clarke (2004, 13).



103

The analysis of business environment of SMEs shows signs of change that can protect us from the danger and helps us to determine where the firm stands on a growth curve and therefore to identify the challenges for which we must be prepared. As Figure 1 illustrates, the starting point of transformation is not focused on business issues, but rather to identify the main categories of external factors of change which can have a major impact. This involves the identification of several important trends and issues to which an SME may be vulnerable.

Tackling the SMEs must be made taking into account the specific context of the economy and its transformations. To understand the change and to survive implies to adapt to the business environment and to influence it. On this stage, the rules are set.

1.2. Evaluation of the internal organization

Once the company has adapted to the external factors that require change, the second element of the transformation process, vital for achieving sustainable change, is the evaluation of the organization‟s adequacy of producing the types of change required by the market and the external environment.

Quick solutions or changes based on one-dimensional network – restructuring in general – rarely give results (Cook et al. 2004, 64). Nobody knows how the company will develop in three or four years, giving them shape as we move. (Deaconu et al. 2004, 68).

The diagram shown in Figure 2 helps us understand what a viable transformation implies. To understand what happen in today‟s businesses is just the starting point.

Factors like „people‟, „systems‟, „structure‟ are like plates that rotate on top of the sticks – there is always the danger that one of the plates will be shacked, threatening to fall and that requires a quick trick to maintain its position (Weiss 2003, 56).

Figure 2. How to organize for a change

Which are the characteristics of the economic

environment and how do they change?

Which is the best strategy? It is proper to the organization?

*What deficiencies of skills *There are necessary systems *Which is the actual structure? we detect to the employees? to determine the operation of *What about sphere of *How competent are the organization? control, hierarchical levels, managers? - operational; responsibility, degree of *How do we describe the - keeping the employees; specialization? organizational culture? - reward systems; *Is this structure working?

- communication. Source: Clarke (2004, 37)

1.3. Approaches to change in the SMEs

Change management approaches have two fundamental purposes: to assist SMEs in achieving their objectives which cannot be reached under the current way they are

organized; to reduce to minimum the negative impact of any changes. The implementation of a well-designed

change can lead to significant improvements in SMEs performances; after any changes, the organization's performance tends to decrease for a period of time before increasing again.

Economic environment

Human Resources

Strategy

Systems

Structure


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These factors can be seen on a simple diagram. Figure 3 shows how results can vary, in terms of operational performance, depending on how the change was given.

Figure 3. Change management objectives

Performance Performance Implementation point of change Implementation point of change

Time Time Source: Radu (2006, 33).

The result on the right is clearly better than the one on the left, on the following grounds: higher final level of performance; faster type of achieving the performance; shorter and less deep reduction in post-shift performance. All change management approaches are closely related to four elements: setting the needed change,

determining in what way the change can be approached, implementing the change in the best way and providing the success of change.

The most famous Lean approaches1 of change management include: total quality management (TQM), Six Sigma or reconfiguration. This essentially means the same thing - determining beneficial change in organizations. Each of these approaches has influenced the effective management of change.

2. Theoretical foundations of change 2.1. Change concept

„Change is the replacement, modification or transformation in shape and/ or in content of an object, process or phenomenon‟ (Burduş et al. 2008, 14).

Change can occur for reasons dependent on natural phenomena or on the will of humankind, when it wants the achievement of this process.

Kurt Lewin2 considered change as a dynamic equilibrium of forces pushing to change on the one hand or causing a resistance to change, on the other hand.

Balance of changing forces after K. Lewin

Elements which determines the change Element which stops the change

Pressures for change Resistance to change

Technological change Outdated mentalities

Knowledge explosion Mental blocks

Aging products Fear of new

Improving working conditions Fear of failure

1 Trends in choosing the specific way to improve an organization's performance can be achieved only after

familiarization with the various Lean tools (ex: good working practices, 5S, visual management, JIT, Kanban, Heijunka, SMED, Poka-Yoke, Hoshun, Kaisen, total quality management, etc.).

2 Kurt Lewin, American psychologist, who was among the first who studied the group dynamics and organizational development and has made important contributions in the study of change management.


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There are two categories of factors that influence change within the organization: ■ External factors that can be controlled to a lesser extent by managers – the changes taking place on

the market: new products introduced by competitors, enhanced advertising for new products, price reductions on various categories of products or improved services offered to customers who want to buy cheaper products and better quality, changes in technology, increasing complexity of life generates complex communication systems, specific external actors, like the international organizations (World Bank, International Monetary Fund and the European Union).

■ Internal factors that changes are acting through in the organization are the processes of decision making, communication, interpersonal relations, leadership, management style etc..

In addition to the factors listed, there are a multitude of factors that, by the nature of their content, generate change.

But there are other factors underlying the change. All these factors can be grouped into four broader groups (Nistorescu 2009, 41):

A. Political factors: political laws, political ideology, laws / international regulations, universal rights, war, local system of taxes, union work groups;

B. Economic factors: competition, suppliers, exchange networks, unemployment rate, wage rates, government economic policy, economic policy in other countries, lending policies;

C. Socio-cultural factors: demographic trends (workers, taxpayers), changes in lifestyle, attitude towards work, attitude towards minority groups, gender issues, environmental care, business ethics;

D. Technological factors: Information technology (Internet), new production processes, computerization of processes, changes in transport technology.

However, even if the required change is simple or complex, the basic process of change remains essentially the same and usually the change agent must raise at least three basic questions (Blokdijk 2008, 176):

1. What are the forces acting upon me? In other words, what kind of pressure should be taken into account as they decide what to change and how could I proceed to change?

2. What must we change? That change must be strategic and be felt by the entire company or relatively limited?

3. How to make the switch? The next question is: „How to actually implement the change?‟. The main concern is that the manager has to ensure that change is both a success and an opportunity.

2.2. Premises of the organizational change process

In general, introducing change in organizations is made by some traditional methods, known as „change plan‟ (Burdus et al. 2008, 34). Specialists have turned their attention to the human factor, conceiving ways of intervention upon human systems, known as the „Human Intervention Systems – HIS3‟. Thus, it stresses the need to ensure a balance between „technical‟ and human changes, the latter being perhaps the most important to adapt to the external environment.

The conception, the design and the implementation of socio-economic measures must start in all cases from the following key assumptions:

The process of change must be controlled, mastered if possible; therefore its prior planning is always needed;

The change process approach must be systemic, because a change in one area determines changes in other areas;

In the change management process the role of the change manager must be recognized; Raising awareness on the need of change of the system or of the organizational culture through their

balanced approach, starting from the reality that the organization as a system includes the organizational culture. The sociologist Mancur Olson has set a general rule of social change which says the longer the period of

paralysis and stagnation, the more difficult to produce a change. Well-organized groups (grouped according to their statutes or to their power) have strengthened their positions and have learned to self protect and oppose any

3 Human Intervention Systems (HSI) is designed and implemented as a result of social processes in which adults are

faced with the need to change their perspectives, attitudes and actions. Depending on the philosophical and theoretical orientation, the task can be approached as a planned, systematic and collaborative. HIS domain is based on social science research that seeks to understand social change and how to improve efficiency in the wide range of social systems.


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changes that might undermine their interests. Systems more open and tolerant – according to the American sociologist Daniel Chirot – have a greater capacity for innovation and adaptation.

The relationship between the past, the present and the future gets new dimensions. A decade or two ago, companies could direct their activities upon their past accumulations, but today the results of the past no longer provide a guarantee of future success. As a result, as Peter Drucker said: „All institutions which are active and operate in the business environment have two time periods: today and tomorrow. The future is preparing today, in most cases, irrevocably. Therefore, managers need to organize both the present and future. In times of change, managers should not assume that the future will be a continuation of the present. Instead they should focus on changing „(Harvard Business Review Magazine, http://hbr.org).

Change, even if it is essential to the organizational success, whenever we are involved in such a situation it is particularly difficult, whether we try to implement it, whether we are victims of others‟ efforts.

2.3. Creating a positive culture change

There are no quick solutions Responsiveness to change cannot be created overnight (Schermerborn, Hunt, and Osborn 2002, 134).

Many positive experiences that require change are needed before people learn to be afraid to take risks, to break with the past and be confident that the transformation will bring something better.

Creating a culture of change implies the modification in daily working modes and not in just side activities. Before developing a plan for change, it is necessary to create both awareness of the organization on the need to change and receptivity to it.

Creating an internal market change For example, surveys on customer satisfaction and on identifying the categories of consumers can be

useful for the organization‟s anticipating and planning capacity concerning new realities. Analysis of external market and working with business teams to diagnose problems is the only real justification and source of legitimacy for the change. As the change must be legitimate and promoted outside, it must be also promoted internally in order to be accepted and implemented by the employees. It is very useful to imagine SMEs as an internal market of initiatives for change, where opinions must be tested and surveys must be used to sense the perceptions internally and to identify the potential factors of resistance.

Full involvement in the process of change The responsiveness to change is created by the feeling that there is no alternative.

An important fact is that the crisis is evident to everyone, that all employees will be helped to establish a relationship so close to the market, consumers and competitors that they realize themselves the need to change. Partly, the solution is training, capacity building of the employees in order to analyze and identify environmental pressures for change; on the other hand, it consists of official communication from the upper levels of what is happening within the organization. (Greenberg, and Baron 2008, 557). To be a real motivator for change, vision must be shared by everyone.

http://hbr.org/


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Figure 4. Establish and maintain control of changes in the organization

3. Strategies for organizational change 3.1. Strategies for action: models and research

Although the mission statement of the company should remain relatively unchanged, it is possible that as market conditions change, a constant need to adapt to the business strategy will occur as well.

The rapid technological changes and the widespread use of the computer, justifies the need for a strategy to develop the organization's ability to effectively manage and capitalize on creative human resources (Şchipoiu-Burlea 2008, 7).

Strategy formulation becomes a problem far more pragmatic than it used to be a time ago when corporate planning departments were isolated in an ivory tower. As a cynic saids: „any idea is called strategy‟. The responsibility still belongs to the director general of corporate strategy, but despite the overall vision, the current context is too complex to be predicted by a single person. Consequently, the responsibility of the strategic transformation is allocated increasingly more to different levels of the organization, both „top down‟ and „bottom up‟. We give as example the Hawthorne Studies4, which do not represent planned change programs, but efforts by researchers to determine the forces that influence employees‟ performance.

4 Professor Elton Mayo from Harvard University was asked to conduct a series of studies on labor productivity at

Western Electric plant in Hawthorne, Illinois. The result of the Hawthorne studies gave rise to managerial school of thought called human relations school, which emphasizes the importance of the relationship between management and workers has to increase productivity.

The manager/ Visionary leadership/ Changing begins with the manager Understanding the process of change and share

experience with others Creating a positive culture change and an

internal market for change

Anticipating and overcoming resistance

The starting point for creating adhesion

Creating a match between words and deeds to define a common vision

Questioning the effectiveness of current system

Comfort disorder/ Open communication

Duration, timing and transition

Achieving change at all levels and employees involvement

Controlling the transformation/ Achieving and strengthen change

Organizational capacity/ Determining the needs to be changed

Implementing and maintaining long-

term change

The environment/ Adapting to changing external pressures

Mediul


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Following the completion of several studies, Professor Lewin has developed a model for analyzing the process of planned change. He laid down the conditions existing to reach equilibrium (with some fluctuations) the following two sets of forces:

Restricting forces which maintain the status quo; Driving forces, which are change-oriented. He named this model of opposing forces (illustrated in the figure below) force field analysis.

Figure 5. Force field analysis

Source: Radu (2006, 39) The force field provides three key strategies for change, as follows: 1. increasing the driving forces; 2. reduction of constraint forces; 3. increasing the forces driving to reduction of the constraint forces. Ample research evidence suggests that simply increasing the driving forces can lead to an enhanced level

of resistance and the change cannot be maintained unless a constant pressure is applied pressure. According to Lewin, the change occurs when the situation is „thawed‟, moved to another level, and then „refrozen‟ to a new position.

3.2. Strategies for achieving organizational change Developing strategies carried out in order to achieve organizational change is a matter of senior

managers. In terms of general principles underlying the shaping process of organizational change, of the incentives

used, and of the means to mitigate resistance to change, can be used following the general strategy (Iles, and Cranfield 2004, 81):

Strategy based on rational approach to change. Such a change strategy is based on developing a plan for change, on the provision of information to those involved and on the use of incentives and results obtained from the participants in the process of organizational change. Promoting this strategy assumes that people will behave rationally and they will pursue their own interests.

Regulatory strategy, the role of physiotherapy. Organizational change is based on redefining and reinterpreting existing norms and values, and by initiating a set of activities that lead to the development of trust in the changes. Promoting such a strategy starts from the premise that people will adhere to new norms and values.

Coercive strategy based on the exercise of power by managers and imposing penalties for non compliance. Promoting such a strategy assumes that people are tolerant and generally do whatever they are said or they can do. Coercive strategy is related to promoting the authoritarian style, distrust of subordinates, but also its disregard for the possibility that the staff is able to contribute in one form or another, in shaping organizational change programs. It is also the most convenient strategy for senior managers: they give mandates and require to be applied strictly.

Strategy of adapting to environmental change is based on conducting a series of organizational changes in response to mutations that occur in business. This strategy is reactive and organizational changes occur only after they have become inevitable.

Choosing the appropriate strategy for change involves the study of the influence factors and prior identifying the size and forms of expressions of support or opposition to the principles of change, the position of

Performance level expected

Coercion

Current level of performance

Driving forces


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the initiators in terms of decision-making capacity, the information and arguments relevant to the design change, the necessary energy for its implementation and the stakes involved. (Cooperrider D. and others, 2007, p.115).

4. Resistance to change

As explained by Edgar Schein, professor of management at MIT Sloan School of Management (MIT Sloan Management Review Magazine, http://sloanreview.mit.edu/ 2003), „resistance to change is a natural reaction.‟ 4.1. Sources of resistance

The attitude of rejecting the change is driven by the fear of those affected, who will not be able to assimilate new procedures, but also by a number of other considerations arising from the perspective of the unknown.

The main causes of the manifestation of resistance to change are (Tabije 2006, 182): a. narrow personal interest. People expect a significant loss as a result of change, fear that they will lose

the position gained, that they will lose prestige and power and that will work harder. Those who resist to change are aware that there is a risk of losing prestige and power because they know better only the old procedures.

b. misunderstanding occurs when change is not sufficiently advertised, its implications are understood. In this case, the expected changes are misinterpreted and rumors take the place of formal information. Rumors targeted against the change, and particularly the threatening ones, tend to have a much stronger impact than any records.

c. different assessment of the situation caused by differences in perception of the situation. Insufficient information or a different interpretation determines various groups and individuals to have a different perspective about the same reality. Accordingly, the settlement procedures are different.

d. intolerance to change, which is caused by the lack of confidence in their ability to acquire new skills and competencies. It is the effect of the shock wave, driven by the desire to avoid surprises. People need time to analyze things in silence. It is necessary to develop a strategy for a longer period of time, a strategic plan to be known in advance.

e. intolerance to other points of view contrary to their own vision, as a manifestation of past experience, of an intolerant behavior or of a dictatorial environment that led to the functioning of the Romanian SMEs for decades. It is a consequence of fear of loss of control, unbalancing the relationship between what can I do to others and what can they do to me. The most common reaction in such situations is reflected in an attempt to save appearances, usually they are not the real reasons invoked.

f. Distrust in the initiators of change, in their ability to seize the real situation and to propose effective measures for change. Mistrust in the initiators of change may cover their capacity and their competence to design a change that will lead to improving the weaknesses and strengthen the competitive position of the organization or their good intentions, fairness and honesty.

The conclusion is therefore that, in the case of a particularly refractory group which believes it will have much to lose as a result of change; the action is a better policy than hoping the problem will disappear.

4.2. Ways to reduce resistance to change

The solution to transform the negative aspects of change into positive ones represent the manager‟s ability to anticipate resistance and to analyze the reasons people oppose to change. The resistance‟s identification lets us know what to do and to introduce change in a favorable light. After consulting several management teams, it was found that there are about seven major factors that determine resistance to change within an organization and, consequently, seven „tricks‟ that managers can call on (Deaconu, Podgoreanu, and Rasca 2004, 130): 1. Loss of control; 2. Why do we need a change? 3. Uncertainty and ambiguity; 4. Unexpected 5. Loss of self esteem; 6. Can I cope with the change? 7. A higher volume of work;

Knowing and understanding the causes of resistance to change are essential for finding the most appropriate means to reduce or even defeat the resistance.

One of the most important ways to reduce human resistance to change is their involvement in planning the change by focusing on their feelings, their own insecurities and their own resistance. When people are confronted with each other openly, when they have information instead of insecurity, they may participate in change rather than resist changing. People must be given the chance to discuss and understand the nature of change and the fears triggered by it.


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Another way to reduce human resistance to change refers to the created anxiety created by the change. The emphasis should be placed on finding the source of discomfort of people who fear the change and not using sanctions or threats as a means to persuade people to engage in change.

In a process of change, given that habits, routines represent the source of resistance to change, we must not ignore the behavioral patterns of work that had already been stated or „institutionalized‟. Communication is one way of reducing resistance to change.

Resistance may be reduced by communicating with employees, helping them understand the need for change. This method is effective when the main cause of resistance is lack of information related to the change process. The time and effort involved in this tactic are its main disadvantages, especially when the change affects a large number of people.

Handling is another way to reduce resistance to change. This method is less costly, but risky if people find out they were duped, the agent‟s credibility being reduced to zero in this case.

The first step in initiating a change process is the diagnosis, finding answers to questions such as „What changes are needed in the organization to secure a more effective functioning?‟. We often assist at changes that no one need. It happens many times to understand, only after a change was made, that it did not answer to the real problems?

5. Conclusions

Change is a continuous and interesting journey, which offers rewards along the way and the leeway to rest. But it is unlikely to reach the proposed destination before things change again. Certainly, there will be no arrival point. We can achieve a successful transformation, but it won‟t last.

Change management is a necessary competence in business nowadays. There is no alternative: transform or disappear! We cannot ignore reality, therefore we must adapt the

mentality, revise our old ideas, reinvent ourselves. Effective approach to change has become an essential element of competitive advantage. It's easy to properly analyze the external environment and still fail because you cannot change the best employees with a pace faster enough to take advantage of market opportunities.

The manager‟s task is to create the fastest transformation that can support the organization and the employees. This involves coordinating the employees during the predictable stages of change process fast and painless. Change can cause suffering, both to productivity and to employees. But the good news is that the transformation process is predictable and controllable in order to understand that the process is useful and can work to modify perceptions about the change, converting those negative into positive.

Culture cannot change quickly. Responsiveness to change can only be created by investing enough time, money and effort to build a favorable domestic market change, to provide employees sufficient training opportunities and to give full attention to customers and profits.

In the transformation process is normal for people to resist changing. Rather than highlight the benefits of change is preferable to minimize the resistance factors.

The transformation will be achieved only if the dissatisfaction with the existing state of affairs is widely manifested. Communication is the antidote to the uncertainty of change. Lack of communication is the reason of the failure of change most frequently cited. The transformation from top to bottom is not sustainable. Early involvement is needed from the bottom up. It takes many communication mechanisms applied simultaneously.

Duration and timing of change is essential because the transformation always takes longer than we think. The trend of change is considered the greatest virtue of capitalism. „The real discovery is not to find new realms, but to see the world with new eyes‟ – Marcel Proust (a

French novelist, essayist and critic).

References:

[1] Blokdijk G. 2008. Change Management 100 Success Secrets, Emereo Pty Ltd, Brisbane, Australia.

[2] Burduş E., Căprărescu Gh., and Androniceanu A. 2008. Organizational Change Management, Editura Economică, Bucureşti (In Romanian).

[3] Clarke L. 2004. The Essence of Change, Prentice Hall Europe, Pearson Education Limited, Harlow, UK.

[4] Cook S., and Macauly S. 2004. Change Management Excellence, Kogan Page Limited, London.


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[5] Cooperrider D., Whitney D., and Stavros J. 2007. Appreciative Inquiry Hanbook for Leaders of Change, 2nd Edition, Berrett-Koehler Publishers, Cleveland, Ohio.

[6] Deaconu A., Podgoreanu S., and Rasca L. 2004. Human factors and organization performance, Editura ASE, Bucureşti, (In Romanian).

[7] Goodwin C. 2007. The Confict Survival Kit, Pearson Education, Harlow, UK, Harlow, UK.

[8] Greenberg J., and Baron R. 2008. Behaviour in Organization, Pearson Education, Harlow, UK.

[9] Iles V., and Cranfield S. 2004. Developing Change Management Skill, NCCSDO, London.

[10] Nicolescu O. 2001. SMEs Management, Editura Economică, Bucureşti, (In Romanian).

[11] Nistorescu T. 2009. Strategic Management, Editura Sitech, Craiova, (In Romanian).

[12] Nistorescu T., and Constantinescu D. 2009. Company Management, Editura Sitech, Craiova, (In Romanian).

[13] Radu L. 2006. Change Management, Central Unit for public Administration Reform, Bucureşti, (In Romanian).

[14] Harvard Business Review – http://hbr.org

[15] MIT Sloan Management Review – http://sloanreview.mit.edu/

[16] Schiopoiu-Burlea A. 2008. Human Resources Management, Editura Universitaria, Craiova, (In Romanian).

[17] Shermerhorn J., Hunt J., and Osborn R. 2002. Organizational Behavior – 7th Edition, Wiley Publisher, University of Phoenix, Phoenix, USA.

[18] Tabije D.I. 2006. Change Management, Best Management Articles, Denver, Colorado, USA.

[19] Taleb N., Goldstein D., and Spitznagel M. 2009. The six mistakes executives make in risk management, Harvard Business School Publishing, Boston, USA.

[20] Weiss A. 2003. Organizational Consulting – How to be an effective internal change agent, John Wiley & Sons, Inc., Hoboken, New Jersey, USA.


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ISO14001 EMS’S IMPACT ON EMPLOYEE ATTITUDES: A REVIEW OF THE LITERATURE

Harjeet KAUR

DBA (UniSA), Faculty of Business, Economics and Accounting Department of Business, HELP University College Malaysia

[email protected]

Abstract

An environmental management system (EMS) provides the framework for continual environmental improvement through effective management of an organization’s environmental impacts. The most well-known and accepted EMS is the ISO 14001 standard on environmental management established by the International Organization for Standardization (ISO). The key components that impact on EMS implementation are a synergistic blend of ‘hard’ and ‘soft’ elements. The elements of soft EMS are essentially dimensions of human resource management (HRM), while the ‘hard’ elements are more technical-oriented. To ensure successful environmental management, the ‘hard’ elements of an EMS must be accompanied by equal attention to the ‘soft’ elements. The results of an EMS program are usually new environmental policies, new organizational structures, new operation processes and added responsibilities on employees. As a result these changes may have an effect on employee attitudes. The ‘soft’ elements must reinforce employees’ commitment to environmental improvement and enhance their job satisfaction and the extent to which this is done may decide the success or failure of ISO14001 EMS. The study of employee commitment in general has not been scarce, but research addressing this issue as it relates to the implementation of an ISO14001 EMS in particular is lacking.

Keywords: employee attitudes, job satisfaction, organizational commitment, HRM elements, soft elements, ISO14001 EMS

JEL Classiffication: J28, M13, O15, Q2

1. Introduction Effective adoption and implementation of ISO 14001 EMS must garner organization-wide support,

contributions and commitment (Pun, and Hui 2001). While current models, such as the ISO 14000 series standards recognize that EMS introduction involves commitment, they do not address problems related to obtaining and maintaining commitment. Without commitment the EMS may become an ineffective paper exercise (Kirkland, and Thompson 1999, 137). Employees who exhibit a strong sense of organizational commitment are inclined to act in the interest of the organization and are less likely to resist to ISO 14001 EMS implementation so long as they are perceived to be in the organization‟s best interest. On the contrary many EMS implementers have found that managers are especially resistant to changes in workload or procedures (Giles 2004). In Singapore, although case studies findings suggest management commitment and employee cooperation as critical success elements for ISO 14001/EMS implementation, difficulty in securing employee commitment was found to be common for the majority of the companies surveyed (Quazi 1999). In Malaysia, the results of a mail survey administered to thirty eight companies showed that ISO14001 implementation did not motivate employees nor encouraged them to work willingly in teams (Tan 2005). Increasing employee motivation for environmental endeavors continues to be poorly understood. This paper aims to provide a motivation for investigating the impact of human resource management (HRM) practices on employee attitudes. An understanding of the human resource (soft) elements enables practitioners to bring about changes in employee behaviors.

2. The TQM and EMS link

Several researchers suggest that the development of an EMS may parallel the establishment of Total Quality Management (TQM) (Daily, et al. 2003, 2007, Klassen, and McLaughlin 1993; Curkovic 1998, Corbett, and Cutler 2000, Daily, and Huang 2001). As a matter of fact ISO 14001 is often referred to as total quality environmental management systems (TQEM) because the philosophies are closely aligned (Bansal, and Hunter 2003, Miles, and Rusell 1997). Among the various definitions of total quality management, Agus, and Abdullah (2000, 56) provides this definition, „TQM is an approach to quality which emphasizes the involvement and commitment of every employee in an organization in order to provide quality products and services to the satisfaction of their customers‟. In the second definition, Aboulnaga (1998, 65) describes TQM as including: „focus of product and service quality towards customer expectation; all of the company‟s departments are involved;


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development of both attitudes and systems, and involvement of all managers and employees‟. An EMS provides a tool for employees and managers to take environmental impacts into consideration when performing daily job function (Ramus 2002). In summary the ISO14001 EMS standard is intended to aid organizations in improving their environmental performance and attain various tangible and intangible benefits (Quazi 1999, Hanna et al. 2000, Daily, and Huang 2001, Zutshi et al. 2008).

Eliminating wastes and continuous improvement are the basic tenets of the TQM philosophy (Sarkis, and Rasheed 1995). ISO 14000 standards have as a foundation, the Plan-Do-Check-Act stages of Deming‟s continuous improvement cycle (Watson, and Emery 2004, Bansal, and Hunter 2003, Darnall 2003, Sarkis 2001, Kitazawa, and Sarkis 2000, Russo, and Fouts 1997). The ISO 14001 EMS standard involves implementation and continuous improvement of five key elements: the environmental policy; the environmental plan; implementation and operation of programs to meet objectives and targets; checking and corrective action; and management review (Zutshi, and Sohal 2004, Babakri, et al. 2003, Aboulnaga 1998). Similar to quality management, the emphasis on waste minimization is the hallmark of environmental management. In fact, the goal of „zero defects‟ in TQM fits well with the concept of „zero emissions‟ in the organization‟s environmental initiatives (Sarkis 2001; Shrivastava 1995).

Second, quality management system takes a systems approach for improving quality so that it applies not only to a specific functional area of the organization, but also looks at relationships between departments (Bansal, and Hunter 2003, Affisco et al. 1997). An EMS such as ISO 14001 does the same as environmental responsibilities are not only confined to the environmental function rather it is coordinated with existing efforts in other areas of an organization such as production, marketing, R&D, operations, finance, quality, environmental, health and safety (EHS), occupational health and safety, and purchasing (Watson, and Emery 2004, Bansal, and Hunter 2003, Affisco, et al. 1997, Zsidisin, and Hendrick 1998, Hanna, et al. 2000, Hart 1995).

Third, researchers have speculated that environmental performance like quality performance comes through significant employee involvement, EI (Daily et al. 2003, 2007, Rothenberg 2003). According to Denton (1999) the monetary savings generated by Dow Chemical‟s energy conservation and Waste Reduction Always Pays Programs (WRAP) have in large part occurred because of good EI planning and activities.

Fourth, competing on quality and environment means achieving stakeholder satisfaction by providing goods and services that meet and surpass expectations (Madu 2004). While quality management systems deal with customer needs, environmental management systems such as ISO 14001 address the needs of broad range of stakeholders and the evolving needs of society for environmental protection and sustainable development (Poksinska et al. 2003; Aboulnaga 1998,; Affisco et al. 1997). Stakeholders are increasingly demanding that businesses in general and manufacturing firms in particular minimize any negative impact of their products and operations on the natural environment (Klassen, and Whybark 1999). For example, consumers report that the environmental attributes of a product or service play a significant role in which products they buy and which products they avoid (Denton 1998).

Fifth, TQM implementation requires a blend of „hard‟ and „soft‟ quality elements. According to Lam (1995, 1996), and Wilkinson (1992), soft TQM emphasizes the management of human resources. Rahman, and Bullock (2005, 74) state that elements of soft TQM are essentially dimensions of human resource management (HRM). „Soft‟ elements are those intangible and difficult to be measured, while „hard‟ elements are more systems-oriented (Lewis et al. 2006, 551).

A review of the literature suggest that successful TQM implementation is dependent on several human resource (HR) elements which include, top management commitment, training, rewards, employee empowerment, employee involvement, communication, feedback, culture, performance appraisal, recognition, and teamwork (see for example Soltani et al. 2006, Jun et al. 2006, Chinen 2000, Daily, and Bishop 2003, Lau, and Idris 2001, Flynn et al. 1994, Jayaram et al. 1999, Howard, and Foster 1999, Thiagaran, and Zairi 1998, Laszlo 1998, Chen 1997).

Besides the technical aspects, the soft elements may also be very critical for successful implementation of the EMS. Pollution prevention as described by Hart (1995, 1000) is „people intensive, rather than technology intensive‟. Rigorous attempts to identify the critical success elements of environmental management began with Wee, and Quazi (2005). They identified and validated seven critical success elements which include: top management commitment, total involvement of employees, training, green product/design, supplier management, measurement and information management. Sparse research exist in the literature examining the impact of soft elements in the implementation of an environmental management system (Wee, and Quazi 2005; Govindarajulu, and Daily 2004; Daily et al. 2003, 2007; Fernandez et al. 2003; Daily, and Huang 2001). Recently, Daily et al.


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(2003, 2007) studied the impact of human resource elements on employee perception of environmental performance in a large organization currently certified to ISO 14001. The findings suggest that management support for an EMS, EMS training, employee‟s psychological empowerment, teamwork, and EMS rewards have a significant relationship to perceived environmental performance and may be significant predictors of success or failure in the implementation of an EMS. In addition Govindarajulu, and Daily (2004, 365) presented a comprehensive theoretical framework for environmental performance by looking at the crucial employer and employee elements affecting environmental performance. The model emphasizes on the integration of management commitment, employee empowerment, rewards, feedback and review, and environmental performance.

3. Empirical studies on employee work attitudes

According to Landy, et al. (1993) as cited by Karia, and Asaari (2006, 33) employee attitude reflects job satisfaction and the individual‟s commitment to the organization. Porter, et al. (1974) defined organizational commitment as a strong belief in and acceptance of the goals and values of the organization and readiness to exert considerable effort on behalf of the organization, as well as a strong desire to maintain membership in the organization. While commitment emphasizes attachment to the employing organization, including its goals and values, satisfaction emphasizes the specific task environment where an employee performs his or her duties (Mowday et al. 1979).

Although various conceptualizations and measurements of the commitment construct abound, attitudinal (or affective) organizational commitment is one of the most often studied variables and is most commonly measured by the OCQ scale (Riketta 2002, Wright, and Bonett 2002, Mathieu, and Zajac 1990). According to Dunham et al. (1994) the OCQ is claimed to provide the same information as Meyer and Allen‟s 1991 affective commitment component. Meyer and Allen (1991) classified organizational commitment into three distinct categories: affective commitment, continuance commitment, and normative commitment. Moreover the OCQ has been associated with much of the development, empirical testing, and practical applications of organizational commitment theories in the US and cross-cultural contexts (Harrison, and Hubbard 1998).

According to Saari, and Judge (2004) the two most extensively validated employee job satisfaction survey measures are the Job Descriptive Index (JDI; Smith, Kendall, and Hulin 1969) and the Minnesota Satisfaction Questionnaire (MSQ; Weiss, Dawis, England, and Lofquist 1967). The MSQ has the advantage of versatility as long and short forms are available, as well as faceted and overall measures.

A few empirical studies have examined employee work attitudes within the context of TQM implementation. For example, Guimaraes (1996) found that the changes in the work environment introduced by TQM in a single company improved job satisfaction, job involvement, commitment to the organization and employee turnover intentions.

Gardner and Carlopio (1996) studied the relationships between employees‟ perceptions of organizational quality efforts and the affective reactions (i.e. job satisfaction, organizational commitment and intentions to turnover). The data was collected from 228 employees within four departments of a large Australian-owned bank. Findings indicate that all the affective reaction variables were significantly related to perceptions of quality efforts. The impact of perceptions of quality efforts was largest for organizational commitment.

Ooi et al. (2007) studied employees‟ perception of soft TQM practices and its impact on employees‟ job satisfaction within a large semiconductor organization in Malaysia. Teamwork, customer focus, organizational culture and organizational trust were significantly associated with improvements in job satisfaction. In addition teamwork was identified as the most significant soft TQM practice affecting job satisfaction. However, reward and recognition was insignificant.

Karia and Asaari (2006) examined the impact of TQM practices on employees‟ work-related attitudes (i.e. job involvement, job satisfaction, career satisfaction and organizational commitment) of 104 employees from various levels and functions from ten organizations in Malaysia. The findings indicate that TQM practices were positively correlated with employees‟ attitudes.

Boon et al. (2005) examined the effects of soft TQM on employee attitudes (i.e. job involvement, career satisfaction and organizational commitment) within a large semiconductor Malaysian TQM prize winning organization. The soft TQM elements include top management (leadership), education and training, employee participation, customer focus, organizational culture and teamwork. A total of 230 employees were sampled from different job levels and functions within the various departments of the TQM prize winning organization. The results indicate that soft TQM practices have a positive effect on employee attitudes. Teamwork was identified as the most significant soft TQM practice affecting employee attitudes.


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Ahmad and Karia (2000) examined the impact of empowerment and teamwork practices on employee work attitudes (i.e. job involvement, job satisfaction, career satisfaction and organizational commitment). A total of 104 employees were sampled from various levels and functions from five Malaysian organizations that implemented some level of TQM practices. The authors concluded that empowerment and teamwork are powerful instruments for quality culture that encourages employee involvement, motivation, satisfaction and commitment.

In light of the preceding discussions, the review of TQM literature suggests that the two most widely studied employee attitudes are organizational commitment and job satisfaction.

Using Govindarajulu and Daily‟s (2004) theoretical framework for environmental performance, Kaur (2010) examined the impact of management commitment, feedback and review, empowerment and rewards on employee attitudes. 472 surveys were distributed to middle and lower level employees within five multiple manufacturing companies currently certified to ISO 14001 EMS. Of the 223 survey responses used in the final data analysis, 211 responses are from the recipients of the Malaysian Prime Minister‟s Hibiscus Award (PMHA). Job satisfaction and organizational commitment were measured by an adapted and shortened form of the Minnesota satisfaction questionnaire (MSQ) and organizational commitment questionnaire (OCQ) respectively. The findings indicate that management commitment, feedback and review, and empowerment have a significant positive relationship to job satisfaction. Moreover, management commitment and empowerment have a significant positive relationship to organizational commitment. 4. Conclusion

Because of the scarcity of empirical research addressing employee attitudes in the environmental management literature, more work is needed to clarify the linkages between the HRM practices and employee attitudes. Practitioners may need to undertake regular attitudinal survey to assess employee reactions to current human resource management (HRM) practices to identify what is working and what is not. An understanding of the human resource (soft) elements enables practitioners to bring about changes in employee attitudes towards environmental endeavors.

Notes The terms „HR elements‟, „human resource elements‟ and „soft elements‟ have been used interchangeably

within this paper.

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ECONOMIC FEASIBILITY OF THE REENGINEERING PROJECTS

Laura ŞTEFĂNESCU [email protected]

Spiru Haret University, Romania Faculty of Financial Management Accounting Craiova

Andy ŞTEFĂNESCU [email protected] University of Craiova, Romania

Faculty of Economics and Business Administration

Abstract Fundamentally, a reengineering project should have, as its common objective, the delivery of a fully functional

business/customer service. The reengineering project should be complementary to and supportive of business processes within the enterprise.

The paper presents an overview of economic feasibility of reengineering projects. Therefore various financial and accounting justification techniques such as payback period (PP), return on investment (ROI), net present value (NPV) and internal rate of return (IRR) are frequently used by managers in order to assess the economic aspects of the project. Furthermore, these methods could be misleading when employing too short payback periods or too high discount rates, neglecting various benefits of the reengineering projects or being unable to quantify them properly in financial terms.

Keywords: reengineering, project, economic feasibility, financial terms JEL Clasiffication: L21, M1, O33

1. Introduction Contemporary business concepts of reengineering emphasis the importance role of a process orientation.

Increasingly, organisations are structuring themselves around their business processes in order to improve responsiveness to business opportunities and threats, and adopting integrated software solutions that mirror and support the needs of their core business processes (Sedera, Rosemann, and Doebeli 2003).

The necessity of reengineering projects is conditioned by the advanced dynamism of the contemporary world, by the continuous and essential changes that take place inside and outside of the companies. The prosper companies that want to maintain forward their competitiveness, are being forced to change the corporative strategy and tactics all the time. Reengineering has been prescribed as an important tool for attaining and maintaining competitiveness. This exploratory empirical investigation into reengineering provides tentative avenues for increasing the probability of success of reengineering projects and raises many issues for further study of the reengineering phenomenon.

To elaborate the reengineering achievement program, the entrepreneurs must have as order of the day some fundamental questions regarding their own companies and the character of their activities: „Why are we doing what we are doing? Why are we proceeding like that?‟. Asking such fundamental questions, people are often forced to see from another perspective the rules already settled, according to which they administrate their business. And, very often, these rules prove to be overcame, irrational or even unacceptable (Bogdănoiu 2009).

Reengineering has nothing in common with the little partial improvements or the excising ones, because it is destined to assure a general growth of efficiency, and, as a result, essential improvements are taking place. These last improvements are achieved by removing all the old and superannuated belongings and replacing them with new ones, of a greater vitality.

2. The landscape of reeingineering projects

Advances in information technology (IT) and rising competition have led to new ways of organizing work. Many of these new organizational forms depart from past practice instead of incrementally improving it. The resulting gains for companies can be substantial. Hallmark, for instance, discarded sequential product development in favor of cross-functional teams and reportedly reduced new product introduction time on one card by 75%. After reorganizing, Bell Atlantic cut service order rework and saved $1 million annually, while simultaneously improving product quality (Brynjolfsson, Renshaw, and Van Alstyne 1996).

Frequently, however, business process reengineering efforts run into serious difficulties. By some estimates, 70% of such projects fail to reach their intended goals (Grant 2002) and a program that seeks to




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become a „House of Quality‟ more often becomes a „House of Cards‟. Because success often depends on coordinating the right technology, the right product-mix and dozens of the right strategic and structural issues all at the same time, near misses can leave a firm worse off than if the change had never been attempted. While several studies have documented the importance of coordination (Schroeder, and Flynn 2002), managers continue to have difficulty achieving it. Often, the problem is not that the proposed system is unworkable but that the transition proves more difficult than people had anticipated. Too often, managers proceed in a hit-or-miss fashion, implementing the most visible bits and pieces of a complex new system, unaware of hidden but critical interconnections.

The path to change has several stumbling blocks. Some companies cannot adapt or they miss new opportunities, leaving them vulnerable to startups (Stary, Barachini, and Suliman 2007). Sometimes companies acquire technology without modifying their human resource practices, mistakenly assuming „technological determinism‟ - that technology's effects are independent of the organizational structure in which it is embedded. In the 1980s, for example, General Motors spent roughly $650 million on technology at one plant without updating its labor management practices. As it turned out, the technology upgrade provided no significant productivity or quality improvements. Recently, in (Changa, Yangb, Chengc, and Sheu 2003), we found that the one-to-one relationship between business strategy and manufacturing flexibility is established to enable managers to set clear priorities in investing and developing necessary manufacturing flexibility.

Econometric research also suggests that there are significant relationships among social networks, technology use, completed projects and revenues for project-based information workers. Results are consistent with simple production models of queuing and multitasking and these methods can be replicated in other settings, suggesting new frontiers for bridging the research on social networks and IT value (Aral, Brynjolfsson, and Van Alstyne 2006). In support of these aims, organisations seek means of better understanding their business processes.

Practitioners and researchers have discussed extensively the various applications of process-modelling at different phases of a reengineering project. Important contingent factors have been reported across various process-modelling contexts. However, little empirical evidence exists on how to conduct process-modelling successfully and how to measure the success of a process-modelling initiative.

Process-modelling is a technique for supporting system life-cycle management (see Figure 1). Regardless of potential benefits, modelling is a resource of intensive activity involving considerable costs (e.g. licenses for the modelling tool, third party modelling expertise, staff training in model development and maintenance). Organizations making these investments need to know if this intermediate procedure is worthwhile. A question often asked by both practitioners and researchers is „in what way(s) would the overall outcome have been different in the absence of modelling?‟ A valid, reliable and feasible process-modelling success measurement-model would aid in addressing this question.

http://www.sciencedirect.com/science?_ob=ArticleURL&_udi=B6VF8-47DXV76-3&_user=10&_coverDate=01%2F25%2F2003&_rdoc=1&_fmt=full&_orig=search&_cdi=6004&_sort=d&_docanchor=&view=c&_acct=C000050221&_version=1&_urlVersion=0&_userid=10&md5=ef479d4a8c2891882b5e60dabc5748c7#affa

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Figure 1. Process – modelling

Source: Schroeder, and Flynn (2002). 3. Useful tools in the economic feasibility of projects

Many traditional financial analysis techniques employed by managers such as payback period and return on investment fail to take the time value of money into consideration. Although useful tools in the financial analysis of investment decisions, their exclusive use can result in faulty decisions such as the acceptance of projects that lose money and the rejection of projects that may represent significant financial advantages. Analytical techniques used in finance to take the time value of money into account are called discounted cash flow methods.

The economic feasibility approach seems to be a very natural and straightforward one and perhaps that is why it is so wide-spread in relevant companies worldwide. The investment has to be financially sound and viable because such a project competes for limited resources with many other projects. Therefore various financial and accounting justification techniques such as payback period (PP), return on investment (ROI), net present value (NPV) and internal rate of return (IRR) are frequently used by managers in order to assess the economic aspects of the project. However, many researchers argue that these methods support decisions that are sensible when viewed in isolation and they do not always indicate the best action when we take into account the whole organizational context (Grant 2002).

Furthermore, these methods could be misleading when employing too short payback periods or too high discount rates, neglecting various benefits of the new reengineering system or being unable to quantify them properly in financial terms. To overcome the problems inherent in using purely economic appraisal approaches, analytic and strategic appraisal approaches have been promoted.

3.1. The use of net present value analysis in the economic feasibility of projects

The net present value (NPV) is the most useful of these discounted cash flow methods. NPV analysis yields a result, expressed in after-tax (important for profit-based operations), that takes into consideration the difference in the value of future cash flows and the cost of raising the capital required for the investment. NPV


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helps make sound decisions about whether to accept or reject potential investment projects based on an objective financial criterion. Projects associated with positive NPVs represent net savings for the organization. Projects associated with an NPV of zero will recuperate only the cost of the capital required to make the investment. Projects associated with negative NPVs represent a financial loss for the organization.

The baseline year is when the initial investment is made. All cash flows occurring in future years are reduced in purchasing power compared to this baseline year. The amount that the cash flows associated with a given year are reduced, or discounted, in value is a function of time and the „hurdle rate‟. The hurdle rate can be the cost of the invested capital if the project is to be funded with borrowed capital or the required minimum return the project must generate in order to justify the investment of internally available funds. This allows for direct comparison of cash flows. A positive NPV of 1.00€ for a project initiated in 2008 with a hurdle rate of 10% means that the project will return the full cost of the invested capital (10%) plus 1.00 € in 2009 – equivalent € value.

The following table illustrates a NPV analysis for a core lab reengineering project at a non-profit organization utilizing internally available funds to finance the project. To simplify matters, the entire investment is made at the beginning of the project. If the client had been a taxable, for-profit operation, the calculation would be more complex because IRS credits for capital cost allowances must be taken into consideration. The economic life of the project is set at five years. This is equivalent to the estimated amount of time that the potential labour savings can be maintained without investing additional capital to replace assets required to initiate the project as they age. It is important to base the estimate of the economic life of a project on this criterion rather than on a set criterion like the payback period. Use of the payback period for the economic life does not account for positive cash flows that may accrue to the hospital after the payback period and may result in the rejection of a financially sound investment.

Table1. An Example of NPV Analysis

Year

Est. Labor Cost Savings Realized in

Year =N

DiscountingFactor (using a 10% ‘hurdle’rate)

Present value of savings at 10%

hurdle rate

Opportunity cost assessed against savings in Year=N

A B C = (A x B) D = (A – C) 1 404.357 € 0,909 € 367.561 € 36.796 € 2 808.714 € 0,826 € 667.998 € 140.716 € 3 808.714 € 0,751 € 607.344 € 201.370 € 4 808.714 € 0,683 € 552.352 € 256.362 € 5 808.714 € 0,621 € 502.211 € 306.503 €

Total 3.639.213 € 2.697.466 € 941.747 € Less: Initial Capital Investments made at time=0 1.400.000 €

Equals: Net present value +1.297.466 €

Source: Data processing after financial reports Because the organization will use internally available funds to finance this project, we have assumed that

the organization can pick from two mutually-exclusive investment projects: 1. Invest €1.400 of its capital resources in the core lab project, or 2. invest the same amount in a 10% security for 5 years.

The return the organization would make from the security represents the „opportunity cost‟ of the core lab project because the organization is foregoing the opportunity to earn the accrued interest on the security in order to mobilize the capital to implement the core lab project. The core lab project must replace this opportunity cost before it can return a positive NPV.

The use of a security as a „challenger‟ to the core lab project is prudent since it requires objective financial proof that the project has the potential to provide a higher return than simply saving the money. The „null hypothesis‟ (H0) states that the core lab project will not outperform the return on the security. This null hypothesis must be disproved in order to accept the management's hypothesis (H1) that investing the money in the core lab project will outperform the return on the security. Since the projects are mutually exclusive, if the core lab project cannot outperform the return made on the security, the analysis will return a negative NPV, H0 would not be rejected and the core lab project would not be accepted. Conversely, if the analysis returns a positive NPV, H0 would be rejected and the core lab project would be accepted.


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The 10% security would pay €700.000 in accrued interest at its maturity date [(€1.400.000 X 10%) X 5 years]. This explains €700.000 of the €941.747 opportunity cost of the core lab project. What about the €241.747 difference? This is caused by the negative impact of inflation on the earnings of the security which, if „left‟ in the investment for 5 years, would endure a €241.747 decrease in their purchasing power. Therefore, to match a return equivalent to €700.000 in „today euros‟, the core lab project must return €941.747 at the end of five years.

The interpretation of the NPV analysis is as follows:

H0: The core lab project will not outperform the security

H1: The core lab project will outperform the security

Criteria for rejection of H0: Core project returns a positive NPV

Result: Core lab project shows an NPV of +€1.297.466

Decision: Reject H0, Accept H1

A positive NPV of €1.297.466 indicates that the project would outperform the security by €1.297.466 after

compensating for the negative impact of inflation and recovery of the €1.400.000 initial investment. It's important to note that the project is expected to return €3.639.213 in total labor cost savings to the

hospital over five years. According to our analysis this amount can now be broken down as follows: 1. €1.400.000 in labor cost savings to replace the capital resources used-up to make the initial

investment. This represents the only „real‟ cost of the project 2. €941.747 in labor cost savings to compensate for the opportunity cost of the project. This is an artificial

cost. 3. €1.297.466 in savings over and above (A) and (B). Finally, at the beginning of an NPV analysis it is important to identify the strategic intent of the project. If

part of the strategic intent is to reduce operating costs and decrease prices. In order to increase organization revenues, the projected increase in revenues needs to be evaluated and included as a positive cash flow in the calculation. If the intent of the project is survival then a negative NPV might be acceptable if the negative financial impact of the investment is outweighed by the potential financial losses that may be associated with rejection of the project. In this case, the analysis led to the conclusion that mobilizing the capital required implementing the core lab project is in keeping with a strategy to maximize potential returns.

3.2. The use of cost benefit analysis (CBA) in the economic fesibility of projects

A popular economic calculation for the „attractiveness‟ of an investment is Return on Investment (ROI). ROI is a calculation of the most tangible financial gains or benefits that can be expected from a project versus the costs for implementing the suggested program or solution. Cost Benefit Analysis (CBA) is more comprehensive than ROI, and attempts to quantify both tangible and intangible costs and benefits.

Table 2 lists some of the potential costs and benefits that may be accrued by a reengineering project. Although the list is not comprehensive, it does provide an indication of the range of factors that you should take into consideration when assessing the economic feasibility. The table includes both qualitative factors, costs or benefits that are subjective in nature, and quantitative factors, costs or benefits for which monetary values can easily be identified. We will discuss the need to take both kinds of factors into account when performing a Cost Benefit Analysis.


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Table 2. Potential costs and benefits of a reengineering project

Type Potential Costs Potential Benefits

Qu

anti

tati

ve Hardware/software upgrades

Fully-burdened cost of labour (salary and benefit)

Expected operational costs Training costs to train developers in

new/updated technologies

Reduced operating costs Reduced personnel costs from a reduction

in staff Increased revenue from additional sales of

your organization products/services

Qu

alit

ativ

e Increased employee dissatisfaction from fear of change

Negative public perception from layoffs as the result of reengineering

Improved decisions as the result of access to accurate and timely information

Raising of existing or introduction of a new barrier to entry within competition out of market

Positive public perception that organization is an innovator

There are two lines of thought regarding qualitative Cost-Benefit analysis. The first strategy is to keep things simple and go with your instincts: if the project seems like a good idea, then it most likely is. The second line of though is that you can quantify the qualitative aspects of a project and thereby compare them fairly. If this is the case, stop wasting everybody's time and simply admit that you're making a judgment-based decision.

So, how would you quantify qualitative factors? To do so, we follow these steps: Identify the qualitative factors. Brainstorming with several people is usually a good option; Quantify the importance of each factor to your organization. For example, give each factor a rating of

one to five, where five is the most important; Numerically rate each alternative against each qualitative factor. For example, rate each alternative on a

scale of zero to ten where ten is the highest possible rating; Multiply the importance weighting by the rating for each alternative; Calculate the overall score for each alternative by summing the individual scores. In most cases, executives expect to see an economic justification based on phased benefits and costs

over a three to five year window (Feibel 2003) Being able to show a positive ROI in a one or two year timeframe will probably make the project an instant hit, but this is an unusual circumstance. Given the time value of money, a euro is worth more today than it will be tomorrow. To account for this economic fact, future costs and benefits need to be „discounted‟ in order to calculate today‟s value. The discount factor, also known as the cost of capital, might be specified by various authorities. Generally, the selected discount rate should be less than the Prime Rate.

4. Conclusion Organizations often utilize standard formulas such as a cost benefit analysis (CBA), return on investment

(ROI) or net present value (NPV) to determine if a project should be undertaken. These investment criteria are significant factors used to decide whether or not to initiate a program or project, but if you are unable to measure the results, then „so what.‟ A sound benefit realization strategy will provide a process along with guidelines to measure actual benefits and a means to hold people accountable for results. By measuring the results of a project, an organization will be able to make informed decisions about how much benefit is available to be reinvested.

ROI and CBA calculations are useful, because they allow you to examine your options and make wise choices. They are also an essential component of your business plan, because they become the „proof‟ that implementing a project is a sound business decision. ROI is useful when costs and benefits are tangible and tightly focused on a specific program with boundaries. CBA is more comprehensive, and is useful when both tangible and intangible costs and benefits need to be considered.

Acknowledgement The presented work has been conducted in the context of the GRANT At_10/2007-2008 -Organizational

Reengineering as an Efficient Solution for Basic Restructuring of Business. Study Case Concerning the


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Elaboration of the Reengineering Projects Using Informational Technologies, funded by The National University Research Council under the contract 80GR/25.05.2007 and 50612/11.06.2008.

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[7] Hynek, J., and Janeček, V. 2007. Advanced Manufacturing Technology Projects Justification, Proceedings of the 4th IEEE International Conference on Mechatronics, University of Kumamoto, Japan, 2007, 1-6.

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[10] Stary, C., Barachini F., and Suliman, H. 2007. Knowledge Management: Innovation, Technology and Cultures, Series on Innovation and Knowledge Management, 2007, www.worldscientific.com.

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VERTICAL INTEGRATION IN HIGH-TRANSACTION COST SECTORS: THE CASE OF THE BULGARIAN PHARMACEUTICAL INDUSTRY

Tamara TODOROVA

American University in Bulgaria, Bulgaria Department of Economics

[email protected]

Abstract Economic theory provides various explanations for vertical integration but transaction costs seem to be a major

determinant of backward, forward and lateral integration. The paper studies integration trends in the newly emerging Bulgarian pharmaceutical sector, seeking transaction cost explanations to the forward integration taking place in it. We hypothesize that asset specificity, above all, determines many of the organizational transformations and adaptations Bulgarian pharmaceutical companies are undergoing. Having special attributes, their products and assets seem to favour a larger size of the companies. Furthermore, as a low-trust, high-transaction cost economy, the Bulgarian economy dictates that a larger scale of operations be internalised within firms rather than carried out by the market.

Keywords: Vertical integration, transaction costs, asset specificity, distribution

JEL Classification: L42, I11, D86, D23

1. Introduction It is commonly believed that vertical integration is an attempt to create monopoly and to seek rents.

Monopoly theories of vertical integration explain it as the instrument of price discrimination and the creation of entry barriers. Alternatively, economic theory justifies integration on the grounds of efficiency achieved through greater economies of scale and scope resulting from mergers. Chandler (1966) maintains that when economies of scope between successive stages due to technological organizational interrelationships are strong enough, these activities should be provided under joint ownership. Such beliefs serve as the ground for the technological determinism behind vertical integration. Other explanations of vertical integration have been the avoidance of factor distortions in monopolized markets (Vernon, and Graham 1971, Schmalensee 1973, Warren-Boulton 1974) or the transfer of risk from one sector of the economy to another (Carlton 1979). In addition, some scholars emphasize that vertical integration can be an organizational form used to avoid taxes on intermediate products (Stigler 1951). In the context of transfer pricing and multinational corporations, vertical integration can be seen as a device to take advantage of the different treatment that national laws and tariff codes provide to the exports of products. Those exports may be treated differently within the boundaries of the firm and through interfirm exchange where intrafirm trade may be favored.

While all of the above might partly be reasons for vertical integration, transaction costs seem to be a chief determinant of vertical integration. The paper studies integration trends and gives transaction cost explanations to the recent developments in the newly emerging Bulgarian pharmaceutical sector. We try to show that asset specificity affects many of the organizational transformations and adaptations Bulgarian companies in the sector are undergoing. Their products and assets have special attributes that determine a larger size of the companies. Furthermore, being a low-trust, high-transaction cost economy, the Bulgarian economy dictates that a larger scale of operations be internalised within firms rather than carried out by the market. Thus, in their dilemma to make-or-buy, given the high market transaction costs in the country, pharmaceutical firms opt to make, rather than buy, which is a possible explanation for the forward integration trends.

The structure of the paper is as follows: Section 1 is an introduction. Section 2 discusses the institutional approach to the study of vertical integration stressing the transaction cost perspective. Section 3 presents the Bulgarian pharmaceutical sector as one of high asset specificity and a possible host for vertical integration. Section 4 examines the potential for empirical research. The paper ends with conclusions.

2. Transaction cost economizing effects of vertical integration

Scholars who question the technological origins of vertical integration adopt an institutional approach to explaining vertical mergers5. According to Williamson (1985, 87) decisions to integrate are rarely due to

5 Ours is not a comprehensive study of the literature on vertical integration.



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technological determinism and technology is fully determinative of economic organization only if 1. there is a single technology, which is strictly superior to all others, and 2. that technology requires a unique organizational form. As there is rarely one single feasible technology and technology hardly determines the choice among alternative organizational forms, vertical integration does not stem from technological reasons, neither from monopoly considerations (Williamson 1983, 614).

A subgroup of scholars see information as the root of vertical integration, where there is uncertainty in the supply of the upstream good with the consequent need for information by downstream firms (Arrow 1975, 1985) or vertical integration is the product of information externalities (Green 1984). Grossman, and Hart (1986, 1987) developed a theory of vertical integration and ownership based on the concept of contractual incompleteness due to asymmetric information between the parties to the contract and outsiders. They do not distinguish between ownership and control and define ownership as a power to exercise control. Barzel (1982), and North (1978) trace vertical integration to difficulties in measurement. Barzel views vertical integration as a means to economize on measurement costs. Firms integrate when measurement of contractual output is difficult and tend to remain independent and trade with each other when output can be measured easily. Barzel (1982, 42) stresses that ownership will change more frequently the less the commodity is subject to change. Being non-durable products and subject to change, medical drugs would change ownership less often than some other products.

Williamson (1985, 86) traces the roots of vertical integration to transaction costs and the condition of asset specificity. Transactions accompanied by investments in durable, transaction-specific assets experience „lock in‟ effects, which is why market exchange by autonomous entities is substituted by unified ownership. Asset specificity arises in relation to special purpose investments that are more risky than general purpose investments because specialized assets cannot find alternative uses without some sacrifice of productive value if contracts are interrupted or terminated earlier. Specificity seems to be higher with fixed costs than with variable costs and takes several different forms: site specificity, physical asset specificity, human asset specificity, dedicated assets and brand name capital. Site specificity is a unique feature of assets located at the same place so that to economize on transportation costs. Physical asset specificity refers to investment in specialized physical capital, the value of which is much smaller in alternative uses than the specific transaction for which it has been intended. Examples of transaction specific human capital investments are specialized training, learning-by-doing economies or team tasks in production operations. Dedicated assets are an investment in generalized production aimed at selling a significant amount of product to a specific customer. Brand name capital represents investment in brand name. Since pharmaceutical producers invest heavily in branded drugs, those drugs represent brand name capital and specific assets to them.

Vertical integration will play a role with high asset specificity. It will not be observed in the neoclassical transaction case where „faceless buyers and sellers meet for an instant to exchange standardized goods at equilibrium prices‟ (Porath 1980, 4). Asset specificity matters for organizational form when it is combined with bounded rationality, opportunism and uncertainty. Bounded rationality is the rationality of individuals who are „intendedly rational but only limitedly so‟ (Simon 1961, xxiv). It differs from maximizing and organic rationality, the former showing a maximizing orientation in the presence of full information, the latter being one of complete ignorance. Opportunism, on the other hand, is the strongest form of self-interest seeking6. It refers to the efforts to hide or distort information, mislead, disguise, obfuscate or confuse. It leads to asymmetric information and behavioral uncertainty in economic transactions. It differs from simple self-interest seeking, which is a semistrong form of self-interest seeking and from obedience, which is equivalent to non-self-interest seeking. In the Bulgarian drug market, bounded rationality, opportunism and uncertainty all take excessive forms. Thus, pharmaceutical producers face excessive opportunism and market uncertainty in their dealings, while their knowledge of the marketplace is far more limited than in other industries. Asset specificity is a factor only with high degree of opportunism. With low opportunism parties are not so vulnerable to the risks of contracting which is illustrated by Table 1. Since opportunism is high in the Bulgarian conditions and pharmaceutical firms offer branded products that represent a form of specific assets, their choice would be geared toward the firm, rather than the market.

6 Williamson (1985, 47) defines opportunism as “self-interest seeking with guile. This includes but is scarcely limited

to more blatant forms, such as lying, stealing, and cheating. Opportunism more often involves subtle forms of deceit. Both active and passive forms and both ex ante and ex post types are included.”


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Table 1. Choice of market versus firm contracting

1.1 Asset Specificity

Low High

2 Opportunism

Low Market Market

High Market Firm

The incentives for vertical integration strengthen, as transactions take on a more specialized character. As

assets become more specific to a single use and, therefore, are less transferable to other uses, parties become more open to opportunism and require the special protection that integration can supply. „Unified governance‟ then takes the place of market governance, which is the prevailing mode of occasional and recurrent contracting with non-specific investment. Williamson (1985, 78) predicts that price and quantity adjustments will be more complete in vertically integrated enterprises than in interfirm trading.

Vertical integration has been described as the „make-or-buy‟ paradigm of transaction cost economics7. Monteverde, and Teece (1982) provided one of the first empirical studies giving a contractual interpretation of vertical integration. They examine the effects of asset specificity defined as worker-specific knowledge on the decisions to produce components or to obtain them from outside suppliers using. Their findings support the transaction cost paradigm formulated by Williamson. In a study on the procurement practices in the aerospace industry Masten (1984) examines both asset specificity and product complexity as determinants of vertical integration. Empirical studies seem to put less emphasis on forward integration into marketing and distribution. In an earlier study Lilien (1979) models a company‟s use of captive (direct) channels versus independent (indirect) channels for a product line. He finds that captive channels appear with larger firms, larger average orders, and more complex products. Anderson and Schmittlein (1984) examine human asset specificity as a factor for vertical integration in the electronics industry. Anderson (1985) develops a model of when the selling function in a district is performed by employees rather than by outside agents. Her main findings are that the greater combination of transaction-specific assets and environmental unpredictability leads to greater likelihood of integration and that unpredictability alone does not have an impact on the use of direct salespeople. John and Weitz (1988) also find that firms are less likely to use reseller channels when specific asset levels are higher. In their study on the carbonated soft drink industry Muris, Scheffman, and Spiller (1992) attribute the move from independent bottlers to captive (integrated) bottling to changes in asset specificity.

What should be taken into account are not just the bureaucratic costs of governance but also the production costs. Williamson emphasizes that when asset specificity is low market contracting between successive production stages has good economizing properties because the governance costs of market procurement are small and production economies can be achieved. As asset specificity increases, vertical integration is the preferred mode of economic organization (Williamson 1985, 90). We can extend this analysis to the individual firm‟s profit. Let the firm choose between two modes of procuring a good. One is the option to make the good to one‟s own requirement and another is to procure it from the market. If we assume that the firm sells its output q at a particular price p , we can treat revenues as constant in both cases and independent of the

asset specificity k 8. Let the profit of buying the item on the market be a function of the asset specificity such that

)()()( kMkCpqk MM (1)

0

k

CM 0

k

M

7 For a more thorough review of the empirical literature see Shelanski, and Klein (1999). 8 Following Williamson‟s notation.


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where )(kCM are the production costs when the item is procured through the market and )(kM are

the governance costs. Asset specificity increases the production and governance costs of market contracting so

we have 0

k

CM and 0

k

M. Furthermore, let the profit of the firm when producing the item be:

)()()( kkCpqk (2)

0

k

C 0

k

where )(kC and )(k are the production and governance costs of producing the item to one‟s own

requirements, respectively. As asset specificity favors internal governance, both the production and the

governance costs of making decrease with asset specificity and 0

k

C, and 0

k

. Subtracting

equations (1) and (2) we obtain

GCkMkkCkCkk MM )()()()()()(

where we set CkCkC M )()( and GkMk )()( . According to Williamson (1985, 92)

C shows the steady state production cost difference between producing to one‟s own requirements and the

steady state cost of procuring the same item on the market. On the other hand, G is the difference in

governance costs, i.e., between the bureaucratic costs of internal governance and the corresponding governance

costs of markets. In Williamson‟s model the difference GC falls with asset specificity, as shown in Figure

1.

C

GC

G

k k̂ k

Figure 1. Comparative production and governance costs

Source: Williamson (1985, 93).

The result GCkkM )()( is depicted in Figure 1. We can review three situations:

1. 0)()( GCkkM

The difference in total costs GC lies above the horizontal access, which implies that the firm would

achieve a greater profit by buying the item from the market rather than producing it. What we observe in this case


131

is that the firm‟s profit is a direct function of asset specificity where for low values of asset specificity below a

critical value k̂ buying the item promises greater returns than making it in the make-or-buy decision.

2. 0)()( GCkkM

This is the point of indifference where some particular asset specificity k̂ yields the same profits within

and outside the firm. It is irrelevant to the firm which mode of procuring the item it would choose – to make or to buy it.

3. 0)()( GCkkM

For a very high asset specificity where actual asset specificity exceeds the critical value k̂ the profit of

making the item exceeds that of buying it on the market. Profitability of producing to one‟s own requirements increases with asset specificity, while that of buying from the market decreases. We can demonstrate the effect of asset specificity on individual profits with the help of differentiation

0

k

M

k

C

k

MM

As both partial derivatives on the right are positive, profitability of obtaining the item through the market

falls with the increase in asset specificity. Asset specificity does not favor market procurement.

0

kk

C

k

The effect of asset specificity on the profit of producing the item is positive which implies that asset

specificity favors own production. This conclusion follows from the fact that the two partial derivatives on the right are negative. As an industry matures, the uncertainty in it decreases and the benefits that accrue to vertical integration presumably decline. This means that vertical integration would mostly be observed in relatively new industries and in sectors producing new products. Thus, the emerging pharmaceutical sector in Bulgaria appears to be a good host for vertical integration. Larger firms will be more integrated into components than smaller ones, ceteris paribus. A multidivisional form firm will be more integrated than a unitary form firm, ceteris paribus.

Integration of peripheral activities includes backward integration into basic materials, lateral integration into components and forward integration into distribution. Forward integration into wholesaling is observed for products that need coordination of marketing and distribution, where branding is practiced or products require special handling. For products and industries where product differentiation is essential the need for proper advertising as part of the promotion mix also determines ownership of wholesaling. The Bulgarian market for medicines is an example of such an industry. Forward integration into retailing extends the case of ownership of distribution where special handling and proper representation of the product continue to be important to the sales of the product. Products that are not long lasting often require such special handling. Products that require information, special demonstration or proper display also determine the ownership of retail stores. Furthermore, the Bulgarian pharmaceutical sector attempts to integrate forward, as medicines require sufficient information to be given to consumers.

In the conditions of high transaction costs asset specificity plays a major role in shaping the structure of the economy. In transitional countries like Bulgaria it could be expected that basic industries will evolve due to excessive opportunism. Sophisticated and complex industries will not advance because of the additional transaction costs that the hold-up problem brings. Firms in Bulgaria will be less likely to trade with sophisticated assets, as they will be exposed to the additional risks of costly bargaining. Basic products would be sold. Management would generally be less competent and skilful and would perform mostly non-specific, standard tasks. Workers will also tend to have very general skills. They will not specialize and invest in firm-specific human capital. For that reason, labor turnover is expected to be high and the effects of learning by doing to be


132

insignificant. In the conditions of costly bargaining, firms will avoid specific assets or will tend to integrate vertically. Non-specific assets would be the preferable mode, as they allow greater reliance on competitive resource allocation and a particular supplier or buyer can easily be replaced with another one. Finally, there would be a greater tendency for large firms to appear in high transaction costs (expensive) markets, which determines strong integration trends in the Bulgarian pharmaceutical industry.

3. The Bulgarian pharmaceutical sector

Pharmacy chains hold about one fourth of the retail drug market in Bulgaria. According to IMS Health, the largest international agency researching pharmaceutical markets, they hold 25% of the market in value terms, while others estimate their market share to be between 20 and 30%, which is the equivalent of 186 and 289 million levs (Nikolova 2005, 6). The number of pharmacies grew from 4000 in 2003 to 4518 in 2004. This shows too many players on a relatively small market. The drug market is expanding and the turnover of all pharmacies increased 15% from 800 million levs in 2003 to 927 million levs in 2004. There are limits to growth, though, as the total number of pharmacists in Bulgaria is 5400, which is the maximum number of licenses that can be obtained. Of all 460 registered wholesalers only 80 are operative. Some believe that there is room for five distributors on the market at the national level, some 10-12 on a regional level, while the number of pharmacies should be half of what it is (Nikolova 2005, 4).

While the Bulgarian population is decreasing, it is demanding more and more sophisticated medicines. Consumers seek medical drugs not only when they are ill, but also when they need better quality and a healthy life. They have higher expectations not only in terms of drugs but also in terms of additional products pharmacies sells such as cosmetics, food additives (vitamins), medical supplies, etc. Customers seek good service, advice, product variety, etc. An exemplary outlet is one, which is fully computerized, has a list of all necessary items, several knowledgeable pharmacists and is usually owned by a large chain. Other considerations are price and geographical proximity. Bulgarian consumers prefer to have their medicines sold at a hand distance.

Profitability in the sector is low. Only half of the pharmacies are profitable. The interfirm indebtedness in the sector reached 500 million levs in the end of 2004. The financial burden falls on distributors while hospitals and part of the pharmacies instead of paying for the drugs received on consignment from one wholesaler approach another wholesaler. Indebtedness in the sector seems to hurt producers the most. Unable to control financial flows and the proper sale of medical drugs they lose profits and encounter high contractual opportunism. The mechanism of consignment does not affect wholesalers and retailers, as they do not invest real capital in the distribution but their losses are rather transferred onto producers who do not receive their payments.

The government controls the distribution of drugs in that the producer sets a particular price and the Health Ministry determines a maximum retail threshold on that price. The presence of multiple layers in the distribution boosts the final price paid by the consumer. Wholesalers and retailers turn out to act only as redistributors. The Bulgarian Health Law does not treat pharmacy chains. According to the Law licenses are issued only to holders of a master‟s degree in pharmacy. It does not treat the ownership, neither the relationship of the owner with the license holder.

The most famous chains in the country are Sanita Franchise (60 outlets), Seyba (110), Sofia Pharmacies (56) and Exemplary Pharmacies (170). There are two major types of pharmacy chains, known as „long‟ and „short‟ chains. The short chains are regional groupings of two, three to five outlets that have been formed after the privatisation of the former state-owned pharmacy companies. Some of the more famous short chains include Mareshki for Northeast Bulgaria, Municipal Pharmacies in Burgas, Interpharma in Stara Zagora, Multipharma in Yambol, etc. The long chains, on the other hand, are franchised under the same trade name. They represent some major investors, producers and wholesale distributors of medicines. Although vertical integration is illegal, a process of consolidation takes place that gives advantages to big market participants. Small pharmacy stores try to stay competitive by violating the rules of honest competition and good customer service. Large pharmacy chains offer big discounts on which small independent outlets cannot compete. At the same time, small pharmacies and independent distributors increase the price of the final good substantially – manufacturers receive only 53% of the final price, the rest being wasted along the distribution channel. Competition takes place on the basis of discounts and not so much on quality of service. As to location, most of the big chains seem to have established themselves in the bigger cities while operating in small towns and villages seems unprofitable. Integration cannot likely affect small family-type pharmacies in small towns, as they do not have competition. Rather, it will reduce the number of pharmacies in the big cities.

There are three leading local drug manufacturers: Actavis, Sopharma and Chaika Pharma. While Actavis and Sopharma emerged from the former Bulgarian pharmaceutical companies Balkanpharma and Sopharma


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after their privatization and restructuring, Chaika Pharma is a new firm established and licensed in 2000. Drug manufacturers insist on the need for full vertical integration along the channel producer-distributor–pharmacy chain. Since the Law on Medical Drugs only allows producers to acquire wholesalers but not retailers, producers secretly develop franchising schemes that do not include direct ownership of retail outlets but de facto allow controlling the financial and commodity flows. Thus, despite the law Sopharma and Chaika Pharma are fully vertically integrated structures and Actavis has attempted to follow with the acquisition of the Hygia distributor.

A second group that of the independent distributors does not plan on vertical integration and the acquisition of downstream firms. Phoenix‟s Lybra and the independent distributor Sting oppose the liberalization and legalization of vertical integration. Through Lybra the Pan-European distributor Phoenix would enter the Bulgarian insulin market thus threatening Tradeconsult, a major distributor of insulin. The three independent national distributors are Sting, Biomeda, and Tradeconsult.

The Law on Medical Drugs prohibits vertical integration along the producer-wholesaler-pharmacy chain. It permits integration only between producer and wholesaler. Drug manufacturers and wholesalers can neither own pharmacies, nor participate in companies, which own pharmacies. Manufacturers cannot own firms that trade with drugs other than their own. An amendment to the Law on Medical Drugs was adopted in May, 2005 prohibiting the participation of manufacturers in wholesaling as well as of wholesalers in manufacturing thus banning effectively the mergers of producers and wholesalers. The aim of the amendment was to block the process of consolidation taking place in the pharmaceutical market and, in particular, vertical integration. Examples of manufacturers related to wholesalers are Sopharma to Sanita and Chaikapharma to Commercial League.

A new law on medicines is to be adopted regulating the distance between two pharmacies, the per capita number of pharmacies, the number of pharmacists per outlet, the product base and the technical equipment. The current Law on Medical Drugs allows pharmacies to sell only medicines, cosmetic, and sanitary products. There is a debate about the sale of vitamins, which are considered food additives but are effectively sold in pharmacies. The new law will be a follow-up to regulations in the European Union, as Bulgaria joined the EU in January 2007. Some countries in the EU permit vertical integration between manufacturers and distributors and others do not but the common trend seems to be the move toward chains and greater liberalization. Bulgaria‟s acceptance into the EU requires distributors and pharmacies to have certificates of good distribution and pharmacy practice and will impose regulations that a number of participants will not be able to abide by. The Bulgarian Parliament, which has the legislative power, is strongly influenced by the lobby of the small, family-type pharmacies. The debate about whether there should be vertical integration continues whereas politicians, health authorities and small businessmen oppose vertical integration on the grounds that it is a potential for monopoly. Foreign companies importing drugs through wholesalers believe there should be a public debate on vertical integration.

The opposition to vertical integration in the pharmaceutical sector goes back to the year 2000 when Commercial League, a leading distributor, attempted to build up a plant for the production of life-saving and life-maintaining medicines such as infusion solutions and amino-acids used in pre-hospital and hospital treatment. Such products find good application in emergency care where quality of early treatment is crucial for overall treatment and insures cost savings. The project developed jointly with the Austrian firm Austroplan would represent a total investment of 46 million deutsche marks. Commercial League has 70 consignment storage houses in Bulgaria but also owns a tablet packaging plant in the city of Varna, at least two pharmacy chains (a total of 30 to 60 outlets) and the Pharmatel Company for door-to-door sales (Alexandrova 2000). The charges against Commercial League were that it would not allow competitive products to be sold in its outlets thus limiting product variety and consumer choice. The other distributors and producers which were not vertically integrated would be at a disadvantage, as vertically integrated structures along the production, wholesale and retail sale of drugs allow achieving a high profit margin. The Law on Medical Drugs stated that vertical integration threatens competition.

Meanwhile, the Executive Agency on Medical Drugs has reported a large number of violations of good commercial practices in pharmacies. Twenty-one of them worked without license in 2004. Small pharmacies often do not store thermo-sensitive drugs properly. Sometimes toxic substances are kept together with all other drugs in the main premise of the pharmacy. A major violation of the regulations on the proper storage of drugs is that narcotics are not kept in special metal cases but are available in the main premise of the pharmacy. There are multiple occasions of storage and sale of medicines beyond their expiration date. The pharmacies continue to sell a large number of medicines, which, for one reason or another, have been banned from sale. Many of the items lack instructions for use in Bulgarian. Assistant pharmacists sell prescribed medicines to patients, which also contradicts the law. A number of medicines are sold without the necessary sale authorization or without the


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accompanying accounting documents. Very often nonexperts operate in the pharmacies. Small, independent pharmacies resort to unfair competition to survive.

Producers cannot control the way their products are sold, displayed or promoted. To circumvent the legal ban on vertical integration they register themselves by legal entities, their distributor by other entities, while pharmacies are registered by individual pharmacies. Such is the connection between the Chaikapharma production plant, its distributor Commercial League and the Exemplary Pharmacies chain (See Table 2).

Table 2. Vertically integrated structures in the Bulgarian pharmaceutical sector

Drug Manufacturer 3 Wholesaler 4 Retailing

Sopharma Sopharma Trading Yes, through Sanita Franchise

Actavis Hygia No, attempted through Mareshki Pharmacies

Chaika Pharma Commercial League Yes, through Exemplary Pharmacies and Pharmatel, attempted Sofia Pharmacies

Table 2 presents the vertically integrated structures in the Bulgarian pharmaceutical industry where each

major drug producer has integrated with a wholesaler. Sopharma and Chaika Pharma are already fully vertically integrated, as shown by Table 2. Sopharma owns Sanita Pharmacies through the Sopharma Trading Holding, while Chaika Pharma owns Exemplary Pharmacies and Pharmatel for door-to-door sales through Commercial League, which also attempted to obtain Sofia Pharmacies. Actavis has attempted to buy out the Mareshki Pharmacies through its distributor Hygia but has not succeeded.

Sopharma is a major pharmaceutical company in Bulgaria concentrating in research, manufacturing and trade in proprietary pharmaceutical substances, phytochemical products and finished drug forms. In the beginning of 2005 the company appropriated shares in a number of pharmacy chains, particularly, 9.99% of Kaliman, 9 shares of Global Medical and 9.99% of Sanita Trading. These are three of the largest wholesalers in the country. The goal was to restructure the Bulgarian pharmaceutical market. Sopharma has been able to protect its branded products and achieve a high degree of profitability through the pursued strategy of vertical integration. The major wholesalers for Sopharma are Sanita Trading, Commercial League, Hygia, Sting, S&D Pharma, Global Medical, Kaliman, Unipharma 2000, Coral, Plamar, Biopharmacy, Multipharm. The new management of the company reduced the copying of trademarks owned by the company and stabilized it financially. The cost reductions resulted from economies on raw material costs, financial costs as well as costs of exchange rate operations.

In 1999 the Icelandic company Actavis invested in the Bulgarian Balkanpharma plant and privatized in the following year the three big pharmaceutical plants in Bulgaria‟s towns Dupnitsa, Troyan and Razgrad. An attempt of the company to vertically integrate was the acquisition of one of the five biggest national distributors in the country Hygia. This was in response to Sopharma‟s obtaining the three major distributors Sanita Trading, Kaliman and Konsumpharm that formed the holding Sopharma Trading. It also followed the purchase of another leading distributor Lybra by the Pan-European distributor Phoenix and the control of Chaika Pharma, the third major drug manufacturer in Bulgaria, over one of the largest wholesalers Commercial League. The price of 33 million levs that Actavis was ready to pay for Hygia was not announced officially as the finalization of the deal was subject to the approval of the Commission for Protecting Competition (CPC). The approval would depend on whether Hygia had a monopoly position on the market. Hygia had been active since 1995 and had 9 storage houses in the country. It was a major supplier for the hospitals, the Ministry of Health and the National Health Case in public procurement.

The process of concentration seems to follow world trends where both horizontal and vertical integration occurs, i.e., mergers of producers as well as mergers of producers and distributors.9 Except economies of scale and transaction cost economies consolidation is driven by the need to generate funds for expensive research in the field of genetics, molecular biology, pharmacology, medicine, etc. Some of the most notable world mergers in the last years have been those between British Glaxo and Wellcome into Glaxo-Wellcome and the Swiss Ciba

9 In the Bulgarian case Biovet, a major producer of veterinary drugs, is a good example of a horizontally integrated

structure pursuing rapid expansion.


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and Sandoz into Novartis, as well as the failed mergers between Smith Kline Beecham Plc. and American Home Products Co. and later Glaxo Wellcome.

4. Potential for empirical research

We have shown that profitability of own production (through vertically integrated structures) increases with asset specificity while that of procuring the products through the market (non-integrated structures) becomes less and less profitable the more specific the assets in question. In the context of Bulgarian pharmaceutical manufacturers and forward integration this finding translates into greater profitability from selling specific medicines carrying the brand name of the manufacturer through its own outlets. In this case, the specific investment made by the company is in brand-name capital, representing a fifth type of asset specificity. At the same time, generic drugs represent a form of non-specific assets that the firm manufactures under a common name. The firm would be likely to use an integrated sales force and own chains of pharmacies when it wants to better display, promote and sell its branded products. This is also in line with the fact that non-integrated pharmacy chains that carry a number of competitive products may not sell those branded drugs in the best way or may even refuse to sell products that go into direct competition with the products of other firms.

It is interesting then to see the effect of drug branding on the profitability of firms. We would also expect it to have an effect on the production and transaction costs of the firm, both of which would be likely to grow the more specific the drug is.

iiiiioi CDCD 321

We can hypothesize an estimation equation where profit is a function of drug branding and total costs such that

i = profit margin (unit profit) of the i th drug;

iD = 1 if branded drug, 0 if generic;

iC = unit costs of producing the i th drug.

Profit can be taken either as an absolute value, i.e., profit margin, or as a rate of return, that is, a

percentage of the total revenue of the company. We expect

01 or profit to be higher with drugs that carry the brand name of the company; this would also

prove greater profitability of own production with asset specificity.

02 higher costs are expected to reduce profit; this would show the combined effect of production

and transaction costs.

03 an interaction term coefficient that leads to a slope dummy; the implication is that profits would

also fall if branded drugs incur higher costs. To the above variables in the model we can add the sales of the i th drug which changes the equation to

iiiiiioi SCDCD 4321

iS sales of the i th drug

where we hypothesize that 04 since with greater sales profit margin is expected to fall. To measure

the effect of drug branding on the decision for forward integration we could use a simple contingency table and a chi-square test.


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Table 3. Contingency table for drug branding versus forward integration

0iB generic drug 1iB specific drug

0iD non-integrated sales

(independent retailers)

1iD vertical integration

(own pharmacies)

Furthermore, to incorporate other relevant variables we can resort to a binomial probability model. Since a

most distinctive form of asset specificity in this case is brand-name capital it is interesting to see the effect of advertising as a form of investment in brand-name capital. Therefore,

),( iii ABfD where

1iD if the pharmaceutical manufacturer is vertically integrated with a pharmacy, 0 otherwise;

1iB if the drug carries the brand name of the manufacturer, 0 if it is generic;

iA = advertising spent on the i th drug

Thus we have

iiio

i

i ABD

D

21

1ln

We expect

01 shows that asset specificity in the form of brand name capital drives forward integration in the

Bulgarian pharmaceutical sector;

02 higher advertising expenditures representing greater investment in brand-name capital also

imply greater tendency for forward integration of drug manufacturers with pharmacies.

5. Conclusion Vertical integration allows Bulgarian pharmaceutical firms to achieve scale economies and reduce

transaction costs. Operating in a high-transaction cost sector and economy, manufacturers are vulnerable to the risks of market contracting and opportunism from distributors. In their attempt to control products all along the marketing channel, they resort to complex legal and accounting manoeuvres through the mechanism of franchising.

Common ownership guarantees common supply, common advertising strategy, low cost and ultimately, low prices of medications. Vertically integrated structures also provide for full control over the financial flows and the movement of drugs along the distribution chain. Integration into wholesale and retail distribution would allow fair competition and quality commitment. Forward integration into wholesaling is especially important for products that need coordination of marketing and distribution. Such is the case of non-generic (branded) drugs, which require special ways of selling. For products and industries where product differentiation is essential the need for proper advertising as part of the promotion mix also determines ownership of wholesaling, as illustrated by the Bulgarian drug market. Forward integration into retailing extends the case of ownership of distribution where special handling and proper representation of the product continue to be important to the sales of the product. Some solutions and medications are nondurable and require special storage and handling. This also necessitates the common ownership of assets – from the production stage to the sale to the final consumer. The specificity of medicines as intermediate products is very high. They are sophisticated products that require information, special demonstration or proper display. Product specificity opens pharmaceutical firms to various market risks. The need to provide detailed information to consumers also determines the ownership of retail stores by producers and a strongly forward integrated Bulgarian pharmaceutical sector. Furthermore, the freedom of distributors to use


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pricing strategies that do not quite match the pricing philosophy or requirements of the producers illustrates the hold-up problem where producers do not have choice but to obey distributors.

Some economic theories charge vertical integration with the attempt to create monopoly and seek rents but on the Bulgarian pharmaceutical market the competition on the generic and the original drug market rules out monopoly, as there are several major producers and the sector rather resembles an oligopolistic industry. This excludes the possibility of monopoly-raised production prices. Instead, it could be expected that efficiency and cost savings resulting from vertical integration would likely reduce prices of medicines. Efficiency would stem both from savings in production and transaction costs where we showed that high degree of asset specificity, in this case, the product specificity of medicines, favors internal organization rather than market contracting.

The mechanism of public procurement in Bulgarian healthcare authorizes the Ministry of Health and the Health Case, the central health insurance authority in Bulgaria, to buy medical products for hospitals and clinics. It could be predicted that this process will greatly be facilitated if these central authorities negotiate with integrated companies that control their financial and commodity flows completely and not with multiple layers of distributors. A smooth process of negotiation would be beneficial not only for the authorities but for patients as a whole.

While there are economies of scale and scope resulting from mergers in the Bulgarian pharmaceutical sector, the major driving force behind those mergers seem to be the high asset specificity of products and the sizable transaction costs faced by firms in the low-trust Bulgarian environment. There are transaction cost explanations to the recent developments in the Bulgarian drug industry that Bulgarian economists and policy makers overlook. As a low-trust, high-transaction cost economy, the Bulgarian economy determines that a larger scale of operations in the pharmaceutical sector be internalised within firms rather than carried out by the market.

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[4] Arrow, K.J. 1985. Informational structure of the firm. American Economic Review, Papers and Proceedings 75: 303-307.

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[9] Chandler, A.D.Jr. 1962. Strategy and Structure. MIT Press: Cambridge, Massachusetts. Subsequently published in New York: Doubleday & Co., 1966.

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[14] Lilien, G.L. 1979. Advisor 2: modeling the marketing mix decision for industrial products. Management Science 25: 191-204.

[15] Masten, S.E. 1984. The organization of production: evidence from the aerospace industry. Journal of Law and Economics 27: 403-417.

[16] Monteverde, K., and Teece D.J. 1982. Supplier switching costs and vertical integration in the automobile industry. Bell Journal of Economics 13: 206-213.

[17] Muris, T.J., Scheffman, D., and Spiller, P. 1992. Strategy and transaction costs: the organization of distribution in the carbonated soft drink industry. Journal of Economics and Management Strategy 1: 83-128.

[18] Nikolova, D. 2005. The neighborhood pharmacy sentenced to an alliance. Capital, Issue 6.

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[20] North, D. 1978. Structure and performance: the task of economic history. Journal of Economic Literature 16 (September): 963-978.

[21] Schmalensee, R. 1973. A note on the theory of vertical integration. Journal of Political Economy 81 (March/April): 422-449.

[22] Shelanski, H.A., and Klein, P.G. 1999. Empirical research in transaction cost economics: a review and assessment. In Carroll, G.R., and Teece, D.J. (Eds.), Firms, Markets and Hierarchies: The Transaction Cost Economics Perspective, Oxford University Press: New York, Oxford.

[23] Simon, H. 1961. Administrative Behavior. 2nd ed. Macmillan: New York. Original publication: 1947.

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THE ROLE OF THE MANAGEMENT IN KOSOVO SMEs, THE HELP THEY NEED TO OVERCOME THE ECONOMIC

CRISIS

Fatos UKAJ Faculty of Applied Science in Business, Pejë, Kosovo

[email protected] Abstract

We must admit, whether we agree or not that the SMEs in Kosovo as well as in the majority of the world’s economy are a driving force for an economic growth, as well as an important part of the national industry. The various flows of economic cycles in transition identify SMEs to be the promoters of the private initiative and necessary entrepreneur activities to face the economic crisis. SMEs have shown their advantage towards the other national industry because they have indicated to be flexible and ready to react quickly towards the market demands and with the same speed to adopt in changes within the environment. Even Kosovo, as an undevelopped economic country, experiencing a 20 years conflict, happens to be in a crossroad in order to determine the appropriate path to be followed that shall set forth the future of the national economy which under the current situation is very dependable and oriented towards importation of goods and services. The situation of the Kosovo SMEs can be described as difficult, as well as facing further difficulties to stabilize their own business and to compete with foreign products that are presented in the domestic market.

The way this problem is overcome in the European Union countries and in countries in transition, which needs to be taken as an example, is that such countries have controlled this problem through regulations or laws the help provide to the SMEs. This needs to be taken as a lesson by Kosovo, aiming to strengthen the SMEs to be capable to compete and grow in the market as well as to impact in national economic growth. Keywords: Management, Small and Medium Enterprises (SME), economic growth, help, competition JEL Classification: L0, L2, L26

1. Introduction At the end of the past century and at the beginning of the 21st Century, the acronym „SME‟ became an

important part and frequently expressed by the economists, politicians and various media. This enabled to view the entire sector as a separate group which is distinguished from the traditional organization of economic enterprises judging by the size as well as from the characteristics of the ownership which make the Small and Medium Enterprises (SME) vary from others. These are enterprises of private property and in most cases, with less than 10 employees. The fact that they are private property makes them more flexible and adaptable to fulfil the market‟s demand and which in fact refers to the owner‟s entrepreneur skills. Being aware of the tough conditions in which the SMEs have developped and are developping, firstly the constant environmental changes, either domestic or external, such changes bring risk and uncertainty for the entrepreneurs. It is necessary to help and support the entrepreneurs from the very establishment of these enterprises and an ongoing support to their business aiming for their growth, enabling them a profitable and friendly environment for the private initiative by focusing on SMEs. This has to be performed by issuing laws that enable trust to invest in Kosovo making it attractive for both parties: local entrepreneurs as well as international ones. The approval of a legislation for business support is based on the European practices and was sponsored and supported by different European Agencies such as ADA (Austrian Development Agency), ATA (Academic Training Association-Netherland), which are ongoing with the Project BSC (Business Start Up Centre), KCBS/USAID with their cluster project in Kosovo and their support of VSAT Project (Voucher Scheme of Advisory and Trainings). It should be noted that fundamental changes can be achieved only by changing the enterprise management approach, personnel, awareness towards the institutions, compliance towards global trends, also coping with the developments that constantly derive.

2. Definition of help and changes that need to take place for SMEs

There are different trends and cycles in transition economies such as: amendments of economic-policy systems, factors that help or obstruct the economy, change of the shape of business development, massive establishment of new enterprises, etc. Policies and development programs for SMEs in Kosovo were compiled in compliance with the recommendations of the European Charter for Small Enterprises in 2003 when Kosovo



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became a member of this Charter. The Agency for Support of SMEs is also a national coordinator of the European Charter for Small Enterprises in Kosovo; in particular its activation and capacity increase have constantly advanced the idea of supporting and assisting SMEs insofar. If this is satisfying from the site and interviews with Kosovo entrepreneurs it turns out that the assistance is not sufficient and of the kind they need, but also receiving the assistance requires from them a lot of „paper work‟ and they are not ready to completely fill in the application for any of the support schemes provided by governmental institutions. On the other hand, those who have entered these support projects consider and assess them as helpful for their businesses.

Figure 1. The role and importance of SMEs in the European economy

Source: EUROSTAT – Statistics in focus, 71/2009

The indicators of growth for small and medium businesses are: permanent innovative activities, external and internal factors, within the internal factors there are the factors that the enterprise depends on or the enterprise itself, whereas external factors are those that they depend on and are subject for institutional influences.

Basic characteristics of SMEs in Kosovo and further on do not differ and they are: they belong to an ownership of an individual or small number of partners (usually family), they are oriented in close local market and rarely in the national one, they have a low participation in national market, adapt easily to market demand, management is reserved for enterprise owners, they do not have stable organization structure for a flexible organization (employees are trained for different tasks), size of enterprise (according to number of employees, sale volume, enterprise assets) is small in comparison with the main competitors in the country (either foreign or domestic). The fact should be highlighted that most of the registered businesses are micro-enterprises (1-9 employees), also the highest number of the employment is in this enterprise category. According to the number of registered employees in KABR (Kosovo Agency for Business Registration) there are 95 931 employees in this category, or 55.90%. In small enterprises there are 15.436 employees employed or 9.00%, in medium enterprises there are 12664 employees, or 7.38%. Large enterprises (over 250 employees) are a particular characteristic and it is worth to note that there are registered as social and also public enterprises (KEK-Kosovo Electrical Corporate, PTK-Post and Telecom of Kosovo, etc.), and including all these, in large enterprises there are 47.578 employees employed, or 27.72% of employment in registered businesses. As far as enterprise size is concerned, they are classified in macro, small and medium enterprises. In order to make this classification, the European Union standards have been used. Among the criteria used by the European Union there is the number of employees, turnover and fixed capital. Considering the difficulties to apply these criteria to define SMEs in Kosovo, the number of employment has been taken as a basis to classify private enterprises in different categories, as following:

Micro enterprises – employ 1 – 9 employees; Small enterprises – employ 10 – 49 employees; and


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Medium enterprises – employ 50 – 249 employees. The following table presents size of enterprises in Kosovo included in the sample and their comparison

with data from Statistics Institute of Kosovo.

Table 1. Number of the SMEs in the end of the 2009 year, structure of the SME as per size

Nr. Classifications Number of Employees Number of

Businesses %

1 Micro Enterprises 1 - 9 employees 73138 98.26

2 Small Enterprises 10 - 49 employees 1096 1.47

3 Middle Enterprises 50 - 249 employees 159 0,21

4 LargeEnterprise(Corporate) 250 - ... employees 43 0,06

Total 74.436 100

Source: Kosovo Statistical Office- (KSO).

Kosovo has natural resources which are not quite used and they represent a potential for rise of new

businesses, and this would lead to a sustainable economical growth. Careful use and exploitation of the existing resources is conditioned from various factors such as socio-economical and natural circumstances, which are an advantage for the growth of several economical fields in Kosovo, where farming and processing of agricultural products, etc can be distinguished. An insisting requirement for Kosovo‟s economical development requests to create conditions first of all to undergo differences in economical development among particular regions within the country. The above mentioned Small and Medium Enterprises representing the main resource for possible employment of labour, unemployment rate being – in Kosovo – 40 %, the chance for absorbance of labour, and the fact that SMEs are a generator of economical growth also in developped countries in the world should have the same importance and role in the development of our economy.

Table 2. Rank of Kosovo as a country for Doing Business

Nr. Country Rank out of 183 countries

1 Singapore 1

2 Bulgaria 44

3 Czech Republic 74

4 Albania 82

5 Croatia 103

6 Kosovo 113

7 Bosnia and Herzegovina 116

Source: World Bank, Doing Business 2010.

Kosovo is ranked on the 113th position out of 183 economies. Singapore is the top ranked economy in the

Ease of Doing Business. There are indicators that rank Kosovo lower or higher as the table below shows:


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Table 3. Rank of Kosovo as a country for Doing Business, advantages and obstacles

Nr. Indicators Rank out of 183 countries

1 Starting a Business 164

2 Protecting Investors 174

3 Enforcing Contracts 157

4 Employing Workers 34

5 Getting Credit 43

Source: World Bank, Doing Business 2010.

3. Enterprise change management

There are several reasons to make changes within organization in view of SMEs in Kosovo, and such changes depend on:

Target-cause - whether there is the adoption of a new way of organization or an evolution of the current one takes place;

The nature of the process – whether it is comprehensive, partial, revolutionary etc.; Content - is related to organizational change or business processes change; Other criteria, in relation to the size and extent of the changes, time scale etc.. Implementation of organizational change within SMEs is not an easy process, which needs to be managed

and carried out in several stages. This brings up the need that despite the entrepreneurs, the noted institutions need to be included in the

game in order to provide support to SMEs in Kosovo. The first step to be undertaken is the identification of the current situation of SMEs and issuance of a

conclusion that such changes must be performed, and to show that they are inevitable. The second step would be to inform the entrepreneurs, owners, managers and employees about the

necessity of such changes - this is going to facilitate the resistance - and support the need for change in enterprises in the future. It is compulsory to establish the cooperation of everybody involved and to actually implement the changes into the enterprises.

It is expected that while we work on change for the organizational management of enterprises, this will also lead to personal changes so this needs to be planned in conjunction with top management and their subordinates.

The objective of Kosovo in the case of developping small and medium enterprises should be focused on these issues:

Development of an economical field which would be able to incite economical growth, increase

employment and decrease the flow of funds from the country for the needs of imported goods - this could be

achieved by stimulating agro-business, processing foods and similar other industries;

Creating a legal environment which would enable the development of SMEs – this could be achieved by

filling the legal gap and clarifying the laws, by the cooperation between the government and interest institutions

(Commercial Chamber) as business representatives, strengthening the protection of the free economy

businesses through arbitration and courts;

Implementation of reforms in public services as a way to provide support in forming small and medium

enterprises – this could be achieved with the communication and coordination between different governmental

institutions, in reducing the need for administrative work and bureaucracy during the commencement phase and

further development of SMEs;

Use and practice of international experiences and possible international support in increasing the capacity of SMEs – this could be achieved by departments in governmental institutions that will be specialized in finding and attracting possible international assistance, based on priority needs of SME sector. Of course previous experience should be a lesson that more can be achieved in this direction;


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Create possibilities and undertake measures which would enable access of SMEs to financial sources which are of vital importance to SME‟s for development - this would be achieved by enabling governmental funds to support SMEs, provision of loan guarantees for SMEs, decrease of loan interest rates, provision of a grace period to return the loan etc.;

Enable the support of SMEs regarding the education and the increase of capacity, improving the qualified structure of employees – this would be achieved by strengthening the existing support network of SMEs, establish a common network for collecting and distributing the information to/from the existing businesses and those that are under development.

Following the actuality in economic development strategy considering the conditions from Kosovo, the

domination of findings is noticed on governmental executives as well as on economists that small and medium enterprises will be the main production pillars in the future, by which the gap will be filled, alongside the failure and closure of large enterprises. I myself am sceptical that this will occur on its own if we consider the current situation of these pillars (SMEs) of economic development in Kosovo – they are ignored and left without due attention. If this continues for a longer time then it will lead to a chaotic condition for which we have examples of the Kosovo economy in the last 20 years, but also the economies of other transition countries.

Certainly, we have to be careful when changing the approach towards the SMEs and in particular we need to be careful to the: managerial strategy, characteristics of entrepreneurs, specific forms of a branch, industry and environment, specifics of a each enterprise. Even the role of the formal and informal activity is noted as a factor to determine the entrepreneurs for an establishment of an enterprise.

4. Conclusion and recommendations

Within the business of each economic and non-economic entity, including the SMEs, there are constantly changes taking place of minor and serious nature within all organizational levels, however such changes do not pose the same meaning for every entity itself. The growth indicators for small and medium enterprises are permanent innovative activities, consideration of external and internal factors. The SMEs have a perspective also due to the fact that in the EU and in the developing countries they are treated as an important economic factor, which is also important for Kosovo as it is being in the first creating phase of the SME sector. In arrears of 20 years in economical growth for Kosovo comparing with the EU and regional countries, the gap could be reduced as a result of the SME skills which in this globalization context are able to adjust and identify market possibilities and needs for their products. Here we have to mention that the size of the enterprise does not constitute as one of the success factors. Due to the fact that changes incurred in organizational matters and in enterprise management something new and unknown is brought being expected to face resistance from the employees towards the changes proposed; such objections firstly are a result of fear against the unknown, lack of concentration to the proposed changes, professional abilities etc. We recommend that the SMEs should rely on their own possibilities and use every support that comes from the outside. In the development strategy of each SME in Kosovo, the following should be included:

education of management and other staff, implementation of quality management and marketing concept as fundament in the SMEs business;

identification and selection of strategic partners in their specific activities; additional attention to permanent development and introduction of new products in the market, and

improvement of the existing ones; attention to product design and packaging, which will be the factor for higher sale and successful

business; attention to creation and development of an information System for communication needs within the

enterprise and with the market. additional attention to geographical extension on the set up of enterprises, by providing support to less

developped regions within Kosovo, providing extra incentives and support. The technological advancement has a positive impact in the development of the SMEs in Kosovo, but this

impact is less influential than in EU countries as well as in South Eastern European countries, which positively impacts as well as it is financially and physically expressed as a respectable percentage and as an indicator for the SMEs in Kosovo. The efficiency of progress in growth of the SMEs in national economy and to the SMEs itself will depend largely on the way of management and to management that will have to face the challenges of identification of the needs for change at the most appropriate time possible and within this all the players need to


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be involved (in the Kosovo case there are the owners and the employees working for them, the noted institutions that work in supporting the SMEs). Only in this way, the development and growth of enterprises as economic entities will be ensured as a stable and sustainable place in a certain economic area, competition advantage in generating profit as one of the intentions and satisfying local and international customers with their products and services. References: [1] Agjencioni për regjistrimin e Bizneseve, http://www.arbk.org/arbk/.

[2] Agjencioni Kosovar për mbështetjen e NVM, http://www.rks-gov.net/sq-AL/Bizneset/ZhvillimiBiznesit/Pages/SherbimetKonsultuese.aspx.

[3] Bibuljica, Husnija. Control and Maintenance Accounting of Information Systems, First on-line International conference World‟s Economies In and After Crisis: Challenges, Threats and Opportunities -WECTO, ASERS Publishing.

[4] Central Bank of Kosovo (BQK), http://bqk-kos.org/?cid=1,25.

[5] Enti i Statistikave te Kosoves, http://www.ksgov.net/ESK/index.php?option=com_content&view=article&id= 186&Itemid=68.

[6] Eurostat, statistics in fokus 71,http://epp.eurostat.ec.europa.eu/cache/ITY_OFFPUB/KS-SF-09-071/EN/KS-SF-09-071-EN.PDF.

[7] Investment Promotion Agency of Kosovo, http://www.invest-ks.org/.

[8] Krasniqi, Armand, and Ukaj, Fatos. 2010. Menaxhimi i Destinacionit ne Turizem. Peje.

[9] Krasniqi, Armand. Protectionist Institutional Financial Crisis in Transition Economies in South Eastern Europe. First on-line International conference „World‟s Economies In and After Crisis: Challenges, Threats and Opportunities‟ - WECTO, ASERS Publishing.

[10] Ukaj, Fatos. 2010. Promotion of Investment in Tourisem- use of the integrated marketing communications. IInd International Conference/Konferenca e IIte Nderkombetare, IIgi Medjunarodna Konferencija, Investments in tourism as a condition of Regional Integration, Center for economic Research/Qendra per Hulumtime Ekonomike/Centar za Ekonomska Istrazivanja, Ulqin/Ulcinj, Montenegro, Prill, Ulqin.

[11] Ukaj, Fatos. 2010. Marketing Concept as a Tool for Development of Tourism in Kosovo. Journal of Environmental Management and Tourism (JEMT) vol. I (1): 57-62. ASERS Publishing. http://www.asers.eu/asers-publishing/ISSN2068-7729.

[12] Ukaj, Fatos. Support of Small - Medium Size Enterprises (SME) - Opportunity for Kosovo to Overcome Economic Crisis, First on-line International conference „World‟s Economies In and After Crisis: Challenges, Threats and Opportunities, WECTO, ASERS Publishing, http://www.asers.eu/asers-publishing.

[13] Ukaj, Fatos. Transport as the factor of sustainable economic development, in its series MPRA Paper with n. 22319, University Library of Munich, Germany.

[14] Ukaj, Fatos. Trashëgimia kulturore dhe historike si potencial i zhvillimit të turizmit- me fokus në regjionet e Kosovës /Cultural and historical heritage in Kosova as a potential for development of tourism - focus on the Kosova regions, in its series MPRA Paper with no. 2159, University Library of Munich, Germany , http://mpra.ub.uni-muenchen.de/21509/.

[15] World Bank, http://www.doingbusiness.org/Documents/CountryProfiles/KSV.pdf.

http://www.arbk.org/arbk/

http://www.rks-gov.net/sq-AL/Bizneset/ZhvillimiBiznesit/Pages/SherbimetKonsultuese.aspx

http://bqk-kos.org/?cid=1,25

http://www.ksgov.net/ESK/index.php?option=com_content&view=article&id=%20186&Itemid=68

http://www.ksgov.net/ESK/index.php?option=com_content&view=article&id=%20186&Itemid=68

http://epp.eurostat.ec.europa.eu/cache/ITY_OFFPUB/KS-SF-09-071/EN/KS-SF-09-071-EN.PDF

http://epp.eurostat.ec.europa.eu/cache/ITY_OFFPUB/KS-SF-09-071/EN/KS-SF-09-071-EN.PDF

http://www.invest-ks.org/

http://www.asers.eu/asers-publishing

http://ideas.repec.org/s/pra/mprapa.html

http://ideas.repec.org/s/pra/mprapa.html

http://mpra.ub.uni-muenchen.de/21509/

http://www.doingbusiness.org/Documents/CountryProfiles/KSV.pdf


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ENTERPRISE MODELING BASED ON COMBINATION OF PROCESS AND REA VALUE CHAIN PERSPECTIVE

Dominik VYMETAL

Silesian University, Czech Republic [email protected] Frantisek HUNKA

University of Ostrava, Czech Republic [email protected]

Miroslav HUCKA VSB-Technical University, Czech Republic

[email protected] Josef KASIK

VSB-Technical University, Czech Republic [email protected]

Abstract The paper focuses on enterprise business value chain modeling as an alternative to business process modeling. Well

known REA methodology proposed by McCarthy and Geerts is used as the basic modeling framework. The research presented in the paper results in a generic semantic enterprise model using REA ontology. This rather static model is then converted into UML activity, sequence and state diagrams thus achieving dynamic view of the REA model. The dynamic REA view connects the process model and the value chain perspectives. It is shown that by using REA model transition called dynamization not only process models at task level can be achieved but also a consistency check of the REA model can be accomplished. By means of step by step value chain modeling of the enterprise a consistent process model can be reached preserving all advantages of the typical business process modeling methods.

Keywords: process model, value chain model, REA, production planning

JEL Classification: L15, L23, M11, O21

1. Introduction

Enterprises have been operating in global competition environment. They are forced to improve quality and flexibility of business operations in general. To achieve this goal, they need to understand the fundaments of their processes with the appropriate theoretical background leading to process optimization and corresponding support by information technologies. Enterprise process optimization is typically based on business process modeling. There are also other modeling perspectives used like information technology (IT) view and business value chain perspective. While the business process perspective concentrates on business processes and workflows aiming to describe company operations, the value chain perspective illustrates the value flows among the participants inside and outside the company. One of important advantages of the value flow modeling is that it captures the cross concern activities and represents the actual aim of the business processes – the value exchanges between the company and the environment. On the other side, the value chain perspective does not capture process sequences and states. It is often assumed that business process and values chain modeling are difficult to interconnect.

In this paper we focus on value chain modeling perspective and possibilities of its interconnection to business process modeling perspective. First, the foundations of value chain methodology are presented and the leading value chain methodology REA (Resources – Events – Agents) is described. Next, the notion of REA operational and REA policy levels and their relation to controlling and controlled company units is presented. This static representation of a company is then supplemented by dynamic views of value chain models presented in form of UML diagrams. This leads to possibility to formulate business process models based on the REA methodology. The last Section presents final discussion and outlines of further research orientation.

2. Value chain models and the REA methodology

New modeling and system design techniques are required for information technologies that can support the enterprise in achieving and sustaining the necessary flexibility. Current techniques use business process models, representing the operations inside the company from the control, data flow, resource handling and co-






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ordination of cross-operational processes points of view (Axenath, Kindler and Rubin 2007; Davenport 1992; Ericson and Penker 2006; Koubarakis and Plexousakis 1999; Řepa 2007; van der Alst 2004; Zdun and Dustdar 2007 etc). Formal notation of business process modeling can be found in Business Process Modelling Notation, 2006. During last few years efforts have been made to generalize modeling attitudes by means of enterprise ontologies (see e.g. Dietz 2006).

Distinctly from business process modeling methods, value chain perspectives typically concentrate on values flows inside the enterprise and on value exchange with the environment, that is, they are primarily based on underlying economic activities. The formal attitude to value chain modeling is defined by corresponding ontologies defining concepts and rules to be shared by other modelers (Cummins 2008; ISO/IEC 15944 2007).

Currently, the most popular value chain enterprise ontologies are e3-value (Gordijn and Akkermans 2003), and the REA (Resources, Events, Agents) ontology (McCarthy 1982; Geerts and McCarthy 2000, 2002).

The e3-value ontology stipulates that the actors exchange value objects by means of value activities. The value activity should yield profit for the actor. Deeper insight in e3-value modeling in e.g. (Gordijn and Akkermans 2003; Huemer 2008), shows that this method only covers exchange and trade processes but omits production and conversion processes. The state-of-the-art e3-value model only focuses on operational level (what has happened) but not on management policy (what could or should happen).

Our object of interest is the REA ontology, because it links together business process modeling with the underlying economic phenomena. The REA model represents a conceptual framework and ontology for Enterprise Information Architectures (McCarthy 1982; Geerts and McCarthy 2007). The REA ontology illustrates the value flows inside and among enterprises. The value flows modeled by means of REA can be decomposed into several levels (Figure 1).

T1 T2

Value chain - transaction cycles

AA RR

Operational level

etc.

T - Transaction cyclesA - economic agents

R - economic resourcesE - economic event

(exchange)

E

Value system (part)

production sales

E

RE

A v

alu

e s

ys

tem

, v

alu

e c

ha

in &

oth

er

en

titi

es

Figure 1. Value flow decomposition by the REA methodology

Source: own

The modeling starts at the highest level – the value system of the enterprise. The enterprise produces and delivers goods and services to receive cash from customers. Working capital (cash) comes from the investors, creditors, and from revenues originating in sales processes. This general value system is expanded into more specific value chains represented by basic transaction cycles decomposing value system entities. Transaction cycles can be generally presented in a form of business patterns, bearing enterprise value system and value chain in mind. The core of the REA models is presented as business patterns modeled at the REA operational level. The concept of operational level using basic notions of economic event, economic resource and economic agent is the base of the REA methodology. It was asserted in many other papers (Dunn , et al., 2004;Hruby, 2006; Chang and Ingraham, 2007; Vymetal , et al., 2008 etc) that more general perspective can be obtained by using the value approach, as the basic cycles and relations are principally the same for all transaction types.


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At the operational level, the economic events run in form of exchange, or conversion (production). During exchange, the providing agents provide their resources (e.g. goods) to receiving agents in order to increase their other resources (e.g. cash). In production, the providing agents provide input resources (e.g. material, tools, labor) to conversion process in order to produce the resource - product. The relation between economic events decreasing the input resources and economic events increasing the output resources is called exchange, eventually conversion duality in the REA terminology. These two basic patterns represent all REA economic events no matter what type of enterprise it concerns. However, it can be clearly seen, that the events at the operational level represent facts („what has happened‟) rather than objectives („what should, could or must happen‟). In general an answer is needed to the question „what is planed or scheduled?‟ This is modeled by REA policy level. The policy level defined in the REA methodology can be looked upon as a set of notions originated by several semantic abstractions of the REA operational level entities. There are two cores semantic abstractions defined for policy level (Geerts and McCarthy, 2006) namely typification and grouping.

In case of typification the specialized instance inherits both structure of data attributes and their contents. So, for example, the policy level entity Product Type defines the structure of the product by means of Bill-of-Material data structure. The Product Type instances define individual Bill-of-Material values valid for actual Product-to-be-produced (the plan „what should happen‟). The instance of Product at operational level inherits both Bill-of-Material data structure (the structure of planned values) and individual values used in production time (facts – „what happened‟).

Resourcetype

Eventtype Commitment

Agenttype

Resource Event Agent

Integration

Policy level

Operational level

typificatiiongrouping



fulfillment

provide

receive

stockflow

duality

Figure 2. Simplified scheme of operational and policy levels

Source: own The grouping semantic abstraction is used when set-level characteristics are of interest and may even

create an integral part together with the typification semantic abstraction. By this semantic abstraction a collection of individual entities may be specified with respect to some common properties. A simplified scheme of operational – policy level integration is presented by Figure 2.

The resource, agent and event entities are typified by policy level entities resource type, event type and agent type correspondingly. In some cases grouping can be also used. However, there is a new entity shown at policy level: the commitment entity. This entity is not defined by typification abstraction. There are still open research challenges regarding fulfillment relationship that are beyond scope of this paper. Commitments are typically used in cases when some event is expected, planed or induced. In fact, the commitment entity can be looked upon as a core connection of economic event at operational level to planning or scheduling entities at policy level. Thus, even in case of the simplified policy level scheme we come to the core notion of controlled and controlling value chain entities of the REA methodology. The operational and policy level entities discussed up to


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now pertain to the controlled part of the enterprise system. The actual attribute values of policy level instances that govern the behavior of operational level items are set by other economic events, namely the events running in the controlling subsystem of the enterprise. This situation is depicted by Figure 3.

The entities of REA operational level are related to corresponding entities of REA policy level by typification, by grouping and fulfillment abstractions. The enterprise objectives govern the behavior of the controlled subsystem by means of objectives, decisions, indicators and rules transferred to corresponding controlled policy level entities and further reflected to operational level entities.

REA policy level “what should happen”

Operational level entities typesOperational level entities groupsRulesPlansBills of material etc.

REA operational level “what happened, what happens”

E_resources - E_events _ E_agents

compa-ny

environ-ment

data on environmentbehaviour(”disturbances”)

Typification

GroupingFulfillment etc.

Controlled system

validation

analysis

etc.

facts

knowledge intensive entitiesvalidation rulesstandards and plans

Controlling system

ControllingsystemObjectives, decisions, indicators

Figure 3. REA levels of controlled enterprise system with feedback to controlling system

Source: own

The facts describing what happens or happened are validated, analyzed and further processed to be compared with the target values. The differences from target values serve as an input to events running in the controlling subsystem. However, the controlling subsystem is also a part of enterprise. Thus, the same patterns should be found there. Indeed, the activities of controlling personnel can be also looked upon on the REA basis. The economic events at controlling subsystem operational level consume the management labor, use needed equipment and other resources. These events result in plans, schedules, production rules, etc., generally, in knowledge intensive controlling resources. The above described scheme is presented in Figure 4. In this figure, only one relation of controlling system to controlled system is shown to simplify the picture. The enterprise value chain can be decomposed into several transaction cycles using business patterns of controlling and controlled subsystems. The controlled subsystems are modeled by REA patterns using their own operational and policy levels. The controlling subsystem sets the rules, indicators, targets etc. of individual controlled subsystems via corresponding policy levels. The events running at controlling operational level follow typical REA patterns of agent-resource-event chains. In this way also overhead costs can be captured and modeled. Following the REA concept, each controlling subsystem needs also its‟ own policy level. Indeed, also controlling subsystem of an enterprise has to follow common rules, laws and other conditions set by the enterprise environment and also to follow the general enterprise strategy expressed by means of strategy objectives. The question arises, how the knowledge intensive resources originating in the controlling system can be transferred to controlled subsystem policy level. Hunka , et al., (2009) proposed the notion of reflection abstraction realizing the connection between knowledge intensive resources produced in controlling subsystem (such as production plan) and corresponding items of controlled policy level items (such as production schedule). Following the steps described herein above and using the concept of reflection the modelers are able to define the static value flow structure of the whole enterprise.


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REA valuechain(transactioncycles)

Controlled system n

Operational level

Controlled systems

REA policy level

REA operational level

deduction, validation, differencies analysis

what should happen

what happened

Controlling system

Objectives DB

Controlled system 1

Controlled system 2

Operational level

Operational level

Integration

Figure 4. Generalized REA scheme of controlling and controlled subsystems

Source: own

3. Dynamization of the REA value chain model 3.1. Substance of dynamization

The REA model at operational level represents the lowest decomposition level of value chain oriented model of chosen enterprise domain. It transparently shows value flows among economic agents and economic events taking part in these flows. Nevertheless, it does not give answers to following questions:

what is the order of individual economic events; which participant – economic agent started the process and by which economic agent will be the

process finished; how to illustrate conditions, joins, forks and eventual cycles in the workflow; consistency checking of the REA model. Of course, an objection can be raised, that the order of events is visible during the running process or after

it had been ended. From the modeling point of view such kind of visibility is not sufficient enough. It is therefore necessary to complement the value chain model by a course of economic events – dynamics of the processes. The method of creating consistent process model based on a REA value chain scheme will be called dynamization (Vymetal, Hucka, Hunka and Kasik 2009). The result of dynamization can be represented by workflow (data flow) schemes, message schemes and state diagrams. Various tools can be used for this task. In our approach, corresponding UML diagrams are used, namely the activity diagrams, sequence diagrams that are complemented by simple process state diagrams. Mainly activity diagrams play an important role in the dynamization processes they enable to describe procedural logic of the REA model. Using of UML notation helps to achieve pattern approach and supports direct link to programming. Extensive literature reviews on UML and patterns usage can be found in (Fowler 1996; Coad, Lefebre and de Luca 1999; Arlow and Neustadt 2003; Ericsson and Penker 2009). The principal difference between them and flowchart notation is that they support parallel behavior. Using UML tools brings following important advantages:

REA models use object oriented perspective so that is why they are typically presented by UML syntax and graphical tools;

using UML activity and sequence diagrams enables using object oriented design methods supported by standard IDE tools.


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Presented extended REA modeling is summed up by Figure 5. The individual transaction cycles are successively decomposed into REA operational and policy level entities following corresponding business patterns. These steps result in static REA diagrams consisting of REA entities and relations among them. Using dynamization the activities of economic agents taking part in economic events are defined and corresponding message flow is inferred. Resulting model constitutes a basis for implementation in concrete programming language. The individual economic events do not depend on processes and organization structure of the enterprise, but on the value flows. In this sense the REA dynamization results in a process model that is consistent with value flows in the enterprise.

T1 T2

A

A

AA R

R

R

R

Operational level

A A A A

Activity diagram

Sequence diagram

Dynamization

etc.

T - Transaction cyclesA - economic agentsR - economic resourcesE - economic event (conversion)

E

Data model of REA rules and entities

RE

A w

ork

flo

wR

EA

valu

e c

hain

s

Figure 5. Extended REA modeling overview

Source: own Let us illustrate the dynamization approach by means of two simple examples.

3.2. Example one – simple production order

Production order is executed as follows. Based on production schedule the production supervisor sends a production order to a worker defining the product-to-be-produced, the production start time and the planned production time. At the same time, the information on product and corresponding Bill of Material is sent to warehouse clerk as an order for necessary tools and material. The warehouse clerk gives out tools and material and the worker starts working. After the product is finished, the worker returns the tools to warehouse clerk (the material was consumed during the production operation) and the warehouse clerk informs the supervisor on the tools return. The supervisor marks the production order as fulfilled. REA model

A simple REA operational level model can be designed with economic agents: supervisor, warehouse clerk and worker, resources labor, material, tools, schedule information and product. The decrement economic events define labor and material consumption and also tools and schedule information use. The increment product assembly event has conversion duality associations with corresponding decrement events. (see Figure 6).

Based on this model following diagrams can be defined during dynamization: production state diagram, UML activity diagram and UML sequence diagram using the operational level items. The formation of above mentioned diagrams is known enough from common practice.


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«economic agent»

Warehouse clerk

«economic agent»

Supervisor

«economic agent»

Worker

«resource»

Material

«resource»

Schedule

knowledge

<<resource>>

Tool

«resource»

Tool

«resource»

Labor

«decrement»

Material issue

«decrement»

Tools usage

«decrement»

Labor consumption

«increment»

Product assembly

«resource»

Product

«conversion>>

«produce»

«provide»

«provide»

«consume»

«use»

«consume»

«receive»

«receive»

«provide»

«receive»

«decrement»

Schedule knowledge

consumption

«consume»

«provide»

«receive»

«receive» receive

Figure 6. Simple production order - REA model

Source: own

Production state diagram The production state diagram includes six states presented in Figure 7. At the initialization stage all

necessary information of production order is sent to the warehouse clerk and to the worker. Using information embedded in the production order, the warehouse clerk supplies material and necessary tool to the worker. The production runs. After the production is finished, necessary information is passed to the supervisor and the order status changes to actualize. In case the order is not fulfilled in time, overdue information is sent to supervisor, the order status is actualized and either the production goes on or the production order is stopped and canceled. The finished production order is marked as finished after all necessary operations were accomplished. As shown in Figure 6, all necessary state diagram entities originated in the REA model.

Activity diagram Activity diagram is used to show the REA entities and associations at operational level from the resources

and activities point of view. The activities take part in conversion and exchange dualities. The significant activity diagram feature is that it defines the process participants (economic agents), starting and ending point of the process and the relation of individual resources to economic agents and events. To facilitate creation of activity diagrams from REA models there are several guidelines of mapping REA model concepts into activity diagram concepts. They follow:

each economic agent is mapped into a single partition (called swim line in UML jargon). This approach makes it clear who does what;

each economic event is transformed into a frame with its name in the heading of the frame; each economic resource is transformed into activity diagram object and is placed either in a defined

swim lane or on the swim lane boundary between two economic agents; individual relation of the REA model is mapped into an activity within the frame; the relations between

frames correspond to REA dualities; standard UML stencil are used for joins and forks; the activities must follow the basic REA succession „provides – resource – receives‟.


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Started

Enabled

Running

Actualized

Closed

Supervisor sends

schedule data to

Warehouse clerk and

Worker

Warehouse clerk provides

tools and materials to

Worker

Production runs

Worker provides Product

to Supervisor and returns

Tools to Warehouse clerk,

Supervisor marks order as

fulfilled

Delayed

Supervisor receives the

warehouse information

and product control

close()

actualize(Product,

Wh information)

timeout

(beyond ordered time)

In case of time

beyond schedule

initialize

(Schedule data)

use(Tool)

consume(Labour, Material)

Figure 7. Production order state diagram

Source: own

The consequences of the rules are as follows: the REA inherent but not direct visible economic event flow logic is visible in the activity diagram; it is possible to start sequence diagram composition if necessary; the swim lane principle orders the economic agents into transparent tabular form what makes the model

more understandable; activity diagram composition imposes REA model consistency check. The resulting activity diagram is shown in Figure 8. Note that there are three partitions (swim lines in UML

jargon) corresponding to three agents in the REA model (worker, warehouse clerk and supervisor). The resources are expressed at the borders of the swim lines. Economic events correspond to the frames in the figure. Proposed mapping between REA model and activity diagram enables consistency checking of the previous REA model. The entities of the REA diagram presented in Figure 6 are all represented by corresponding activity diagram entities. Hence, the dynamization of the REA diagram is possible.

Sequence diagram Sequence diagrams are used to present sequence of activities and messages that invoke them. The

sequence of activities is presented by a set of uncontinuous graphical objects recording activities of individual economic agents. The activities are placed in swim lanes of individual economic agents. The economic agents exchange messages registering operations with economic resources. The economic resources serve here as parameters of exchanged messages. In this sense the REA sequence diagrams fulfill principles of object oriented programming. The individual messages represent methods called by economic agents in order to accomplish activities at REA operational level. The sequence diagram composition is not necessary condition for REA dynamization; however it complements it and enables further consistency check of REA models. Figure 9 presents the sequence diagram of simple production order.


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Supervisor Worker Warehouse clerk

Schedule knowledge

consumption

Labor consumption

Tool usage

Material issue

Product assembly

Schedule

knowledge

Labor

Provide Consume

Provide

Tool

Material

Product

Consume

Use Provide

ProvideConsume

Receive Provide Tool Receive

conversion

Figure 8. Activity diagram of a simple production order

Source: own The operation „Supervisor activities‟ starts with two asynchronous messages sent to the worker and to

the warehouse clerk. Both messages deliver information needed to start and run production. On message delivery the warehouse clerk gives out necessary material and tools to the worker, who starts production. On finishing the product the worker informs the supervisor and returns the tools to the warehouse clerk, who sends


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confirmation to the supervisor. Having received both messages the supervisor marks the production order as finished. All necessary messages in this diagram originate from the basic REA model. Thus the sequence diagram can be also inferred from the operational level REA model.

supervisor :Agent warehouse clerk : Agent worker: Agent

Operation: supervisor activities Operation: warehouse clerk activities Operation: worker activities

close()

receive()

close ()

provide (ScheduleData.Material&Tool)

provide(ScheduelData.LaborAssignment)

receive()

provide(Material, Tool)

receive()

provide(Assembly.Product)

provide(ScheduleData.Tool)provide(Tool)

Figure 9. Sequence diagram of a simple production order Source: own

3.3. Example two – purchase of services The firm is purchasing an Inspection service in order to control the quality of products manufactured

according to the first example. REA model

There are two agents – Enterprise with resources Product and Cash and Inspection service provider with its resource Inspection service.

The Enterprise delivers resource Product for inspection. The Product and Inspection service are consumed during the decrement events Delivery for Inspection and Inspection service consumption in a conversion process connected to increment event Inspection producing resource Product of higher quality. On the other side, the consumption of resource Inspection service is mapped into increment event Inspection service delivery, which is paid for by cash consumed in decrement event Cash disbursement. The REA model is presented in Figure 10. Activity diagram

In the first example, it was shown that activity diagram is the main means of dynamization and consistency check of the REA model. This is why only activity diagram of the second example will be shown. The activity diagram is presented in Figure 10. There are two swim lanes in the activity diagram corresponding the agents Inspection service provider and Enterprise. Each economic event from the REA model is put into frames, the resources and value flows are mapped into the frames correspondingly. We can see that all entities in the activity diagram are in accordance with the REA model. The second example demonstrates that the REA model dynamization can be done for various model types.


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«agent»

Enterprise

«resource»

Product

«resource»

Inspection

service

«decrement»

Delivery for

inspection

«decrement»

Inspection

service

consumption

«increment»

Inspection

«consume»

«conversion duality»

«conversion» Inspection

«consume»Resource is used

by inspectionChange of

product quality

«increment»

Inspection service

delivery

«decrement»

Cash

disbursement

«resource»

Cash

«inflow»

«exchange duality»

«exchange process» Inspection service procurement

«consumption»

«agent»

Inspection service

provider

«production»

«agent»

Enterprise

«agent»

Inspection service

provider

«provedes»

«provides»«receives»«receives»

«provides»

«receives»

«receives»

«receives»

«provides»«provides»

Figure 10. Purchase of services

Source: own

4. Closing discussion and conclusion

In this paper we presented closed up modeling method based on the REA framework. The original static REA modeling was extended by means of stepwise dynamization consisting of REA model transition to UML activity, state and sequence diagrams. During transition, all REA entities were used and consistency check of original REA model was accomplished. UML activity, state and sequence diagrams thus create the bottom level of the whole model. The crucial issue is a transition form the level of REA model into UML activity diagram. To facilitate the process and make it more transparent, unique mapping between both perspectives was designed and verified. Each agent is mapped into a single partition which is important because agents play decisive roles in those processes. Each event is transformed into a unique frame. The frames are named after events. So the simple checking of transition is that the number of frames has to comply to the number of events. Resources are illustrated in the border lines between two neighboring agents. The activity diagram also reflects relations between entities in the REA model. Finally, each activity diagram has its starting point and point of terminations that are also illustrated in the diagram. UML state and sequence diagrams utilize UML activity diagram for describing different views on the problem. Transition described in the paper shows potential for introduction the commitments into the activity diagram too what could lead to modeling of cycles. But this is a task for further research. Thus, it can be seen that business process modeling based on value chain is possible and advantages of value chains can be used. However, there are still questions open for further research. Firstly, no iterations or cycles were modeled. The production schedule normally consists of more production runs planned what leads to necessary modeling of cyclic operations. Secondly, we used a very simple model leaving other processes like planning, reservations, co-operations of more workers or machines beyond model scope. Thirdly, like majority of REA models, our model was created from the single company perspective which makes it difficult to use it to model networks of collaborating trading parties. These questions represent the next research challenges.


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Inspection

Delivery for inspection

Inspection service consumption

Cash disbursement

Inspection service

delivery

Inspection service provider Enterprise

Inspection

service

Cash

Inspection

service

Product

Product

Provides

Provides

Provides

Provides

Provides

receives

Receives

Receives

Receives

Receives

Figure 11. Activity diagram

Source: own

Acknowledgement The paper was supported by the grant reference No. 402/08/0277 provided by The Grant Agency of the

Czech Republic.


157

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