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When enough is enough

ONE of the key determinants of a company’s ability to create value for its shareholders is the competitive environment in which it operates. Michael Porter’s highly influential works Competitive Advantage and Competitive Strategy provide a framework for examining the forces influencing industry structure and competitive behaviour of rivals. Business owners and shareholders should regard these frameworks as a starting point for obtaining a greater understanding of their business and its underlying economic performance.

Care should be taken in applying these frameworks because within a given industry there will typically be a range of observed economic performance and value creation. What can always be said is that it takes exceptional management talent to create and sustain over time superior shareholder returns in potentially economically unattractive industries. CEOs at the helm of companies are deservedly lauded – Paul Little at Toll Holdings, Michael Chaney at Wesfarmers and others.

One of the factors influencing competitive behaviour is the regulatory or legal environment in which a firm operates. This raises the question: what role should the government play in regulating economic activities?

The first point that should be noted is the variety of different ways regulation, licensing, taxation, approvals and other administrative actions influence what goes on around us. No one would argue against the need to license electricians or surgeons.

The difficulty lies in determining when the benefits of a licensing regime are outweighed by the costs, which are often hidden or not immediately apparent.

Typically, such costs take the form of undue barriers to entry for new competitors and excessive returns to existing licence holders. This represents a transfer of value from the end consumer back up the supply chain.

As with many of these questions, the answer is not immediately obvious and the range of competing objectives is often very wide. Many people waiting for a taxi on New Year’s Eve (who are still thinking at that time of night) may question the benefits of the taxi licensing regime, yet for the owners of taxi plates, the same licensing system ensures that each owner is capable of earning an adequate rate of return on their investment across the rest of the year.

Another question is, who should bear the costs of unwinding licensing regimes which have passed their use-by date. A good example is the explicit cost of payments made under milk deregulation. Ultimately the benefits to consumers of lower priced milk, produced by the most efficient farmers irrespective of where their farm is (measured in fractions of a cent per litre), should outweigh these costs (tens or hundreds of thousand dollars to individual farmers) so that the economy as a whole is better off.

Other forms of regulation may be more explicit – cross media ownership laws, the so-called four pillars banking policy, foreign investment review and the like.

Again, the difficulty lies in determining whether the benefits of the regulation – diversity of media ownership and content, competition and protection of Australian national interests as a whole – outweigh whatever costs are imposed.

A different problem is created where government policy attempts to create a competitive market outcome where the underlying industry structure may not allow for such an outcome. Many of these industries have been thought of as “natural monopolies” – electricity, gas pipelines, railways and telecommunications.

A further complication is added when government-owned enterprises compete against the private sector. It is not clear that the legislative mechanisms that have been used to date, both here and overseas, have adequately captured both the short and long-term market signals present in a truly competitive market.

For a majority of business owners, some form of government regulation is a fact of life. Ideally, the level of regulation should be the minimum required to achieve the underlying policy outcomes (which should be explicitly stated). The difficulty is knowing whether this has been achieved at any given time. The task is always to be aware of the impact of changes in regulations on your business and its competitive environment.

Andrew Manton is an associate at Trudo. He can be contacted at andrew.manton@trudo.com.au or through the office at Business News.

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