An Analysis of Value Determination in the Building and Construction Industry

Transcription

1 An Analysis of Value Determination in the Building and Construction Industry M. Dreschler, Ph.D. student, Delft University of Technology, the Netherlands R.M. Beheshti, daily supervisor, Delft University of Technology, the Netherlands H.A.J. de Ridder, professor, Delft University of Technology, the Netherlands Abstract This paper discusses the concept and definition of value that is crucial for a research into value quantification in the Dutch building and construction (BC) industry. The goal of this Ph.D. research is to find some scientifically sound methods for quantification of value for the Dutch BC industry. This is necessary because value remains implicit in the Dutch BC industry, being the reason that decisions based on the value price ratio cannot be made. Definitions are described from different perspectives. Subsequently these aspects of value are evaluated. As a result, the value of a BC project is defined as the amount in which all persons involved are influenced in their well being by the project. How the concept of value is used within the context of this paper is illustrated by placing the concept of value in a value model. The definition and model will be used in the forthcoming stages of this research project, in which public clients, knowledge institutes, contractors and developers will participate. Keywords: Value, value definition, value determination, value quantification, Value Price Cost model. 1. Introduction It is argued that the use of a Value Price Cost (VPC) model is essential for improving the performance and effectiveness of the Building and Construction industry (BC) [1]. The last two factors in this model, namely the price and cost, have been the subject of numerous investigations while the first factor, i.e. value, remains to be explicitly defined and hence requires further investigation. For the VPC model to work, the value for several construction objects has to be established, thus a value determination or value taxation system is needed. This proves to be difficult, because the different project stakeholders tend to have different (subjective or partial) opinions about the project value. Also the value can alter due to changed insights and circumstances, pointing to the necessity of formulating a sound value assessment methodology, acceptable by all project stakeholders. Value determination is a subjective process. When more than one person or interest group are involved, which is often the case in the BC industry, selection of the alternative with best value 265

2 for money becomes difficult. Decision makers need an acceptable (realistic and fair) method for determining the total value of an alternative solution. This implies that they need to combine partial value judgments into a total value judgment. The most common methods to do so are (societal) Cost Benefit Analysis (CBA) and Multi Criteria Evaluation (MCE). Most impactevaluation methods can be used as a part of one of these two analysis methods [2, 3, 4]. The disadvantage of CBA is that some costs or benefits cannot (easily) be expressed in monetary terms. On the other hand these types of effects can be taken into account with the MCE. The problem of the MCE is that weighing of effects can be arbitrary. In this context, a deeper understanding of the concept of value is needed. In section 2, existing definitions of value are described. These definitions of value are evaluated and, as a result, a general definition of value is formulated, applicable to the BC industry. In section 3 it is made clear how the concept of value determination is used in this article and what is meant by it. Section 4 states the planned research and section 5 concludes this paper. 2. Definition of value Decision making processes in the BC industry, often involves using the concept of value. Although roughly pointing at the same thing, several meanings can be attached to the concept of value. A definition of value is needed for a meaningful communicating of the subject of quantification of value. Section 2.1 presents an inventory of different views on value. These are compared in section 2.2. Subsequently, a definition suitable for the research is formulated in section Different views on value There are numerous views to describe the notion of value [URL 1, URL 2, URL 3]. Several definitions of value have been found in literature. Next sub sections discuss the most important and relevant definitions value for the BC industry Value engineering definition According to Kelly [5] value is a measure expressed in currency, effort or exchange or on a comparative scale which reflects the desire to obtain or retain an item, service or ideal. Most sources in the literature represent the relationship of value to function and cost by the following expression: Value = Function Cost 266

3 Function is a characteristic activity or action for which a thing is specifically fitted or used or for which something exists. Therefore something can be termed functional when it is designed primarily in accordance with the requirements of use rather than primarily in accordance with fashion, taste or even rules or regulations. Value engineers distinguish between a basic function and a secondary function. A basic function is defined as the performance characteristics that must be attained by the technical solution chosen. Secondary functions are the performance characteristics of the technical solution chosen other than the required basic function. According to this definition, value is a ratio, of which the dimension is dependent on the unit of function. The ratio resembles efficiency or productivity. The outcome of decisions using this definition depends on the way functionality is measured Definition used in economics Several definitions of value can be founding the economic literature. A general definition of value is the amount (of money or goods or services) that is considered to be a fair equivalent for something else. This is also called willingness to pay. For different customers, the willingness to pay differs. They value the product differently. One customer may derive more utility from a product (or has more to spend) than another. In neoclassical economics the willingness to pay for different people is combined into the demand curve. The minimum supply price for several suppliers is combined into the supply curve. The neoclassical theory states that in an open and competitive market, equilibrium will be reached and the society s net valuation is maximized (Figure 1) [6]. Figure 1: Market equilibrium & related principles To neoclassical economics, the value of an object or service is often seen as nothing but the price it would bring in an open and competitive market. This equilibrium value is referred to as market value. Consumers who would be willing to pay more than the market value experience a benefit. This difference in value is called the consumer surplus. Producers who would be willing to sell 267

4 for less than the market value also experience a benefit. This difference in value is called the producer surplus. The total surplus, the sum of consumer surplus and producer surplus, is called the net valuation in a market. As stated earlier, at equilibrium the society s net valuation is maximized Value Price Cost model definition As a framework for analysing transactions in the BC industry, De Ridder [1] introduced the Value Price Cost model (Figure 2). benefit profit total benefit client supplier value price costs Figure 2: Value Price Cost model The parameters in this model can be compared to the principles of neoclassical economics. Value relates to the willingness to pay for a certain object. In theory, the cost is the minimum amount a producer is willing to accept. The price lies somewhere in between value and cost, dividing the total benefit into a consumer surplus and a producer surplus Cost Benefit Analysis definition In an integral or societal Cost Benefit Analysis (CBA), value consists of all the plusses (cashflows and other intangible benefits) of a project. The value is compared with all the minuses (the costs and disadvantages) of the project 1. As with the previous two definitions, the difference is the net value or total benefit. A frequent problem with CBA is that typically the costs are tangible, hard and financial, while the benefits are hard and tangible, but also soft and intangible. Caution should be taken here against people who claim that "if you can't measure it, then it does not exist or it has no value". Especially in more strategic investments, frequently the intangible benefits clearly outweigh the financial benefits [URL 4]. 1 An example of a CBA with an elaborated quantification of value can be found at 268

5 The starting point of a societal CBA is that the go/no go decision is based on the effects the project has on the well being of all citizens. This starting point is known as welfarism [3]. Welfarism is based on the premise that actions, policies and/or rules should be evaluated on the basis of their consequences. Welfarism is the view that the morally significant consequences have impacts on human welfare. There are many different understandings of human welfare, but the term welfarism is usually associated with the economic conception of welfare. Economists usually think of individual welfare in terms of utility functions. Social welfare can be conceived as an aggregation of individual utilities. Welfarism can be contrasted to other consequentialist theories, such as utilitarianism. Welfarist views have been especially influential in the law and economics movement. Shavell and Kaplow have argued in their influential book Fairness versus Welfare that welfare should be the exclusive criteria by which legal analysts evaluate legal policy choices [URL 5]. Van der Heijden [2] presents three methods for expressing the effects of projects. If the advantages and disadvantages of a project can be measured in physical units, valuation can be based on existing market prices. Prerequisite to this is a well functioning price mechanism. Is this prerequisite lacking then the so called shadow or calculation prices can be used. For non priced effects, many approximation methods can be found in the literature. Non priced effects are effects corresponding to products and/or services, for which an (economic) market doesn t exist, such as clean air The ethical definition The values that a group or person holds are usually categorised into ethical values and ideological values. Ethical values may be thought of as those values, which serve to distinguish between good and bad, right and wrong, and moral and immoral. At a societal level, these values frequently form a basis for what is permitted and what is prohibited. Ideological values deal with the broader or more abstract areas of politics, religion, economics, and social mores. In theory, the broader ideological values should derive logically, as natural consequences from the particulars of fundamental ethical values and their priorities. But although ideally a value system ought to be consistent, quite often this is not the case [URL 6] The financial definition Investment decisions are often based on the difference between expected costs and expected revenues. To compare future cash flows, the Net Present Value (NPV) is calculated. Sometimes aspects like quality ( deterioration) and risks are included in these calculations. If the calculated value is positive, the go decision is likely. If the value is negative, the no go decision is very likely. Typically the alternative with the highest value is selected. Often the result of decision 269

6 making using this financial definition of value depends on assumptions about parameters such as interest. 2.2 Evaluation of definitions Based on this (non exhaustive) literature research, already some conclusions can be drawn. All definitions except the ethical definition compare some level of performance, functionality, utility, benefit or quality ( perception) with the associated level of price or cost. Three categories can be distinguished: value as a ratio (I), value as a surplus (II), or value as an absolute quantity 2 (III), as illustrated in Figure 3. c Value = a Level of performance functionality utility benefit quality perception Level of Cost Price b I II III a/b (ratio) c (difference) a (absolute quantity) Figure 3: Three categories of value definitions The value engineering definition belongs to the first category, the financial definition to the second. The economic and the Value Price Cost model definitions belong to the third category. The Cost Benefit Analysis definition is used in both the second and third category. 2.3 Definition of value for this research Methods for determining the cost of BC objects and in a lesser degree the price are well known, well researched and sometimes quite straightforward. But the determination of the level of performance, functionality, utility, benefit or quality ( perception) is much less straightforward and often subject to discussion and hence the subject of this investigation. The focus is on the 2 In the mathematical sense absolute means bigger than zero. But value can also be negative, when a project has a negative impact on a stakeholder. In the context of this article absolute quantity should be read as some level of performance, functionality, utility, benefit or quality ( perception). 270

7 elaboration of the level of performance, functionality, utility, benefit or quality ( perception). Therefore value will be defined as some absolute quantity (category III). Also the welfarism viewpoint is adopted. This viewpoint originates from the cost benefit analysis and states that a person or group becomes a stakeholder as soon as they are affected in their wellbeing to some extent. This leads to the following definition of value: The value of a BC project is the amount in which all persons involved are influenced in their well being as a consequence of the project. This definition is still quite broad and makes quantification of value difficult, because it is hard to establish measurable relations between (features of) constructions and the well being of people. How to measure this effect in well being still needs to be translated into practical guidelines and assumptions. This requires introducing simplifications. The definition contains the notions of subjectivity and negotiation. In this paper, value is a part of a decision making process. It puts the focus from the build object, to the psychology of those who experience the effects of the build objects. 3. Value model Based on the definition of value, a model for value determination is composed, incorporating elements from the Multi Criteria Evaluation method, integrated decision making and stakeholder analysis. The value determination model is incorporated into the Value Price Cost model, shown in Figure

8 Figure 4: A model for value determination incorporated in the Value Price Cost model In the model, the value judgments of the people or groups that are affected in their well being by a project proposal (the stakeholders) are added up to determine the total value of a project. If the value judgments are quantitative and comparable, they can simply be summed up. This is the case when the value judgments are expressed in monetary terms and the judgments have equal weight. If the value judgements are qualitative or are not comparable, they have to be weighed in order to determine the total value. The value judgment of a stakeholder is determined by the effect of the proposed project on his or her well being. This has often several dimensions; a project proposal can have several impacts on several aspects of the well being. The stakeholder implicitly weighs these influences and reaches a value judgment. This weighing is influenced by personal preference, perception, pre disposition and the available background information. 272

9 4. Goals and planned follow up The formulated definition of value and the model for value quantification will be used in this Ph.D. research into quantification of value. The preliminary work plan contains several elements. First, several parties from the BC industry will be involved. Public clients, knowledge institutes, contractors and developers will be interviewed about how they quantify value. This will be done for several construction types. An inventory of their methods and needs will be made. The methods and their area of application will be structured into a value quantification system. The developed value quantification system will be tested and validated, in some real life projects or as a hind cast simulation. This will refine the value quantification system. 5. Conclusions In this article, several definitions of value have been compared. Three categories of definitions were encountered. This proved to be very useful, because it becomes clear that using definitions from different categories could result in fundamental communication and interpretation problems. The value of a BC project is defined as the amount in which all persons involved are influenced in their well being as a consequence of the project. The definition contains the notions of subjectivity and negotiation. In this paper, value is a part of a decision making process. It puts the focus from the build object, to the psychology of those who experience the effects of the build objects. In the value quantification model, value is treated as a multi dimensional property of a project proposal. In the planned Ph.D. research it remains to be seen whether clients in the BC industry are able to define their willingness to pay without the knowledge of other projects. References [1] Ridder, H.A.J. de, Klauw, R.A. van der & Vrijhoef, R. (2002) Het nieuwe bouwen in Nederland, TNO, Delft. [2] Heijden, R.E.C.M. van der (1990) Plan en projektevaluatie, Delft University of Technology, 19, [3] Eijgenraam, C.J.J. et al. (2000) Deel I Hoofdrapport Evaluatie van grote infrastructuurprojecten Leidraad voor kosten baten analyse Onderzoeksprogramma Economische Effecten Infrastructuur, Ministry of Transport, Public Works and Water Management, 11 [4] Wee, B. van, Dijst, M. (2002) Verkeer en vervoer in hoofdlijnen, Coutinho, Bussum,

10 [5] Kelly, J., Male, S. & Graham, D. (2004) Value management of construction projects, Blackwell Science Ltd, Oxford, 17 [6] Dobson, S., Palfreman, S. (1999) Introduction to Economics, Oxford university press, Oxford, 34 [7] Eijgenraam, C.J.J. et al. (2000) Welvaartsaspecten bij de evauatie van infrastructuurprojecten Onderzoeksprogramma Economische Effecten Infrastructuur (cluster B, deelstudie B1), Ministry of Transport, Public Works and Water Management, 25 Internet: [URL 1] [URL 2] [URL 3] bin/webwn2.0?stage=1&word=value [URL 4] benefit_analysis.html [URL 5] [URL 6] 274