How Regulation Changes Growth and Competition In Any Industry

By Logan
Estop-Hall

The role of Government regulations

No matter your view on centralised governance, or whether governance becomes more decentralised over time (now that blockchain solves for the Byzantine General Problem) – ‘Regulation’ is here to stay (unless we enter a period of global decline and chaos which I strongly doubt). 

If you view Regulation as ‘rules of the game’ then it is clear they will have an impact on how to ‘play’, and what makes one business a ‘winner’ over another. Therefore understanding how regulations can impact competition and therefore growth is critical to any business growth strategy. 

Government Regulations will typically manifest in industries that are deemed to be salient, or are aligned with specific governmental (and political) objectives such as full employment, regional development, indigenous raw materials, strategic industries (such as AI), defence and even things of cultural importance. This can make regulations both long (when strategic) and short term (when based on political objectives), and they can both hinder and accelerate growth and profitability within industries. 

This post will dive into some core topics relating to regulation in business, all of which are pertinent to anyone designing and deploying business growth strategies.

Government as a Force 

No Industry Structural Analysis can be completed without reviewing government policies, present and pending. It is far better to review each of Porter’s 5 Forces through the lens of government regulation, instead of seeing this as an independent actor. 

There are many ways governments around the world can apply pressure to the competitive landscape – ultimately they set the ‘rules of the game’. These can be direct or indirect. 

Direct intervention comes in the form of full blown regulation such as: 

  • Licensing (entry to industry)
  • Competitive practices 

Indirect intervention is more subtle, giving second order effects:

  • Regulation of product quality
  • Regulation of safety requirements 
  • Regulation of environmental concerns 
  • Tariffs on foreign investments 

While these regulations often aim to achieve virtuous political objectives, they can disadvantage smaller firms by raising capital requirements and increasing barriers to entry. Examples include: 

  • Raising capital requirements 
  • Increasing economies of scale by requiring high levels of R&D testing

Governments can also act as buyer/supplier in many industries. Based on its policies and objectives it can dramatically shift the supply/demand balance within an industry. War is a simple example. When governments go to war they become a bigger buyer of arms and munitions. 

Tax incentives can increase capacity expansion 

Perverse tax incentives aimed to increase national capacity can skew capacity planning in an industry, resulting in many businesses to collectively over-invest in capacity building and  significantly changing the supply demand ratios. 

Tax breaks within an industry can encourage businesses to invest profits back into capacity expansion which can quickly result in too much supply being available. This decreases the power of suppliers (as buyers now have more bargaining power), which in turn can result in price drops and profit loss. 

If a country wants to build an indigenous strategic industry the same domestic overproduction can happen. However, this can cause major issues when the minimum efficient scale is large in comparison to international markets (ie building local capacity too quickly in relation to global capacity). 

Even a desire to promote full employment can increase pressures on businesses to maintain or expand employment, which can increase production and lead to over-capacity.

Competitor constraints 

When performing a Competitive Analysis it’s important to understand if there are previous regulatory, antitrust or other social constraints on a business. If a business has previously had antitrust issues or constraints, then it is less likely to retaliate to a small business – providing some ‘cover’ for a business to scale into a particular strategy/industry. 

When performing a Competitive Analysis ask: 

  • Are there any previous antitrust issues and what were they? 
  • Are there any consent decrees (a settlement agreement between government agency and business) and what were they? 

If you’re aware of any specific constraints on a business, this provides an opportunity to move against that company strategically.  

The big lesson here is that a smaller business trying to get into an industry could expect some ‘protection’ if choosing to move against a businesses with a history of flying close to antitrust issues. 

Rapid shifts in demand

Changes in regulation can cause rapid shifts in demand, which gives those businesses willing to move quickly opportunities for growth and expansion into an industry. 

Examples of this would be the introduction of GDPR in the EU increasing demand for legal and technical services and products relating to data privacy and security (such as our Data Strategy Consulting). 

Governments can subsidise emerging technologies in new industries, which can shift the industry dynamics. These subsidies can often be driven by political pressure, specifically in areas of cultural concern. 

Although not all regulation is ‘signposted’, it’s very much worth having an eye on draft regulation and ensuring you’re aware of the progress of anything that might shift demand aggressively. 

Exit Barriers and Divestment 

Regulations can make it difficult for companies to exit industries, especially when governments are concerned about local employment and the community impact of any divestment. Sometimes the costs of divestment are so large that a business chooses to remain within an industry it does not want to be in. 

This can create opportunities for smaller, more agile businesses to thrive by staying cost-efficient and leveraging new technologies. Over time, larger competitors may be forced to divest, absorbing the high costs of exit – giving the smaller businesses a major competitive boost (aka growth!!!). 

Constraints in Emerging Industries 

Emerging industries often face regulatory hurdles that impede growth. In healthcare, for instance, lengthy pre-certification testing can delay the introduction of new products. Regulators, often not specialists in the industry, may be overly cautious and slow to respond to technological advancements. The regulation of the Crypto industry is a clear example of how innovation and growth are limited by regulators that have not fully understood the technology (this is slowly changing, as governments become aware of the potential consequences of not being competitive in this space). 

On the other hand, regulations can also accelerate new industry growth by mandating certain standards, such as smoke alarms in construction.

We can’t talk about emerging industries without talking about AI. A lack of regulation in AI has resulted in innovation and industry growth far beyond expectations. However, this industry is particularly interesting, as it’s both strategically important (regulators will want to reduce constraints) and yet [potentially] a major threat to humankind (regulators will want to increase constraints). We don’t know where this industry will go, but I will predict it will change the face of the planet in one way or another. 

Entry and Exit Barriers 

Regulations can act as barriers to entry and exit. Existing subsidies may give established, legacy firms a lasting advantage and even an early warning of new entrants (as they apply for industry licensing). 

Conversely, social and governmental restrictions can make it challenging to exit a market due to concerns over job losses and community impact, which can hinder existing companies from divesting and improving their profitability (Exit Barriers and Divestment above). 

Local Governance and Fragmentation 

Various regulatory frameworks (e.g federal system) can result in local regulatory restrictions, as seen in liquor sales and housing rental in the USA, that dramatically shift the industry landscape. 

Governments can even prevent industry consolidation, maintaining a fragmented industry. An example of this is the cannabis industry in the USA, where the banking system is unable to facilitate (easily/legally) cross state money transfers and thus consolidation.  

Local regulations can cause industry fragmentation, as seen in the case of liquor sales and property rentals in the USA. This means the legal framework can be different per location/state, enabling local fragmented firms to operate and thrive. 

Product Adoption 

Industries that are highly regulated are more likely to be slow in technology adoption. This is primarily due to their supply being more heavily scrutinised, making procurement more drawn out and extensive. 

Therefore, for rapid product adoption a business wants to enter a less regulated industry. 

Summary 

Any growth strategy aiming to increase revenue generation and profit potential must consider regulation, and ensure the evaluation of industry economics through this lens. 

Regulation can be both strategic and political, meaning that it can have rapid and widespread impacts on the potential growth in any industry – especially those seen as salient. 

Understanding how regulation can impact competition and growth potential, companies can better navigate their industries and the opportunities present in them. 

Having worked in regulated and non-regulated industries, there are clear differences that need to be understood and leveraged where possible. Feel free to get in touch if you’re working in a regulated industry and want support in evaluating the regulatory landscape and identifying a relevant growth strategy.