The Case for Unfair Competition
Captive operations like in-plants support their parent organizations’ missions, bringing better flexibility and control. For this reason, insists one university administrator, the competition should be unfair.September 2011 By Burr Millsap
THIS IS an argument for unfair competition. In the end, it will conclude that service departments and auxiliary enterprises (SDAEs) should have an unfair advantage. It will suggest that institutional customers (i.e., departments) should be made to do business with the SDAEs and should be asked to pay a higher-than-market price for the related products or services.
Sound crazy? It did to me, too…but I think the case is a pretty good one. Read on.
SDAEs are a problem, but they are indispensable on every campus. Service departments, such as the in-plant print shop, are those organizational units whose mission it is to serve the needs of other departments on a business-type basis. The key feature of a service department is that it charges for its services, rather than being mission-funded as are, say, academic and administrative departments.
Under mission funding (sometimes called direct funding), a department is granted its budget. It doesn't have to do anything to earn that budget other than to accomplish its mission. An academic department's mission is to teach, and so it teaches. The mission funding pays for that.
Mission funding works well when the service offered by the department is not subject to abuse if it were offered free. The accounting office is an excellent example. People don't fall all over themselves to take advantage of free accounting.
But mission funding won't work for service departments. If printing services were free to other departments, they would be abused. The same with photography, painting, woodworking, television services, and the like. The giving away of these types of services encourages the human tendency to overuse and abuse.
Accordingly, the service department charge-back model works well, and the service department acts like an internal business. The obvious question is, "Since these types of services are commercially available, why do we duplicate them with a department inside the institution?" The answer to that question is a little more complex than you'd think, and I'll discuss it a little later.
Auxiliary enterprises are those organizational units whose mission it is to serve the students, faculty, and staff. The products and services offered by auxiliary enterprises could be said to be personal in nature. Book stores, dining halls, copy shops, athletics…these are excellent examples of auxiliary enterprises.
If mission-funding is inappropriate for service departments, it is really inappropriate for auxiliary enterprises. The tendency for overuse and abuse would be much greater for these types of operations. The chargeback or sales model is the only one that will allow this type of unit to operate effectively.
While auxiliary enterprises exist mainly to serve students, faculty, and staff, their products and services may also be used by other departments. So, in many instances, auxiliary enterprises act as service departments.
Why Do We Have Them?
The burning question is, "Why do we have service departments and auxiliary enterprises (SDAEs)?" If we can find these services commercially, in the community, why do we go to the trouble of setting them up within the institution?
There are at least seven reasons why SDAEs are necessary.
1. Captivity. Within an institution, the feature of captivity is attractive and essential. Departments need to have certain services available on a captive basis to streamline the shopping-buying-getting process. It is a feature of efficiency.
2. Availability. SDAEs typically offer superior availability of their products or services. When and where they do a better job of this than the market, they represent a real advantage to the support and operation of the institution.
3. Quality Control. Generally, the institution has a better handle on the quality it receives when it can control the supplier of a product or services. This may not be true in every case, but even the thought that the control is possible is sometimes justification enough.
4. Responsiveness. By virtue of their captivity, SDAEs are (arguably) the most responsive alternative for providing a product or service. Of course, it would be preferable that their responsiveness is natural and spontaneous, but because SDAEs are under the control of the institution, their responsiveness can be made to happen.
5. Internal Control. SDAEs are excellent tools by which the institution can exercise good internal controls. For example, the risk of collusion between vendor and buyer is reduced when both are employed by the same entity. The institution can enforce accounting and other important controls directly and effectively.
6. Economy. Many times SDAEs are the most economical way to meet the institution's needs. The market may not have a good representation of the needed product or service, and the best solution may be to set up an SDAE.
7. Budgetary/Financial Flexibility. Since SDAEs are part of the institution, the funds they generate through business with other departments (and with "the outside") offers the institutional leadership a heightened measure of budgetary and financial flexibility. Sitting on top of it all, the institution's leadership enjoys some, if not much, discretion about how the circulation of funds can be used and directed to best accomplish the institution's mission.
Competing with the Market
The institutional models with which I'm familiar require that, above a certain dollar level, SDAEs must formally compete with the market. At the University of Oklahoma, this dollar level is $35,000. If a department has a requirement at that level, which could be met by an SDAE, then the SDAE must formally compete against the market for that business. My argument here is that the SDAE shouldn't have to do that. Here's why.
Basic Purpose. The fundamental reasons for the existence of the SDAEs are responsiveness and availability. They are organized for a purpose, and that is to be available and responsive to the needs of the departments of the institution. They were called into being for that very reason, and that is sufficient. As long as they serve that purpose well and at a fair price, they should not have to struggle for the very existence that was originally demanded by the organization.
Quality Control/Internal Control. The value that the SDAE adds in the form of control must not be understated. The SDAE is not just another source for a product or service. It is an integral part of the institution that has the edge on what departments need and the institution wants. It is a control point—a special source of quality and result. It arises from the very need of the institution, and it has a distinctive sense of how the institution and its departments can best be served. The SDAE can also serve as an integral element in the institution's system of internal control. As compared with the general market, the SDAE is in a better position to help preserve the institution's assets and protect them from theft, pilferage, loss, and other perils.
Limited Flexibility of Funding and Cost Control. The SDAE is at a serious disadvantage when it comes to earning revenues and controlling costs. If it belongs to a tax-supported institution, it may enjoy the advantage of some measure of subsidy. Accordingly, it must be very careful about how low its prices can go. If it cuts its prices too deeply, market competitors may cry "foul," accusing it of using its subsidized situation to run them out of business. It must therefore sometimes keep its prices artificially high to avoid this criticism. On the cost side, paid leave and fringe benefits represent another area of cost disadvantage, since the leave and benefits programs offered by most institutions are fairly generous.
Closed Economy. To a certain degree, the institution can be viewed as a closed economy, especially with regard to the business conducted among the departments and the SDAEs. The funds circulate within the institution and usually wind up on the president's desk to re-allocate according to his/her priorities. This is not a bad thing, and it should be understood as such by the departments that would otherwise break ranks and take their business outside.
Family Unit. The institution is a family, comprising a variety of members. Each department furthers the mission and the good of the family, largely by virtue of the interaction it has with the other departments. It is common for family members to do business among themselves in spite of the acute economic advantages of taking the business outside. For the overall good of the family, it is highly beneficial for the business to remain within it.
It's the Institution's Money. In the end, all funds belong to the institution. A department's budget is not its own. Even for those departments that receive money from grants or from some kind of selling activity, those funds are derived through the greater strength of the institution. Accordingly, the institution has a perfectly valid right to dictate that SDAEs shall receive preference (or even stronger, exclusivity) when it comes to the acquisition of certain products or services.
If the basic purpose of the SDAE's existence is valid and is an integral component of the institution's mission and character, then the SDAE should not be required to prove its worth solely on the basis of competition against the market. The competition should be unfair, in some measure, in favor of the SDAE.
That being said, other controls and requirements must be placed upon the SDAE to ensure that its prices are not outrageous and that the quality it delivers exceeds the expectations that underlie its having been brought into existence in the first place.
Burr Millsap is the associate vice president for Administrative Affairs at the University of Oklahoma, and serves as adjunct faculty for Oklahoma City University and the Francis Tuttle Technology Center. Mr. Millsap, who is a CPA, teaches courses in accounting and financial management. He has written three texts: Accounting Lite, Accounting and Finance for Nonprofit Organizations, and Accounting and Finance Fundamentals. He is the 2002 recipient of the NAEP Neil D. Markee Communicator Award and the 2004 recipient of the NAEP Professional Perspective Award. He has contributed several articles to the NAEP Journal, and serves as associate editor.
Reprinted by permission of the National Association of Educational Procurement. Article first appeared in the September 2005 issue of the NAEP Journal, pages 10-13.