How to Measure the Efficiency and Performance of Public Enterprises? Learn about:- 1. Introduction to Measurement of Efficiency 2. Criterion of Profits 3. Adherence to Time-Schedule and Cost Estimates 4. Labour Productivity 5. Cost of Production 6. Comparative Data 7. Overall Index of Efficiency 8. Comparison of Efficiency with Private Sector 9. Factors Contributing Towards Poor Performance.
Contents:
- Introduction to Measurement of Efficiency
- Criterion of Profits
- Adherence to Time-Schedule and Cost Estimates
- Labour Productivity
- Cost of Production
- Comparative Data
- Overall Index of Efficiency
- Comparison of Efficiency with Private Sector
- Factors Contributing Towards Poor Performance
1. Introduction to Measurement of Efficiency:
Measurement of efficiency in public enterprises is a very complicated problem. “…like so many terms having a very large and indeterminable connotation, the term ‘efficiency’ is so wide and porous that there is little interpretation that it can successfully resist.” It involves a large number of interdependent variables.
Even if all of them were amenable to precise measurement, which is not true in actual practice, there still remains the problem of attaching suitable weights to different variables. Consideration has to be given, for instance, to the cost of production of service per unit of resource, the satisfaction of the consumers in respect to quantities, qualities, and prices, the state of labour relations and the degree to which a spirit of willing co-operation has been created among members of staff, and the ability of the whole organisation to adjust itself to changing circumstances, its readiness to make experiments and to quickly adopt the latest technical improvements.
The problem is made more complicated by the entrance of value considerations through the term ‘public interest’. The public enterprises are expected to serve public interest. The term ‘public interest’ is amenable to different interpretations. “…it is not always possible to provide a list of what is contained in the bag of this term.”
“The performance record of the nationalized industries had been the subject of lively controversy, with government official, parliamentarian, layman or economist attacking or defending it on the basis of concepts, often not clearly defined, of how enterprises should be run in the public interest. In practice the record is a highly complex one and defies simple description or evaluation.”
The most difficult problem is that of the selection of suitable standards. “The suitability of any unit of measurement will depend much upon the significance we attach to the word ‘efficiency'”. If industrial efficiency consists, as E.A.G. Robinson maintains, “in trying to do with eight men what we have hitherto been doing with ten men”, labour productivity per man-hour would be a satisfactory criterion of measuring industrial efficiency.
If, however, the term “efficiency” is used in a wider sense, that is, obtaining the greatest results at least cost, cost of production per unit would be an appropriate criterion of efficiency. A private industrialist would, however, view efficiency from a different angle. His objective is to maximise profits and, therefore, his criterion would be the rate of profit that he can earn. We briefly examine below the important criteria of measuring efficiency in public enterprises.
2. Criterion of Profits
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This criterion has the great advantage that it is simple to calculate and understand. It provides a common standard of measuring efficiency of different enterprises. It is a general criterion which indicates the overall efficiency combining all the different operations together.
In private enterprise, guided by the objective of profit maximisation, profits provide the most important criterion of efficiency. In contrast, the public sector is normally not guided entirely by the profit motive and therefore the profits earned by a public enterprise are not a very appropriate criterion of its efficiency.
“Private investment is only held justifiable on business principles if in the foreseeable future there are reasonable prospects of a fair rate of return on the capital invested therein. Public investment, on the other hand, while not shunning profits, would move in whatever the social benefit/social cost ratio justified it”.
While applying profits as a criterion of efficiency in a public enterprise, an important thing that has to be kept in mind is whether the enterprise is operating under monopolistic or competitive conditions. A public enterprise operating under monopolistic conditions can inflate profits by restricting output and thereby artificially raising prices, which is not possible under competitive conditions.
Such profits are the result not of the efficient conduct of the enterprise but of the monopolistic position enjoyed by it. The profits, to be a test of efficiency, must not be the result of exploitation.
Though the profits are an important yardstick of efficiency, it would be a mistake to adopt them as the sole criterion of efficiency. In addition to efficiency, profits are affected by a number of other factors, viz., intensity of capital structure, size or scale of operation, location, degree of integration, efficiency of various inputs, imperfections of markets, changes in demand, fiscal and taxation policies, inflationary conditions, cyclical fluctuations, etc. All such factors should be taken into consideration while evaluating the efficiency of a public enterprise.
A public enterprise may come into existence as a result of nationalisation of a private-owned industry or from state venturing into a new field of economic activity. The public enterprise may operate along with its counterparts in the private sector or may be the sole producer in that field. The objective as well as the method of operation would differ from enterprise to enterprise and this would have to be kept in view in evaluating the efficiency of an enterprise.
In case of nationalised industries, comparison is possible between two periods before and after the nationalisation. A transport undertaking under private management, for instance, may be exploiting only the most profitable areas. After nationalisation, in the larger interest of the country, it may decide to extend services to the unexploited, sparsely populated and apparently unprofitable regions.
In such cases efficiency before and after nationalisation cannot be compared on the basis of profits. Similarly, comparison on the basis of profits may be vitiated if the enterprise functions in the two periods under different market structures. Before nationalisation the enterprise, for instance, may be operating under competitive conditions and after nationalisation it may have monopoly and as a result enjoy certain direct and indirect benefits in hiring labour and capital, purchasing raw materials and marketing the products.
Even when the public enterprises operate in a competitive market along with private enterprises, the objectives and the principles being followed in the two sectors would have to be kept in view while making a comparison of efficiency on the basis of profits.
Keeping in view the national objective of attainment of a socialist society, the public enterprises, for instance, may be offering more favourable conditions of service to labour than those offered by the private enterprises. For purposes of comparison, the profits of enterprises in the two sectors would have to be suitably adjusted to take account of such factors.
Some enterprises may not yield profits during the initial stages of their operation. They may take some time for their construction before they can gear to full operation. In such circumstances, the enterprises would take time to fructify. Here profits cannot be used as a yardstick of efficiency. In such cases, efficiency would have to be judged with reference to the judicious application of men and resources in keeping with the time-schedule and cost-estimates.
Lord Latham, a former chairman of London Transport Executive, points out that if circumstances are favourable, satisfactory profits can conceal inefficiency while in unfavourable circumstances a proper degree of efficiency may be achieved in spite of an absence of profits.
He emphasizes that in a public enterprise consideration must be paid to other criteria also. According to him, the test of efficiency should be whether the service provides facilities which are reasonably adequate to meet the public needs at prices which are also reasonable and which will enable the undertaking to pay its way. The pursuit of maximum efficiency in this sense becomes the most economical use of resources for a given return in goods and services.
Professor Sargent Florence and Gilvert Walker contend that breaking even or making a surplus is the best primary test of efficiency in the public sector provided that certain conditions are fulfilled. In the first place, the surplus should not be the result of exploitation. Secondly, money costs should reflect real costs and must not leave social costs out of account. Thirdly, the surplus should result from a small margin on a large output rather than a large margin on a small output.
In short, the prime measure of efficiency is the ability to break even, or slightly more than even, at the greatest level of production. Ancillary tests of vigorous management are lower prices, higher quality, or an extended range of goods and services.
3. Adherence to Time-Schedule and Cost Estimates
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Though adherence to time-schedule and cost estimates is one of the important criteria of efficiency, it may be foiled by inaccurate budget estimates. If the estimates are revised frequently, the efficiency of the enterprise cannot be evaluated with the help of this criterion.
The cost of DVC, for instance, was originally estimated Rs.55 crores and was subsequently revised from time to time. According to the 1960 estimates, it stood at Rs.107 crores. Such frequent and large revisions indicate lack of farsightedness in regard to possible variation in cost of factors to be utilized in constructing the undertaking including wage structure and cost of capital goods and other accessories.
In such cases, the efficiency of the enterprise can hardly be judged with the help of this criterion. Similar has been the case of the estimates for three steel plants at Rourkela, Durgapur and Bhilai. The original estimate for these three plants was Rs.353 crores and subsequently it was revised to Rs.439 crores raising the investment within a short period by about 25 per cent. The foreign exchange component increased from Rs.228.5 crores to Rs.292 crores rising by about 28 per cent.
The time schedule is another measure of efficiency. A public enterprise would be expected to adhere to the time schedule laid down in the project plan. But often there are difficulties in keeping the time schedule. Shortage of competent technicians is one of the important difficulties.
It took more than two years, for instance, for the DVC to find a chief engineer and it was confessed that the person appointed was not the best under the circumstances because other foreigners either did not respond or demanded much higher remuneration which the DVC could not afford to pay.
Secondly, there is the difficulty of obtaining capital goods in time. The target dates for the construction of various dams in the DVC have been frequently extended because of the non-availability of capital goods in time.
4. Labour Productivity:
Labour productivity per man-hour is a fairly satisfactory indication of efficiency. There are, however, a number of difficulties in its actual application. It is difficult to precisely measure the labour productivity per man-hour. Even if such computations are possible, they cannot be used for inter-comparisons because the statistical data of different units are not homogeneous.
The goods produced by different units differ widely in regard to dimension, texture, design, finish and quality. Further, the equipment employed by different mills differs so widely in respect of machinery employed, capacity and actual output that it is difficult to find any satisfactory basis for comparing the relative efficiency of different units.
5. Cost of Production
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Cost of production per unit of output is an important criterion of efficiency. The lower the cost per unit of output, the higher would be the efficiency of the enterprise.
There are, however, difficulties in inter-comparison of cost data of different units working under widely different conditions. The units are located at different places and, therefore, enjoy economies of location to different degrees. “The distance of mills from the centres of raw materials, and from the source of power, the varying rates of wages and conditions of labour in different parts of the country, the marked divergences as regards the character and accessibility of the principal markets and other differences arising from the local environment of the industry are so great that the costing data available for comparison will not be truly homogeneous.”
Even if we confine the comparison to units located in the same area and enjoying the same benefits in regard to location, there will still remain considerable differences in respect of technical equipment and type of goods manufactured. When the different units operate under widely different conditions, there does not appear much basis for inter-comparison of the cost data.
In comparing the cost-structure of different units, there arises the question whether the costs should be expressed as “per unit of output” or as “percentage of the value of goods produced”. In industries producing more or less homogeneous type of goods like sugar or cement, the efficiency of different units can be compared on the basis of cost of production per unit.
But in industries whose products differ considerably in regard to quality, cost of production per unit of output cannot form a satisfactory basis for comparing the efficiency of different units. The efficiency of a unit producing coarse cloth, for instance, cannot be compared with that of another unit producing finer varieties of cloth on the basis of their cost of production per unit of output.
The cost of production per unit of output would vary according to the quality of output. In such cases, for making comparisons of efficiency, the cost would have to be expressed as “percentage of the value of goods produced” or as “percentage of total turnover”.
In addition to difficulties of inter-comparison, the criterion suffers from several shortcomings and its actual application involves many problems. The unit cost of production depends on a number of factors, e.g. technique of production, organisation, labour relations, productive enthusiasm, skill and training, etc., which are all partially independent variables.
As a result, a decline in unit cost, which may at first sight be taken to indicate a general improvement in efficiency, may conceal the fact that a deterioration in, say, the administrative organisation has been more than counterbalanced by the introduction of a new machine.
Similarly cordial labour relations may lead to decreased unit costs in spite of technical stagnation and organisational obsolescence. Thus, there is the need for techniques of measuring the movement and the mutual interaction of the various factors which influence the efficiency of public enterprises in contrast to criteria which measure efficiency in terms of a few arbitrarily selected factors.
Cost reduction criterion presupposes some basic concept of cost already in vogue which would supply the yardstick of cost of production per unit of service. If standard norms regarding the cost of production are laid down, the efficiency of the enterprise can be judged by its success in keeping the actual costs within these limits. The usefulness of this measure will obviously depend on the care with which the norms are set up.
If they are based on purely historical costs, they may provide only a rough measure of efficiency. In spite of this the norms based on historical costs may have to be used in the earlier stages of an enterprise as the building of norms on the basis of detailed study takes time. Some experience of the actual working of the enterprise would be necessary before they are built up.
If prices of most of the inputs remain more or less unchanged, such norms will provide a rough basis for measuring efficiency. Even if the prices are fluctuating, costs at fixed prices of inputs can be specially calculated to provide a basis for comparison.
There are always some reserves in any production process which provide an opportunity for the efficient management to reduce costs below the norms set up on the basis of previous history. This, however, involves the difficulty that as these reserves are utilized and wastes eliminated, such efforts will yield progressively diminishing returns. This will be more so because year after year the norms themselves will be lowered according to the cost level actually obtained.
If cost reduction in relation to norms historically established is the sole measurement of efficiency and every attainment in cost reduction leads to a lowering down of cost norms, the management may have a tendency to be cautious not to attain a very large cost reduction in any particular year. “The experience of Polish industrial management where such methods were used for some time indicates that such difficulties are likely to arise”.
Though cost norms based purely on historical data may be used in the early stages, efforts should be made to calculate standard costs for various inputs on the basis of proper study of the processes of production. The general cost norms will be an addition of these with a certain allowance for overheads.
An important disadvantage of an overall measure of efficiency like profitability or cost reduction is that in a complex undertaking producing a number of products, the overall measure of efficiency may not satisfactorily reveal the level of efficiency in particular sections of the enterprise.
Efficiency in some parts may be quite high and conceal low efficiency in other parts of the enterprise. This shows the need for maintaining separate accounts for different parts of the undertakings so as to provide a measure of efficiency in different parts.
The operating costs may sometimes rise because of factors which are beyond the control of the public enterprise; this should be kept in view while evaluating the efficiency of a public enterprise.
Care should be taken that the reduced cost is not at the cost of quality. “Efficiency, in terms of reduced cost without quality production, amounts to nothing except inefficiency”.
6. Comparative Data
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Appraisal of performance is basically an exercise in comparisons. These comparisons can be made in three possible ways. In the first place, management’s performance in different periods can be compared to assess the changes recorded over time. Secondly, comparisons can be made between the performances of different enterprises over the same period. Thirdly, actual performance can be measured against certain hypothetical standards.
In regard to the first two methods, it is essential that the same set of indicators is used whether for measuring performance in different periods of time or in different enterprises. For the third method, standards have to be laid down based on the performance data of similar enterprises in the past and on a detailed analysis of the various elements of production. This is a very difficult task.
The criteria for evaluating performance mentioned above only indicate the strategy for undertaking the task. To give them an operational shape, it is necessary to select certain ratios to serve as indicators of performance. The ratios relevant to the first criterion would depend upon the non-commercial objectives prescribed for the public enterprises.
The objective may be to develop a particular industry or provide a service to the community at reasonable cost or develop the economic conditions of a particular area or section of the community. The success in these matters may be judged by the volume of output, the distribution of the products or services and the less tangible social value of the capital investment.
In regard to the second criterion, namely, that of maximising profits, the return on capital employed, which is itself ratio, is the most important indicator. The variable indicating the quality of output would differ from one enterprise to another depending upon the nature of the product or service provided by the enterprise.
In case of public utilities like electricity and transport undertakings, for instance, important indicators would be the punctuality and regularity with which services are provided. In case of engineering and manufacturing concerns, useful indicators are the extent of consumers’ demand for the products and their acceptability in the market.
These indicators, however, involve difficulties in case of enterprises operating under monopoly conditions. As regards the last criterion, namely, economy and efficiency in the use of resources, it is not very difficult to select ratios indicating the utilisation, in physical and financial terms, of each category of input per unit of output.
Some people suggest a comparison of public enterprises with their counterparts in the private sector. Such an evaluation will be reasonable if done scientifically and with reference to comparable. This suggestion has not been well received because of a number of reasons.
In the first place, common denominators for making such a comparison exist only for a limited field of activity. One of the important reasons for this is the different motives of operation. Secondly, there are difficulties in making comparisons over a period of time. There may take place substantial differences over two periods in regard to important matters like technique of production, size of demand, etc. Thirdly, the comparison may be difficult because of differences in age, methods of raising capital, facilities available, etc.
Some enterprises have a number of units. For example, “in France the tobacco monopoly consists of twenty-two factories, the National Stud Farms have twenty-one stables of stallions, the national aircraft construction corporations…consists of several factories”.
Since different units of the enterprise perform more or less the same operation, it would be useful to compare costs in each unit. Thus inter-unit comparisons in public enterprises would be more meaningful and useful than comparisons of public enterprises with their counterparts in the private sector.
7. Overall Index of Efficiency
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The foregoing analysis shows that none of the criteria by itself is adequate to evaluate the efficiency of a unit. If all these criteria are used, there is every possibility that the distortions attributable to any one criterion taken singly may be offset. Further, if the application of all these criteria reveals the dominance of the same tendencies, the general conclusions are verified and confirmed.
In fact, there is the need to explore the possibilities of constructing an overall Index of Efficiency not only to compare the relative efficiency of different units but also to keep a continuous watch over the progress made by an individual unit over a period of time in the reduction of costs, maximization of output and most economic utilisation of the human and material resources available to the community. Such an index should also take into account the direct and indirect social costs and benefits accruing to the community as a result of the setting up of the enterprise.
There are, of course, conceptual, technical and statistical difficulties in measuring the social benefits and costs. Many social costs and benefits are not amendable to measurement with any degree of precision or scientific exactitude. There is also the problem of assigning appropriate weights to different items of economic and social costs in an overall index of industrial efficiency because this involves value judgments and ideological preferences for end-objectives.
8. Comparison of Efficiency with Private Sector:
The public sector undertakings in India have been criticised for showing poor returns. This criticism is true in case of many public undertakings which have shown a very low rate of returns or even losses. But at the same time, some public undertakings have shown quite good returns. In fact, even in the private sector, there are profit-earning enterprises as well as sick enterprises.
No doubt, the average rate of return in the public sector is lower than that in the private sector; but this does not mean that the performance in the public sector is correspondingly poor. While fully recognising the need and scope for improvement in the performance of public sector undertakings, it may be pointed out that it would be wrong to compare the profitability of public enterprises with that of private enterprises without keeping in view certain important distinctive features of the public undertakings.
To cite the Study Team on Public Undertakings, “The distinctive features of the public sector in our country should be borne in mind while comparing the profitability of public enterprises with that of private concerns”. The fact that the prices of commodities like steel, oil, coal and fertilizers which substantially account for the total turnover of the industrial enterprises of the Central Government are regulated or fixed by the government cannot be ignored.
Since most of these goods are what can be described as essential commodities, the government tries to give full protection to the interests of consumers. The result is that the prices fixed are often on the low side and do not make sufficient allowance for the increased capital costs of setting up new plants in these sectors. These factors which bring down the average figures of performance are often overlooked while evaluating the performance of the public sector in terms of profitability.
Professor K.N. Raj has contended that the loss in public sector basic industries essentially flows from their financial structure. An important portion of the capital employed in these industries, for instance, is in the form of loan capital. This tends to get reflected in the rates of return when they are calculated as percentages of paid up capital and after deducting interest payments as a cost item.
The practices in regard to depreciation provisions also differ and the public sector plants have a tendency to provide for significantly higher rates.
Rate of return in public sector is also low because of the long gestation period involved in capital-intensive industries like steel, engineering, chemicals, fertilizers, petroleum and heavy machinery. Another cause of low returns is heavy expenditure on townships, hospitals, schools, etc. which is rather on the high side. Social responsibilities in terms of labour welfare also find greater reflections in the public sector investment than in the private sector.
There exists considerable tax evasion in the private sector while the public sector pays full taxes. This is one of the reasons for low returns in the public sector. The loss to the government on account of low returns is partly compensated by the higher tax collections resulting from absence of tax evasion.
9. Factors Contributing Towards Poor Performance
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Low returns in the public undertakings are also partly because of poor performance of the public undertakings.
We briefly describe below some of the important factors which have contributed towards poor performance of the public undertakings:
1. Over-Capitalization:
The Study Team on Public Undertakings found that many public undertakings were overcapitalised. This leads to surplus machine capacity and avoidable expenditure. Over-capitalisation is because of bad planning.
2. Large Overhead Expenditure:
In many undertakings cost of production is high and return low because of excessive overhead expenditure. There is extravagance in overhead expenditure particularly on township and other welfare activities which needs to be curtailed.
3. Over-Employment:
Owing to defective planning and forethought and delay in construction, many public undertakings have got burdened with man-power far in excess of their needs. This has led to heavy recurring expenditure.
4. Delay in Construction of Projects:
Delay in the completion of projects has often led to a large increase in the cost of construction. For example, Trombay Unit of Fertilizer Corporation took 6-7 years to complete against the original estimate of three years. As a result, estimated cost of construction-rose from Rs.27 crores in 1959 to Rs.40 crores in 1965.
5. Absence of Trained Man-Power:
Many public undertakings were set up in India at a time when technological competence was inadequate to conceive, plan and implement such large projects. Some of these projects were set up in India for the first time and, therefore, the required trained man-power or technical know-how was not readily available.
6. Poor Management-Labour Relations:
In many public undertakings, production, sales and revenue have been affected adversely by indiscipline among workers and poor management- labour relations. Production and sales have been hit by lockouts, sit-down strikes, work to rule agitation and violent disturbances.
7. Plants Operating Below Rated Capacity:
Unutilised plant capacity involves heavy losses or eating away a considerable portion of profits. Some enterprises have not laid down precise targets of production to be attained within a given period based on proper assessment of capacities.
8. Absence of Sound Pricing Policy:
No doubt, it would not be desirable to raise prices in basic and essential industries like fertilizers, coal, oil, electricity, transport, etc., which are directly connected with the development of the economy and the welfare of the masses, but certainly due weightage can be given to adequate returns in pricing the products of other industries.
‘Public sector for public good’ sentiment has to be judged with reality. Further, external influences on optimum pricing policy, optimum price structures and price regulation, however, desirable, often interfere with the single-minded devotion of the management to commercial efficiency and profitability.
9. Recruitment and Promotion Policy:
The public enterprises in India have not followed a scientific recruitment policy. There have been frequent transfers of staff. More importance has been given to seniority than to merit in staff promotions.