AN OVERVIEW OF PREFERENTIAL PROCUREMENT IN SOUTH AFRICA. Government initiatives and private sector responses

Transcription

1 AN OVERVIEW OF PREFERENTIAL PROCUREMENT IN SOUTH AFRICA Government initiatives and private sector responses Tracy van der Heijden Independent Consultant Centre for Poverty, Employment and Growth Human Sciences Research Council March 2008 centre for poverty employment and growth innovative employment strategies

2 centre for poverty employment and growth HSRC Human Sciences Research Council March 2008 Acknowledgements We gratefully acknowledge the financial support of the WK Kellogg Foundation Produced by: Tracy van der Heijden Contact: Dr Miriam Altman Executive Director, CPEG, HSRC Tel:

3 An overview of preferential procurement in South Africa: government initiatives and private sector responses Contents EXECUTIVE SUMMARY BACKGROUND AN OVERVIEW OF KEY PREFERENTIAL PROCUREMENT DRIVERS GOVERNMENT INITIATIVES...12 Code and Statement 500: Preferential Procurement...16 Code and Statement 600: Enterprise Development...21 Code and Statement 700: Socio-economic development THE RISE OF THE RATINGS AGENCIES CASE STUDY 1: WOOLWORTHS LIMITED COMPANY PROFILE AND FINANCIAL OVERVIEW HISTORY OF PREFERENTIAL PROCUREMENT OTHER ISSUES CASE STUDY 2: DIMENSION DATA LIMITED COMPANY PROFILE AND FINANCIAL OVERVIEW HISTORY OF PREFERENTIAL PROCUREMENT CASE STUDY 3: ESKOM COMPANY PROFILE HISTORY OF PREFERENTIAL PROCUREMENT KEY ISSUES CONCLUSIONS...52 APPENDIX A EMPOWERMENT SCORE FOR TOP 200 COMPANIES

4 centre for poverty employment and growth HSRC Tables Table 1 Strategy for BBBEE: elements and weightings...13 Table 2 Codes of Good Practice and relevant Statements...14 Table 3 Summary of obstacles, implications and solutions presented by the Codes of Good Practice and relevant Statements...15 Table 4 Categories of BBBEE complaint suppliers in Preferential Procurement scorecard...17 Table 5 Preferential Procurement scorecard: calculation of components by enhancement factor...18 Table 6 the dti s guidelines for calculating TMPS...19 Table 7 BBBEE Procurement Recognition Level of suppliers...21 Table 8 Enterprise Development card...22 Table 9 Beneficiaries of Enterprise Development defined...22 Table 10 Qualifying Enterprise Development contributions...23 Table 11 Benefit Factor Matrix...25 Table 12 The Socio-economic Development card...26 Table 13 Definition of beneficiaries of socio-economic development...27 Table 14 Qualifying contributions...27 Table 15 Code 700 Benefit Factor Matrix...28 Table 16 Empowerdex Generic card*...30 Table 17 Woolworths turnover and profit figures, 2006 and Table 18 Eskom core and support business division...47 Table 19 Eskom s BEE targets for the past eight years...50 Table 20 Eskom s promotion and empowerment of black women entrepreneurs..50 Figures Figure 1 Woolworths Limited corporate structure...36 Figure 2 Governance structure of Eskom Holdings Limited

5 An overview of preferential procurement in South Africa: government initiatives and private sector responses Executive Summary Fostering the development and growth of small and medium-sized enterprises (SMEs) is a key issue in increasing employment opportunities and raising personal incomes. In addition, supporting the growth of SMEs owned by previously disadvantaged population groups, black women and young people is important to achieve a more equitable economy. However, given the structure of the South African formal economy, which is dominated by large and well-established companies, barriers to entry for new SMEs owned by these target beneficiaries are significant. One important way in which SMEs can enter the market is as suppliers to larger companies. A conscious focus by large private and public sector companies on procuring goods and services from smaller companies with a certain demographic profile preferential procurement can be a significant tool in increasing the number of sustainable small businesses. Closely aligned to the concept of preferential procurement is that of enterprise development. There are two important developments at work in the preferential procurement market. The first is government s initiatives to move from a policy of promoting black economic empowerment (BEE) to one of promoting BBBEE. The second is the increased use of objective rating scores and scorecards to ascertain a company s compliance with BBBEE goals. In certain important ways, the increased use of the latter is working to undermine the goals of the former. Government initiatives Preferential procurement is a key part of government s strategy to promote BBBEE. Until fairly recently, private sector companies had a certain measure of autonomy in how they were judged on their BEE status, with a clear focus on shareholding and employment profile. In response to the perceived shortcomings in achieving the goals of empowerment, a document titled A Strategy for Broad-Based Black Economic Empowerment was released in Before the release of the Strategy on Broad-Based Black Economic Empowerment, there existed no framework for the measurement of BBBEE. The Strategy provided the outline of a broad-based scorecard, comprising the seven elements of BBBEE, together with weightings, but did not contain detail on measurement principles and the application of the scorecard. The seven elements and their respective weightings out of 100 (depicted in the table below as per the Generic card) are the criteria used by the various ratings agencies to compile an empowerment score. (Qualifying small enterprises essentially companies with an annual turnover of less than R35- million only have to use four of these categories to compile a score, and they may select these four categories from the possible seven. Each one then carries an equal weighting of 25 points.) 5

6 centre for poverty employment and growth HSRC Strategy for BBBEE: elements and weightings Element Points Ownership 20 Management Control 10 Employment Equity 15 Skills Development 15 Preferential Procurement 20 Enterprise Development 15 Socio-Economic Development 5 Total 100 Code and Statement 500: Preferential Procurement The dti states the following as its incentive for this part of the scorecard: Preferential Procurement is used to drive transformation throughout the economy by encouraging procurement only from suppliers that are compliant with the B-BBEE scorecard: There is a market tendency to interpret B-BBEE compliance as only having ownership by black people without looking at the level of compliance with other B-BBEE requirements. This has resulted in a number of sham transactions/ fronting activities being entered into in a scramble to meet this compliance requirement. Enterprises are encouraged to procure from those entities that have a good B-BBEE contribution level based on their performance on the scorecard. A supplier that has a very good B-BBEE contribution level is likely to be chosen as a preferred supplier as compared to his peers as they will give the enterprise they are providing goods and services to a good scoring on their own scorecard as well. Incentive to procure from Qualifying Small Enterprises and Exempted Micro Enterprises: Statement 500 has a specific indicator for the recognition of BEE procurement spend from Qualifying Small Enterprises (QSEs) and Exempted Micro Enterprises (EMEs) by allocating specific scorecard points to procurement from these entities exclusively. The Preferential Procurement scorecard offers BBBEE procurement recognition from three categories of BBBEE compliant suppliers, as summarised in the table below. 6

7 An overview of preferential procurement in South Africa: government initiatives and private sector responses Categories of BBBEE complaint suppliers in Preferential Procurement scorecard (A) BEE compliant suppliers which will enjoy preferential procurement recognition Beneficiary category BEE compliant suppliers Based on BEE contribution level (B) QSE and EME suppliers Based on BEE contribution level (C) 50% black-owned companies and 30% black women-owned companies Based purely on ownership status Source: the dti Description of beneficiary Includes all BEE compliant companies: Of any size; With 30% or more on the Generic or QSE scorecards; and/or EMEs. Includes: QSEs proportional representation based on their score on the QSE scorecard to be applied; EMEs proportional representation based on their deemed Level 4 status and Level 3 status if they are 50% black-owned or 50% black women-owned. Includes BEE compliant companies: Large entities; QSEs; and EMEs that are 50% black-owned or 30% black women-owned. Purchasing goods and services from each of these three categories of supplier will influence the preferential procurement component of a company s BBBEE rating as follows: Total maximum from preferential procurement 20 points Of which: All BEE compliant suppliers 12 points QSE and EME suppliers 3 points 50% black-owned 3 points 30% black women-owned 2 points These categories are not mutually exclusive. For example, a company can claim points under the first category, but scores additional points if one of the suppliers is also a QSE and/or a 50% black-owned company. The calculation of each of these components is fairly complex, allowing companies to claim more points for more compliant suppliers, and also rewarding value-adding companies and enterprise development. The Corporate Response: The Rise of the Ratings Agencies The majority of companies in South Africa does not appear to believe that preferential procurement or enterprise development (with a few notable exceptions for the latter) contribute to company profitability and/or lower costs. The main incentive for engaging in these activities is almost always the desire to appear 7

8 centre for poverty employment and growth HSRC compliant, usually to prospective clients in both the private and public sector. This is unlikely to change any time soon. Until the release of the detailed government BBBEE scorecards, companies had some latitude in presenting their level of compliance. Anecdotal evidence suggests that companies would highlight those areas in which they were able to do well (such as the workforce profile) and gloss over those areas where it was more difficult. For example, preferential procurement would tend to be easier for certain companies (such as those who purchase a large amount of fairly standardised goods and/or basic services), but much more difficult for those with complex supply chains, such as fresh food retailers. This is no longer possible, since the scorecard means that all aspects of BBBEE must be taken into account by all companies. The 2007 TEC Empowerdex survey is attached as Annexure A. It should be noted that this survey only includes listed companies, and does not include parastatal organisations such as Eskom. The most important fact that stands out is that 120 of the 200 companies surveyed have a score of less than 30, and can therefore be considered non-compliant. Admittedly, it appears that many of the data sets are missing, indicating that they were not submitted to Empowerdex. However, this in turn suggests that companies either do not bother to keep these records and/or that they are not too interested in their official empowerment rating. Neither scenario is particularly encouraging. After more than 10 years of efforts to encourage transformation, this result can best be described as disappointing. The following are the key observations that are particularly important for the purpose of this study. 1. The very poor showing of preferential procurement An initial assessment would conclude that the introduction of a more broad-based empowerment scorecard would have a positive impact on preferential procurement. However, the results of the survey do not support this assumption. Of the 200 companies included in this survey, only 34 had a preferential procurement score of more than 50% (that is, 10 or more out of a possible total of 20.) 59 of the top 100 scored more than 10 for ownership, but only 32 of these scored 10 or more for preferential procurement. Given that preferential procurement is a key issue in creating sustainable income and employment opportunities and in driving equity, we can expect that government will pay closer attention to how this is progressing. The findings of the 2008 survey (due out later this year) will provide more information on how companies are doing with respect to their preferential procurement targets. 2. A poor preferential procurement score seems to be one of the key issues in getting a higher overall score Most companies aim to be at least a Level 4 contributor, at which point one counts as a 100% value partner in the preferential procurement pyramid (see table 7). In order to be a Level 4 contributor, one requires a total score of more than 65 points, but less than or equal to 75 points. Only the top 10 companies in this survey fitted into that 8

9 An overview of preferential procurement in South Africa: government initiatives and private sector responses category. Another 16 companies had scores of 55 or higher, but less than 65. Most of the companies in the top 11 to 40 places could make a significant improvement in their scores through better skills development programme and improved preferential procurement levels. This suggests that companies may be more open to innovative ideas around how to increase their preferential procurement score. 3. s for enterprise development are much higher than expected A surprising number of companies scored full marks for enterprise development, and many scored very high in this category. This is surprising, since at first glance it would not appear that there is that much enterprise development occurring. This may suggest that there is some dubious accounting around the calculation of the enterprise development component on the face of it, it is difficult to see how some of the listed companies could score full marks for enterprise development. It may also suggest that the enterprise development compliance targets have been set too low, and that increasing these targets should be considered. 4. An unintended bias against small companies Procurement from companies that have an annual turnover of less than R35-million (QSEs), which arguably is the most important part of preferential procurement, only receives a maximum additional points allocation of 3. The unintended result is that there is little real incentive for all but the most civic-minded of companies to make a real effort to procure from small PDI enterprises. Given that it is often more difficult and time-consuming to identify and establish a successful and sustainable relationship with such an enterprise, and the total procurement allocated to that company would be such a small share of total procurement, the fact that there is no BBBEE rating reward for doing so is an issue. Allocating a higher score to doing business with small companies that have a minimum 50% black shareholding would provide a better incentive. One idea would be to have a sliding scale solution, where there is a higher reward for dealing with small black companies, but that this declines over time, recognising that these companies have been mainstreamed. 5. The sector in which the company operates may affect its ability to increase preferential procurement We have already discussed how a company that has professional services as a key procurement item (for example, companies that are in financial services) may face a relatively easier task since there is a sizeable pool of suppliers to choose from, fees tend to be high and there is a benefit factor that can be applied to increase the value of that procurement. Companies that procure largely goods and not services face a very different sort of challenge in increasing preferential procurement. If one is a large retailer, one would generally require large numbers of items that can be provided to stores around the country. This tends to preclude smaller PDI companies, which must be a key beneficiary group for preferential procurement to achieve the intended impact. The 9

10 centre for poverty employment and growth HSRC author does not believe it is coincidence that retailers have some of the lowest preferential procurement ratings on the list: Edcon (6.93 out of 20), Lewis Group (7.47 out of 20), Massmart (4.8 out of 20), Woolworths (2.64 out of 20), Spar (1.82 out of 20) and Pick n Pay (0.05 out of 20). For example, a retailer like Pick n Pay probably has to purchase a considerable amount from a company like Tiger Brands. However, the latter has such a low BBBEE rating (less than 40 a level 8 contributor) that only 10% of expenditure on its goods will count towards the preferential procurement score. 6. The customer profile of the company may affect its desire to increase its BBBEE rating The argument is sometimes put forward that the real incentive to improve a BBBEE rating is the perceptions of existing and potential customers. This works to some extent in the existing rating structure, where companies would prefer to buy goods and services from companies that have a higher rating in order to push up their own rating. The public sector is also an important customer for many companies, and is is probably the most demanding of all clients. However, there is an interesting argument to be made that when the customers are the general members of the public, there is much less pressure to have a good BBBEE score. 10

11 An overview of preferential procurement in South Africa: government initiatives and private sector responses 1 Background Fostering the development and growth of small and medium-sized enterprises (SMEs) is a key issue in increasing employment opportunities and raising personal incomes. In addition, supporting the growth of SMEs owned by previously disadvantaged population groups, black women and young people is important to achieve a more equitable economy. However, given the structure of the South African formal economy, which is dominated by large and well-established companies, barriers to entry for new SMEs owned by these target beneficiaries are significant. One important way in which SMEs can enter the market is as suppliers to larger companies. A conscious focus by large private and public sector companies on procuring goods and services from smaller companies with a certain demographic profile preferential procurement can be a significant tool in increasing the number of sustainable small businesses. Closely aligned to the concept of preferential procurement is that of enterprise development. In many instances, smaller companies owned by previously disadvantaged individuals (PDIs) exactly who one would think of as the most important beneficiaries of any preferential procurement lack the skills, experience and/or capital to be able to service a large company. Therefore, many of these large companies (and particularly the very largest of them) implemented a strategy of working to develop these small businesses to the point where they would be able to deliver to the buying company s standards. This is obviously a time- and resource-consuming exercise, but it is also the strategy that would appear to have the most desirable results. A successful enterprise development strategy can create sustainable PDI-owned businesses that may otherwise never have survived or even come into existence. The formation of sustainable PDI-owned companies is often viewed as the most important tool in improving equity and income. Although enterprise development is mainly the preserve of the largest and most committed companies, encouraging more large businesses to look at enterprise development as a key component of their empowerment strategy could have a significant long-term impact. The increased focus on all aspects of broad-based black economic empowerment (BBBEE) by larger (particularly publicly listed) companies, in line with a greater government drive to increase BBBEE, has raised the possibility for preferential procurement to be a meaningful tool for expanding employment and income opportunities. This paper examines how preferential procurement is being implemented in corporate South Africa by examining how three companies in three very different sectors, with different customer profiles and different management approaches, have addressed the issue. The paper starts with an overview of how corporate BBBEE ratings are currently undertaken in response to government initiatives, since we argue that this 11

12 centre for poverty employment and growth HSRC has a profound impact on the way in which companies approach the design and implementation of their BBBEE strategy. 2 An overview of key preferential procurement drivers There are two important developments at work in the preferential procurement market. The first is government s initiatives to move from a policy of promoting black economic empowerment (BEE) to one of promoting BBBEE. The second is the increased use of objective rating scores and scorecards to ascertain a company s compliance with BBBEE goals. In certain important ways, the increased use of the latter is working to undermine the goals of the former. 2.1 Government initiatives Preferential procurement is a key part of government s strategy to promote BBBEE. Until fairly recently, private sector companies had a certain measure of autonomy in how they were judged on their BEE status, with a clear focus on shareholding and employment profile. In response to the perceived shortcomings in achieving the goals of empowerment, a document titled A Strategy for Broad-Based Black Economic Empowerment was released in Before the release of the Strategy on Broad-Based Black Economic Empowerment, there existed no framework for the measurement of BBBEE. The Strategy provided the outline of a broad-based scorecard, comprising the seven elements of BBBEE, together with weightings, but did not contain detail on measurement principles and the application of the scorecard. The seven elements and their respective weightings out of 100 (depicted in table 1 as per the Generic card) are the criteria used by the various ratings agencies to compile an empowerment score. (Qualifying small enterprises essentially companies with an annual turnover of less than R35-million only have to use four of these categories to compile a score, and they may select these four categories from the possible seven. Each one then carries an equal weighting of 25 points.) These empowerment scorecard components, together with various guideline documents, make up the complete Codes of Good Practice (see table 2). Each code is associated with an explanatory Statement, indicating how that code should be interpreted and applied. For the purposes of this study, we are concerned largely with the details of the codes and statements 500 and 600, but because of the way in which it has been structured, code and statement 700 also has an impact on how companies approach and implement socio-economic development strategies, which is important from the point of view of this report. 12

13 An overview of preferential procurement in South Africa: government initiatives and private sector responses Table 1 Strategy for BBBEE: elements and weightings Element Points Ownership 20 Management Control 10 Employment Equity 15 Skills Development 15 Preferential Procurement 20 Enterprise Development 15 Socio-Economic Development 5 Total 100 By the beginning of 2004 when the BEE Act was promulgated, numerous sectors of the economy had already drafted industry charters on BEE and transformation. Whilst some contained scorecards loosely based on the broad-based scorecard contained in the Strategy, others were merely written undertakings of commitment to transformation. In addition, several of these charters were drafted prior to the release of the Strategy and stakeholders therefore had little point of reference in terms of broad-based elements and weightings. Furthermore, it became evident that other pertinent issues surrounding the measurement of BEE needed to be addressed to accelerate the transformation process. The Codes of Good Practice provided some solutions to these historical BEE implementation obstacles (see table 3). 13

14 centre for poverty employment and growth HSRC Table 2 Codes of Good Practice and relevant Statements Code 000 Code Framework for the Measurement of BBBEE (carries general principles and Generic card) Code 100 Measurement of the Ownership Element of BBBEE (measures the effective ownership of enterprises by black people) Code 200 Measurement of the Management Control Element of BBBEE (measures effective control of enterprises by black people) Code 300 Measurement of the Employment Equity Element of BBBEE (measures initiatives intended to achieve equality in the workplace) Code 400 Measurement of the Skills Development Element of BBBEE (measures the extent to which to which employers carry out initiatives designed to develop the competencies of black people) Code 500 Measurement of the Preferential Procurement Element of BBBEE (measures the extent to which enterprises buy goods and services from BEE-compliant suppliers) Code 600 Measurement of the Enterprise Development Element of BBBEE (measures the extent to which enterprises carry out initiatives aimed at contributing to enterprise development ) Code 700 Measurement of the Socio-Economic Development Element of BBBEE (measures the extent to which enterprises carry out initiatives aimed at contributing to socio-economic development and promoting access to the economy for black people) Code 800 Qualifying Small Enterprises (QSEs) Code 900 Public Private Partnership Code Source: Department of Trade and Industry (the dti) Statement Statement 000 The General Principles and the Generic card Statement 003 Guidelines for the Development and Gazetting of Transformation Charters and Sector Codes Statement 004 Guidelines for Special Entities Statement 100 The General Principles for Measuring Ownership Statement 102 The Recognition in the Sale Assets Statement 103 The Recognition of Equity Equivalents for Multinationals Statement 200 The General Principles for Measuring Management Control Statement 300 The General Principles for Measuring Employment Equity Statement 400 The General Principles for Measuring Skills Development Statement 500 The General Principles for Measuring Preferential Procurement Statement 600 The General Principles for Measuring Enterprise Development Statement 700 The General Principles for Measuring Socio-Economic Development (SED) Statement 800 to 807 General Principles for QSEs in all the Elements of the card To be Gazetted as a Code once Aligned with the Generic Codes 14

15 An overview of preferential procurement in South Africa: government initiatives and private sector responses Table 3 Summary of obstacles, implications and solutions presented by the Codes of Good Practice and relevant Statements Historical BEE implementation obstacles Lack of uniform framework for the recognition and measurement of BEE. Extensive delays in BEE implementation due to differences in interpretation. Disparity in definitions and targets in charters and other BEE requirements. Status of transformation charters was unclear. Lack of underlying economic substance to many BEE transactions. Fronting due to lack of implementation guidelines. Very little transformation within management levels. Uncertainty as to what type of skills development initiatives could be counted towards skills development spend. Narrow-based recognition tended to benefit a limited number of black people with access to capital. Lack of awareness of enterprise development in and of itself, as well as a lack of awareness of what constitutes enterprise development. Implications Created confusion as the same BEE initiatives or transactions may have received different BEE recognition by different organs of state, business entities and verification agencies. Sectors were often locked in contentious debates around certain aspects of BEE, thereby delaying the implementation of broadbased BEE initiatives. Different charters introduced definitions, targets and processes which may have diluted or negated the impact of the Strategy and circumvented the principles of the BEE Act. Confusion and delays in BEE implementation resulted since companies were uncertain as to the status and application of charters. Many BEE transactions boasted high percentage levels of legal black ownership, but often the actual economic benefits accruing to black shareholders proved to be significantly lower. Lack of understanding of BEE and its elements often resulted in fronting and meant that fronting was more difficult to detect. Despite various attempts at transformation within entities there is still a lack of sufficient representation of black people within management levels. Skills spend may not necessarily have been aligned to a particular learning outcome. Only a limited number of black people have tended to benefit from BEE to date. Unlike corporate social investment, enterprise development is a fairly new concept and fairly specific to BBBEE. For this reason, the lack of documentation with examples of what constitutes enterprise development has made enterprise development one of the least implemented elements on the scorecard Solution presented by the Codes of Good Practice Standardisation of BEE recognition and measurement principles to provide clarity. Standardisation of BEE recognition and measurement principles to provide clarity. Specification of the requirements for the development and recognition of industry charters (reducing disparity in principles and definitions as a result of industry charters). Specification of the requirements for the development and recognition of industry charters. Provision of a balanced ownership scorecard which measures voting rights and net economic interest in the hands of black people. Provision of definitions, principles and processes to implement proper BBBEE initiatives. The codes encourage focus on black representation at junior, middle, senior and top management levels within organisations. Alignment of skills development spend on black employees to the learning programme matrix as issued under the Skills Development Act to ensure clear and quantifiable outcomes. The Codes promote BBBEE by encouraging that procurement opportunities be made available to BBBEE compliant suppliers, black-owned and black women-owned entities, and small and micro enterprises. Code 600 outlines the principle of enterprise development and supplies numerous examples of what kinds of initiatives constitute enterprise development. 15

16 centre for poverty employment and growth HSRC Historical BEE implementation obstacles Corporate social investment initiatives were not necessarily linked to the objective of bringing their beneficiaries into the mainstream economy. BEE was seen as an obstacle to small business development due to an increase in the regulatory burden. Implications The black majority remain largely outside of the mainstream economy Small businesses tended to ignore BEE or resort to fronting techniques to maintain clients for business purposes Solution presented by the Codes of Good Practice Code 700, whilst acknowledging that certain social objectives may not necessarily facilitate access to the mainstream economy, nevertheless encourages the implementation of initiatives which are socio-economic in nature and which are linked to the concept of assisting black people to be better equipped to access the mainstream economy. Exemption of all entities with an annual turnover of less than R 5-million. The inclusion of comprehensive statements for the measurement of BBBEE amongst Qualifying Small Enterprises (QSEs), based on a flexible approach where QSEs are only measured against 4 of the 7 elements of their choice. Code and Statement 500: Preferential Procurement the dti states the following as its incentive for this part of the scorecard: Preferential Procurement is used to drive transformation throughout the economy by encouraging procurement only from suppliers that are compliant with the B-BBEE scorecard: There is a market tendency to interpret B-BBEE compliance as only having ownership by black people without looking at the level of compliance with other B-BBEE requirements. This has resulted in a number of sham transactions/ fronting activities being entered into in a scramble to meet this compliance requirement. Enterprises are encouraged to procure from those entities that have a good B-BBEE contribution level based on their performance on the scorecard. A supplier that has a very good B-BBEE contribution level is likely to be chosen as a preferred supplier as compared to his peers as they will give the enterprise they are providing goods and services to a good scoring on their own scorecard as well. Incentive to procure from Qualifying Small Enterprises and Exempted Micro Enterprises: Statement 500 has a specific indicator for the recognition of BEE procurement spend from Qualifying Small Enterprises (QSEs) and Exempted Micro Enterprises (EMEs) by allocating specific scorecard points to procurement from these entities exclusively. The Preferential Procurement scorecard offers BBBEE procurement recognition from three categories of BBBEE compliant suppliers, as summarised in table 4. 16

17 An overview of preferential procurement in South Africa: government initiatives and private sector responses Table 4 Categories of BBBEE complaint suppliers in Preferential Procurement scorecard (A) BEE compliant suppliers which will enjoy preferential procurement recognition Beneficiary category BEE compliant suppliers Based on BEE contribution level (B) QSE and EME suppliers Based on BEE contribution level (C) 50% black-owned companies and 30% black women-owned companies Based purely on ownership status Source: the dti Description of beneficiary Includes all BEE compliant companies: Of any size; With 30% or more on the Generic or QSE scorecards; and/or EMEs. Includes: QSEs proportional representation based on their score on the QSE scorecard to be applied; EMEs proportional representation based on their deemed Level 4 status and Level 3 status if they are 50% black-owned or 50% black women-owned. Includes BEE compliant companies: Large entities; QSEs; and EMEs that are 50% black-owned or 30% black women-owned. Purchasing goods and services from each of these three categories of supplier will influence the preferential procurement component of a company s BBBEE rating as follows: Total maximum from preferential procurement 20 points Of which: All BEE compliant suppliers 12 points QSE and EME suppliers 3 points 50% black-owned 3 points 30% black women-owned 2 points These categories are not mutually exclusive. For example, a company can claim points under the first category, but scores additional points if one of the suppliers is also a QSE and/or a 50% black-owned company. The calculation of each of these components is fairly complex, allowing companies to claim more points for more compliant suppliers, and also rewarding value-adding companies and enterprise development. These are summarised in table 5. 17

18 centre for poverty employment and growth HSRC Table 5 Preferential Procurement scorecard: calculation of components by enhancement factor Enhancement factor Qualifying BBBEE value-adding supplier that beneficiates raw materials or tend to manufacture and/or produce locally Qualifying BBBEE spend where the supplier is also an enterprise development beneficiary Minimum 50% black-owned suppliers of professional and consulting services Quantum Spend to this supplier is weighted at 1.25 x actual spend when calculating preferential procurement Spend to this supplier is weighted at 1.25 x actual spend when calculating preferential procurement Factor of 1.25 is applied It should be noted that this enhancement factor can only be applied when the supplier is a qualifying BBBEE supplier. Therefore, procurement from a value-adding company that is not BBBEE compliant will not be adjusted by the enhancement factor. In order to calculate a company s actual preferential procurement spend, the following process is followed: 1. Calculate the Total Measured Procurement Spend (TMPS); 2. Determine the BBBEE Procurement Recognition Level of each supplier; 3. Identify QSE and EME suppliers from this list; 4. Identify 50% black-owned and 30% black women-owned suppliers from this list; and 5. Identify companies that are adding value to imported products and/or manufacturing locally. Companies obviously have an interest in having a TMPS that is as low as possible, since that will increase the apparent percentage of spend allocated to preferential suppliers. Therefore, the dti has set out detailed guidelines for calculating TMPS (see table 6). 18

19 An overview of preferential procurement in South Africa: government initiatives and private sector responses Table 6 the dti s guidelines for calculating TMPS Total Measured Procurement Spend (TMPS) Spend item (included in TMPS save for any exceptions outlined in the adjacent column) Exceptions (may be permissibly excluded from TMPS) 1. Cost of sales No exceptions 2. Operational expenditure No exceptions 3. Capital expenditure No exceptions 4. Public sector procurement from Schedule 2 (e.g. Eskom) & 3 (e.g. State Iinformation Technology Agency, or SITA) listed organs of state and public entities as per the PFMA Procurement from Schedule 1 organs of state and public entities is excluded from Total Measured Procurement Spend, unless the procurement is from a local government entity acting as a reseller 5. Monopolistic procurement No exceptions 6. Third-party procurement (not pass-through, third-party procurement) 7. Labour brokers and independent contractors No exceptions Pass through third-party procurement where the measured entity may be acting as an agent in normal business practices. In other words, procurement spend which may pass through an agent (the measured entity) but which is not recorded as an expense in the entity s financial statements but is recorded in the third party s financial statements. For example, a travel agent buying on behalf of a third party 8. Pension and medical aid contributions Exclude capital investment portion only 9. Trade commissions No exceptions 10. Empowerment-related expenditure The following empowerment-related expenditure is excluded from TMPS: Investments in or loans to an associated enterprise (as defined in Statement 102); and Investments, loans or donations which qualify for enterprise development and socio-economic development recognition under Codes 600 and Imports Several exceptions see below 12. Intra-group procurement Exceptions as per the guideline on Complex Structures and Transactions Source: the dti 19

20 centre for poverty employment and growth HSRC EXCLUSIONS FROM TMPS Permissible exclusions from TMPS are strictly defined in Statement 500. They are: Taxation. Public sector procurement (schedule 1 entities as per the Public Finance Management Act No. 1 of 1999 [PFMA]). Salaries, wages and emoluments. Pass-through third-party procurement (where no entries relating to this procurement appear in the books of the measured entity). Empowerment-related procurement associated with investments, loans or donations to associated enterprises or enterprise development beneficiaries. Imported capital goods or components for value-added production in South Africa, provided that: there is no existing local production of such goods or components; and importing such capital goods or components promotes further valueadded production within South Africa. Imported goods and services if there is no local production of such goods or services including instances where: the imported goods or services carry a brand different to the locally produced goods or services; or where the imported goods or services have different technical specifications to those produced locally. The BBBEE Procurement Recognition Level of each supplier is determined by how well they have scored on the Generic card described above (see table 7). EMEs obtain an automatic, deemed Level 4 Contributor Status (100% BEE procurement recognition). The practical/likely implications of how preferential procurement spend is calculated is discussed in more detail below. 20

21 An overview of preferential procurement in South Africa: government initiatives and private sector responses Table 7 BBBEE Procurement Recognition Level of suppliers Source: the dti Code and Statement 600: Enterprise Development According to the dti, the motivation for including enterprise development in the BBBEE codes was as follows: The Enterprise Development Element of the Generic card aims to address certain key challenges facing QSEs, EMEs and more specifically black-owned entities that struggle to take their businesses from survivalist and/or micro level to a level of sustainability and profitability. The challenges which Code 600 therefore seeks to address include: 1. High failure rate amongst black-owned start-ups due to lack of access to financing and other business support. Many black entrepreneurs struggle to take their businesses from a survivalist or micro-level to the next phase, owing to one or more of the following: lack of access to capital, lack of collateral, and lack of education, training and experience. Statement 600 therefore attempts to address these challenges by providing recognition for, inter alia: BEE status Qualification Investments, loans, grants, guarantees and provision of seed capital; Access to credit, interest-free loans and relaxed security requirements; and Time spent on training and mentoring of black entrepreneurs/start-ups. 2. Job-creation cannot be attained without the growth of the small business sector. Most analysts agree that growth with respect to job creation will predominantly come from the small business sector. This will only be made possible if small businesses are assisted to grow, develop and graduate from micro and survivalist entities to become sustainable, job-creating enterprises. By providing recognition for various types of BEE procurement recognition level Level One Contributor 100 points on the Generic/QSE card 135 Level Two Contributor 85 but <100 points on the Generic/QSE card 125 Level Three Contributor 75 but <85 on the Generic/QSE card 110 Level Four Contributor 65 but <75 on the Generic/QSE card 100 Level Five Contributor 55 but <65 on the Generic/QSE card 80 Level Six Contributor 45 but <55 on the Generic/QSE card 60 Level Seven Contributor 40 but <45 on the Generic/QSE card 50 Level Eight Contributor 30 but <40 on the Generic/QSE card 10 Non-compliant Contributor <30 on the Generic/QSE card 0 21

22 centre for poverty employment and growth HSRC assistance to small, medium- and micro-sized enterprises with the objective of expanding their operational and financial capacity, Statement 600 seeks to ensure that such assistance is incentivised. Table 8 Enterprise Development card Criteria Weighting points Compliance target Average annual value of all Enterprise Development Contributions and Sector Specific Programmes by the measured entity as a percentage of target 15 3% of net profit after tax (NPAT) The weighting of different types of Qualifying Enterprise Development Contributions is effectively increased or decreased by means of the Benefit Factor Matrix. This Matrix encourages spend in certain areas by awarding full recognition (100%) in such areas, whilst still allowing significant recognition (80%) in other areas. Table 9 Beneficiaries of Enterprise Development defined Beneficiary Enterprise Development Category A (QSEs & EMEs) Description of beneficiary QSEs and EMEs which are 50% black-owned or 50% black women-owned. Any size entities which are: Enterprise Development Category B (Any size of entity) Sector-Specific Programmes 50% black-owned or 50% black women-owned; 25% black-owned or 25% black women-owned which also have a BEE Status Level of one to six. The beneficiaries of sector-specific programmes must meet the definitions of enterprise development beneficiaries. Source: the dti 22

23 An overview of preferential procurement in South Africa: government initiatives and private sector responses Table 10 Qualifying Enterprise Development contributions Type General nature and objective Examples Category A beneficiaries (QSEs or EMEs that are 50% blackowned or 50% black women-owned) Category B beneficiaries Any size companies that are: 50% black-owned or 50% black women-owned; 25% black-owned or 25% black women-owned which also have a BEE Status Level of one to six Sector Specific Source: the dti Enterprise development initiatives: Should typically aim to assist and accelerate the development, sustainability and ultimate financial and operational independence of the beneficiaries they assist. This is usually achieved by helping beneficiaries to expand their operational and financial capacity. These are to be included in Sector Codes or as sector-specific initiatives and not as part of the Generic Codes. Code 600 includes this category to give individual sectors the flexibility to define their own sector-specific contributions. Grants; Investments in beneficiary entities; Loans; Guarantees/security; Seed capital; Access to finance through provision of collateral/relaxed security; requirements; Early payments for goods supplied; Extended credit terms for procurement amounts owed by beneficiary entity; Infrastructure support to suppliers and other entities in the same area or community; Beneficiation; Labour-intensive production and construction methods; and Investment and support to enterprises operating in rural communities. Can be determined by: Each sector through the process of sector codes; Each sector through other processes, i.e. those areas identified as requiring to be specifically addressed through enterprise development initiatives in sectors that do not have charters/sector codes. 23

24 centre for poverty employment and growth HSRC KEY MEASUREMENT PRINCIPLES 1. Cumulative recognition to allow for fluctuations in spend based on the financial needs of different projects in different years. All enterprise development contributions are measured cumulatively from the earlier of the commencement of the Codes or a maximum of five years prior to the commencement of the codes until the date of measurement. This cumulative period will be limited to five years at a time; in other words, the sum of contributions is averaged over the number of years (limited to a maximum of five years). The figures to be used will be either of the following: The annual average value of the amount of money spent by the measured entity and the average NPAT over that cumulative period; or The value of the actual amount of money spent by the measured entity in the preceding financial year and the actual NPAT in the preceding financial period. In the case where the measured entity has not recorded any NPAT, either in the preceding financial period or at any time during the five-year cumulative period, or the net profit margin is less than a quarter of the norm in the industry, then turnover should be used as a base for determining their target. The following formula should be utilised: 3% x Indicative Profit Margin x Turnover (the Indicative Profit Margin is the profit margin in the last year in which the company s profit margin was at least one quarter of the industry norm). 2. Inception date allows for recognition of prior spend if an entity so wishes. Certain companies may wish to choose an inception date which is not the date of commencement of the Codes, but an earlier date. This is to allow recognition for companies that were early starters and contributed to enterprise development initiatives before the commencement of the Codes. However, companies must be able to produce evidence of contributions prior to the gazetting of the Codes if they wish to claim this spend, as they would for recognition claims following the gazetting of the Codes. 3. Encouraging particular types of enterprise development spend. the dti has determined that not all expenditure on enterprise development has the same impact. Therefore it has developed a Benefit Factor Matrix to incentivise spend in certain areas, whilst still allowing significant recognition in the other areas of enterprise development. This means that different types of expenditure are weighted by 100%, by less than 100% and/or by more than 100% when calculating the value of that expenditure for the purposes of ascertaining the enterprise development portion of the BBBEE score. This Benefit Factor Matrix is shown in table

25 An overview of preferential procurement in South Africa: government initiatives and private sector responses Table 11 Benefit Factor Matrix Qualifying contribution type Contribution amount Benefit factor Grant and related contributions Grant contribution Full grant amount 100 Direct cost incurred in supporting enterprise Verifiable cost (including both 100 development monetary and non-monetary) Discounts in addition to normal business practices Discount amount (in addition to 100 normal business discount) Overhead costs incurred in supporting enterprise development (including people appointed in enterprise development) Verifiable costs (including both monetary and non-monetary) 80 Loans and related contributions Interest-free loan with no security requirements Outstanding loan amount 100 Standard loan to black-owned EMEs and QSEs Outstanding loan amount 70 Standard loan provided to other beneficiary Outstanding loan amount 60 enterprises Guarantees provided on behalf of a beneficiary Guarantee amount 3 entity Lower interest rate Outstanding loan amount = (prime rate less actual rate) Equity investments and related contributions Minority investment in black-owned EMEs and Investment amount 100 QSEs Minority investment in other beneficiary enterprises Investment amount 80 Enterprise development investment with lower dividend to financier Contributions made in the form of human resource capacity Investment amount Professional services rendered at no cost Commercial hourly rate of professional 80 Professional services rendered at a discount Time of employees of measured entity productively deployed in assisting beneficiaries Other contributions Value of discount based on commercial hourly rate of professional Total annual cost to company of the employee divided by 160 Dividend rate of ordinary shareholders - actual dividend rate of contributor Shorter payment periods Percentage of invoiced amount Percentage, being 15 days less the number of days from invoice date to payment date Source: the dti The result of using this benefit matrix is that companies which are engaging in enterprise development are able to fully capture all the inputs that they are making, whether direct financial support, indirect financial support or assistance in kind. Since in-kind contributions (such as mentoring) are often key factors in creating sustainable enterprises, it is important that they are included. This may also act as an incentive to companies to increase their enterprise development score by encouraging the use of this kind of support

26 centre for poverty employment and growth HSRC Code and Statement 700: Socio-economic development The contents of Code 700 are important for the purpose of our investigation, since it requires that companies consider corporate social investment (CSI) projects, which encourage economic participation, rather than simple charity projects, which have generally been the more popular, since they tend to be easier to conceive and implement. The result is that, in terms of the Generic card, companies can only claim CSI spend that is linked to economic participation. We would expect the result of this to be a significant increase in the number of companies actively seeking CSI projects that focus on increased economic participation. Code 700 s goal is to encourage initiatives that enhance the ability of black people who remain non-participants in the economic mainstream to be included in economic participation in a sustainable manner. Statement 700 adheres to the principle that socio-economic development initiatives should strive to facilitate access to the mainstream economy for black people. It does so by encouraging socio-economic development contributions that are linked to improving the financial circumstances of beneficiaries. Examples of such initiatives would be: Provision of development capital for communities; Training or mentoring to beneficiary communities which will assist them to increase financial capacity; and Offering preferential terms to beneficiary communities when purchasing their goods/services (for example, early payment). Table 12 The Socio-economic Development card Criteria Weighting points Compliance target Annual average value of all socioeconomic development contributions by the measured entity as a percentage of the target 5 1% of NPAT Source: the dti The Socio-economic Development card contains an indicator that measures socio-economic development contributions to defined beneficiaries, as well as contributions to certain Approved Projects, such as projects in rural or underdeveloped urban areas, earmarked by government for development, and any sector-specific contributions which have been approved through gazetting of a particular industry s Sector Code. 26

27 An overview of preferential procurement in South Africa: government initiatives and private sector responses Table 13 Definition of beneficiaries of socio-economic development Beneficiary Socio-economic development Approved socio-economic development programmes Description of beneficiary Social development beneficiaries are either black individuals or, as is more commonly the case, communities or groups of people. In the latter case the percentage of black people within the beneficiary group affects the amount of spend recognition in terms of the Codes: Where 75% of the beneficiary group is black, the full value of contributions is recognisable. Where less than 75% of the beneficiary group is black, then value of the contribution is multiplied by the percentage benefiting black people. The beneficiaries of Approved Socio-Economic Development programmes must meet the definition of socio-economic development beneficiaries. Qualifying Contributions is a collective term for socio-economic development contributions and approved socio-economic development programme contributions. However, such contributions must be made to the defined beneficiaries of socioeconomic development initiatives and must be directly aligned to the socio-economic development principle of resulting in sustainable economic participation with the clear goal of discouraging perpetual dependence on hand-outs. Table 14 Qualifying contributions Type General nature & objective Examples Socio-economic development Development programmes (especially for Black contributions should typically strive to Designated Groups as defined in Code 100) promote access to the economy for HIV/ AIDS & healthcare support beneficiaries Support to schools and educational assistance through bursaries Skills development for the unemployed; ABET programme support Socio-development Support for arts and culture Guarantees/ security for beneficiaries Development capital for beneficiary communities Training/ mentoring of communities to assist them to increase their financial capacity Investment in the social wage of employees (e.g. housing, transport and healthcare) Approved socioeconomic development programmes Source: the dti Contributions to projects which have been approved by organs of state as well as those that are sector-specific, as agreed to by sector representatives through their Sector Codes. Approved Project contributions include: Infrastructure development; Reconstruction in underdeveloped areas; Rural communities; and Geographical areas identified in the government s Integrated Sustainable Rural Development and Urban Renewal Projects. 27

28 centre for poverty employment and growth HSRC As is the case with Code and Statement 600, Code 700 is associated with a Benefit Matrix, which assigns a different weighting to different types of contribution, and allows companies to claim non-financial contribution. The Benefit Matrix for Code 700 contributions is indicated in table 14. Table 15 Code 700 Benefit Factor Matrix Qualifying contribution type Contribution amount Benefit factor Grant and related contributions Grant contribution Full grant amount 100 Direct cost incurred in supporting socio-economic development, or approved socio-economic development contributions Verifiable cost (including both monetary and non-monetary) 100 Discounts in addition to normal business practices supporting socioeconomic development, or approved socio-economic development contributions Overhead costs incurred in supporting socio-economic development, or approved socio-economic development contributions Discount amount (in addition to normal business discount) Verifiable costs (including both monetary and non-monetary) Contributions made in the form of human resource capacity Professional services rendered at no cost supporting socio-economic development, or approved socioeconomic development contributions Professional services rendered at a discount supporting socio-economic development, or approved socioeconomic development contributions Time of employees of measured entity productively deployed in assisting beneficiaries and supporting socioeconomic development, or approved socio-economic development contributions Source: the dti Commercial hourly rate of professional Value of discount based on commercial hourly rate of professional Monthly salary divided by The rise of the ratings agencies The majority of companies in South Africa does not believe that preferential procurement or enterprise development (with a few notable exceptions for the latter) contribute to company profitability and/or lower costs. The main incentive for engaging in these activities is almost always the desire to appear compliant, usually to prospective clients in both the private and public sector. This is unlikely to change any 28

29 An overview of preferential procurement in South Africa: government initiatives and private sector responses time soon. Until the release of the detailed government BBBEE scorecards, companies had some latitude in presenting their level of compliance. Anecdotal evidence suggests that companies would highlight those areas in which they were able to do well (such as the workforce profile) and gloss over those areas where it was more difficult. For example, preferential procurement would tend to be easier for certain companies (such as those who purchase a large amount of fairly standardised goods and/or basic services), but much more difficult for those with complex supply chains, such as fresh food retailers. This is no longer possible, since the scorecard means that all aspects of BBBEE must be taken into account by all companies. The second important impact is a result of the sheer complexity of the scorecards. Previously, most companies could ramble their way through the reporting of their BEE initiatives in their annual reports, focusing attention on attractive stories. However, the introduction of a uniform scorecard for everyone has greatly increased the value of the scorecard rating result, which is a very objective measure. The third important impact is the way in which the areas of preferential procurement, enterprise development and socio-economic development have been weighted. Enterprise development makes up a full 15% of the total score, but only a few companies are active in enterprise development in any meaningful way. Reaching the target of 3% of NPAT is going to prove a considerable challenge for many companies. For example, Pick n Pay would have to spend around R25-million each year on enterprise development to reach this target. Therefore we would expect that those companies that have limited ability to change factors such as ownership would be taking a very good look at efforts in enterprise development to try and improve their scores. (Given that most companies do not have the capacity to implement and run meaningful enterprise development initiatives, this may create some interesting opportunities in this space.) The increased focus on economic participation initiatives in what is essentially CSI can be expected to have the same impact. The leading rating agency in South Africa is Empowerdex, and it is worth taking a look at its Generic card ratings for the top 200 empowerment countries in South Africa. The Empowerdex rating scorecard mirrors that of the dti, as can be seen from its format in table

30 centre for poverty employment and growth HSRC Table 16 Empowerdex Generic card* Element Category Indicator Ownership: Measures effective ownership of companies by black people. Code 100 Total Points = 20. Management Control: Measures effective control of companies by black people Code 200 Total Points = 10. Employment Equity: Measures initiatives intended to achieve equity in the workplace Code 300 Total Points = 15. Weighting points Interim target Compliance target Voting rights Exercisable voting rights in the enterprise in the hands of black people 3 25%+1 vote Exercisable voting rights in the enterprise in the hands of black women 2 10% Economic Economic interest of black people in the enterprise 4 25% interest Economic interest of black women in the enterprise 2 10% Economic interest of the following black natural people in the enterprise: Black designated groups; Black participants in Employee Ownership Schemes; Black beneficiaries of Broad-Based Ownership Schemes; or Black participants in co-operatives 1 2.5% Realisation Ownership fulfilment No 1 points restrictions Net value 7 25% Bonus points Involvement in the ownership of the enterprise of black new entrants 2 10% Involvement in the ownership of the enterprise of black participants: in Employee Ownership Schemes; 1 10% of Broad-Based Ownership Schemes; Co-operatives Board Exercisable voting rights of black board members participation using the Adjusted Recognition for Gender 3 50% Black executive directors using the Adjusted Recognition for Gender 2 50% Top Black senior top management using the Adjusted management Recognition for Gender 3 40% Black other top management using the Adjusted Recognition for Gender 2 40% Bonus point Black independent non-executive board members 1 40% Bonus points Black disabled employees as a percentage of all employees using the Adjusted Recognition for Gender Black employees in senior management as a percentage of all such employees using the Adjusted Recognition for Gender Black employees in middle management as a percentage of all such employees using the Adjusted Recognition for Gender Black employees in junior management as a percentage of all such employees using the Adjusted Recognition for Gender Bonus points for meeting and exceeding EAP targets in each of the above categories 2 2% 3% 5 43% 60% 4 63% 75% 4 68% 80% Element Category Indicator Weighting Interim Compliance 3 30

31 An overview of preferential procurement in South Africa: government initiatives and private sector responses Skills Development: Measures the extent to which employers develop the competencies of black employees Code 400 Total Points = 15. Preferential Procurement: Measures the extent to which companies buy goods and services from BEE compliant suppliers as well as black-owned entities Code 500 Total Points = 20. Enterprise Development: Measures the extent to which companies carry out initiatives contributing to enterprise development Code 600 Total Points = 15. Socio-Economic Development: Code 700 Total Points = 5. Skills development spend on learning programmes Learnerships Source: Empowerdex * Copyright: Empowerdex Skills development expenditure on learning programmes specified in the Learning Programme Matrix for black employees as a percentage of leviable amount using the Adjusted Recognition for Gender Skills development expenditure on learning programmes specified in the Learning Programme Matrix for black employees with disabilities as a percentage of leviable amount using the Adjusted Recognition for Gender Number of black employees participating in learnerships or Category B, C and D programmes as a percentage of total employees using the Adjusted Recognition for Gender BEE procurement spend from all suppliers based on the BBBEE Procurement Recognition Levels as a percentage of Total Measured Procurement Spend BEE procurement spend from qualifying small enterprises or from EMEs based on the applicable BBBEE Procurement Recognition Levels as a percentage of Total Measured Procurement Spend B-BBEE procurement spend from any of the following suppliers as a percentage of Total Measured Procurement Spend: Suppliers that are 50% black-owned (3 of % points); or Suppliers that are 30% black women-owned (2 out of 5 points) Average annual value of all enterprise development contributions and sector-specific programmes made by the measured entity as a percentage of the target Average annual value of all socio-economic development contributions made by the measured entity as a percentage of the target points target target 6 3% 3 0.3% 6 5% 12 50% 70% 3 10% 15% 5 15% 20% 15 3% of NPAT 5 1% of NPAT 31

32 centre for poverty employment and growth HSRC The 2007 TEC Empowerdex survey is attached as Annexure A. It should be noted that this survey only includes listed companies, and does not include parastatal organisations such as Eskom. The most important fact that stands out is that 120 of the 200 companies surveyed have a score of less than 30, and can therefore be considered non-compliant. Admittedly, it appears that many of the data sets are missing, indicating that they were not submitted to Empowerdex. However, this in turn suggests that companies either do not bother to keep these records and/or that they are not too interested in their official empowerment rating. Neither scenario is particularly encouraging. After more than 10 years of efforts to encourage transformation, this result can best be described as disappointing. The following are the key observations that are particularly important for the purpose of this study. 7. The very poor showing of preferential procurement An initial assessment would conclude that the introduction of a more broad-based empowerment scorecard would have a positive impact on preferential procurement. However, the results of the survey do not support this assumption. Of the 200 companies included in this survey, only 34 had a preferential procurement score of more than 50% (that is, 10 or more out of a possible total of 20.) 59 of the top 100 scored more than 10 for ownership, but only 32 of these scored 10 or more for preferential procurement. Given that preferential procurement is a key issue in creating sustainable income and employment opportunities and in driving equity, we can expect that government will pay closer attention to how this is progressing. The findings of the 2008 survey (due out later this year) will provide more information on how companies are doing with respect to their preferential procurement targets. The company with the highest preferential procurement score was Barnard Jacobs, with a score of It must be noted that this is a relatively small company, and that they would probably have professional services as a key procurement item. Given the benefit factor that is applied to this kind of procurement, it is probably easier to meet procurement targets in this environment than in others. A full 158 of the companies received an overall rating of less than 55, making them level 6 contributors. The result is that purchases from these companies will only contribute 60% of every R1 spent towards the preferential procurement target. This could be one reason why the preferential procurement scores are so low: Companies are buying from big companies that have low scores, and this in turn pulls their own scores down. For example, SAB Miller would supply a large number of retailers through its ABI subsidiary, but SAB Miller s score is only 45, which means that only 60% of that expenditure counts. The only way for companies to break out of this preferential procurement codependence cycle will be to make a genuine effort to deal with smaller black-owned businesses. 32

33 An overview of preferential procurement in South Africa: government initiatives and private sector responses (As an aside: It is very interesting to note how very low the skills development scores are. Looking at the generic scorecard, it may be that companies are not initiating learnerships. Whatever the reason, the poor showing in this area seems to undermine the private sector s claims that the lack of skills is a key constraint to growth, since they do not seem to be motivated to activity in this area.) 8. A poor preferential procurement score seems to be one of the key issues in getting a higher overall score Most companies aim to be at least a Level 4 contributor, at which point one counts as a 100% value partner in the preferential procurement pyramid (see table 7). In order to be a Level 4 contributor, one requires a total score of more than 65 points, but less than or equal to 75 points. Only the top 10 companies in this survey fitted into that category. Another 16 companies had scores of 55 or higher, but less than 65. Most of the companies in the top 11 to 40 places could make a significant improvement in their scores through better skills development programme and improved preferential procurement levels. This suggests that companies may be more open to innovative ideas around how to increase their preferential procurement score. 9. s for enterprise development are much higher than expected A surprising number of companies scored full marks for enterprise development, and many scored very high in this category. This is surprising, since at first glance it would not appear that there is that much enterprise development occurring. This may suggest that there is some dubious accounting around the calculation of the enterprise development component on the face of it, it is difficult to see how some of the listed companies could score full marks for enterprise development. It may also suggest that the enterprise development compliance targets have been set too low, and that increasing these targets should be considered. What is particularly interesting is that there does not seem to be a clear correlation between the enterprise development score and the preferential procurement score, as one would expect. For example, Spar scored a dismal 1.84 out of 20 for preferential procurement, but scored full marks of for enterprise development. The respective scores of Lewis Group are 7.47 and Pick n Pay scores 5.77 out of 15 for enterprise development, but only 0.05 for preferential procurement. One possible explanation for the high enterprise development scores in some of the retail stores such as Spar may be the role of franchisees, since support of the latter could be included in the enterprise development amounts. 33

34 centre for poverty employment and growth HSRC 10. An unintended bias against small companies Procurement from companies that have an annual turnover of less than R35-million (QSEs), which arguably is the most important part of preferential procurement, only receives a maximum additional points allocation of 3. The unintended result is that there is little real incentive for all but the most civic-minded of companies to make a real effort to procure from small PDI enterprises. Given that it is often more difficult and time-consuming to identify and establish a successful and sustainable relationship with such an enterprise, and the total procurement allocated to that company would be such a small share of total procurement, the fact that there is no BBBEE rating reward for doing so is an issue. Allocating a higher score to doing business with small companies that have a minimum 50% black shareholding would provide a better incentive. One idea would be to have a sliding scale solution, where there is a higher reward for dealing with small black companies, but that this declines over time, recognising that these companies have been mainstreamed. 11. The sector in which the company operates may affect its ability to increase preferential procurement We have already discussed how a company that has professional services as a key procurement item (for example, companies that are in financial services) may face a relatively easier task since there is a sizeable pool of suppliers to choose from, fees tend to be high and there is a benefit factor that can be applied to increase the value of that procurement. Companies that procure largely goods and not services face a very different sort of challenge in increasing preferential procurement. If one is a large retailer, one would generally require large numbers of items that can be provided to stores around the country. This tends to preclude smaller PDI companies, which must be a key beneficiary group for preferential procurement to achieve the intended impact. The author does not believe it is coincidence that retailers have some of the lowest preferential procurement ratings on the list: Edcon (6.93 out of 20), Lewis Group (7.47 out of 20), Massmart (4.8 out of 20), Woolworths (2.64 out of 20), Spar (1.82 out of 20) and Pick n Pay (0.05 out of 20). For example, a retailer like Pick n Pay probably has to purchase a considerable amount from a company like Tiger Brands. However, the latter has such a low BBBEE rating (less than 40 a level 8 contributor) that only 10% of expenditure on its goods will count towards the preferential procurement score. 12. The customer profile of the company may affect its desire to increase its BBBEE rating The argument is sometimes put forward that the real incentive to improve a BBBEE rating is the perceptions of existing and potential customers. This works to some extent in the existing rating structure, where companies would prefer to buy goods and services from companies that have a higher rating in order to push up their own rating. The public sector is also an important customer for many companies, and is is probably the most demanding of all clients. 34

35 An overview of preferential procurement in South Africa: government initiatives and private sector responses However, there is an interesting argument to be made that when the customers are the general members of the public, there is much less pressure to have a good BBBEE score (this issue is discussed in more detail below, in the Woolworths assessment). 35

36 centre for poverty employment and growth HSRC 3 Case study 1: Woolworths Limited 3.1 Company profile and financial overview A household name throughout southern Africa, Woolworths sells a wide range of products including food, clothing, beauty, homeware and more under its own label in some 300 stores nationwide, as well as through franchise partners in Africa and the Middle East. Its corporate structure is summarised in figure 1. Figure 1 Woolworths Limited corporate structure Source: Woolworths Holdings Limited For the remainder of this report, we have focused on the operations of the South African subsidiary Woolworths (Pty) Ltd only. 36