Increased regulation not always negative

By on July 30, 2014

The long-term effects of new laws can be very different to what regulators initially intend.  While increased regulation tends to reduce competition, which is bad for consumers, it can actually benefit established businesses by making it harder for competitors to enter their industry.  

South African businesses face an array of regulations and compliance requirements that seems to increase every year.  Examples include the new BEE codes, revisions to the Mining Charter, the effects of the credit amnesty on providers of credit, bans on tobacco advertising, a proposed ban on alcohol advertising and the effects of the Basel III phase-ins on banks and insurers.

“Given the choice, as consumers, we’d prefer less regulation rather than more,” says Linda Eedes, Senior Analyst at RECM.  “Increased regulation tends to reduce competition and makes it more difficult for the average firm in an industry to compete. The higher costs associated with compliance also reduce profitability with only a few winners benefitting.  Consumers usually fare better in a freely competitive environment.”

Regulation can also entrench the incumbents in an industry and make it difficult for new entrants to gain a foothold.  “South African banks are a good example of this,” says Eedes.  “It’s very difficult for anyone new to enter the industry given the high costs of complying with regulation. This gives the well-established banks a significant and sustainable advantage over new entrants.”

According to Eedes, when regulation establishes high barriers to entry in an industry that protect excess returns into the future, this can be good for investors however.  “Even though we don’t like excessive regulation, a sustainable competitive advantage is one of the things we look for when identifying quality businesses in which to invest. The gaming industry is another example of a highly regulated industry where the incumbents have a significant advantage due to the high barriers these regulations create. This is one of the reasons we have invested in several gaming businesses including Sun International, Tsogo Sun and Grand Parade Investments.”

Eedes refers to the well-meaning legislation around the tobacco industry as a demonstration of the unintended consequences of regulation.  “Sales reduced, as the legislation intended, and so did competition, but the firms that remain have become super profitable as a result.  Compare that to the IT industry, which has very little regulation.  The ability for new entrants to compete has been a boon for consumers – innovative new technologies positively affect their lives and prices continue to fall.”

“We spend a lot of time and effort on understanding how the political and regulatory framework of an industry affects its long-term prospects”, says Eedes. “We can’t necessarily predict the outcomes (intended and unintended) of new legislation with any confidence.  Nor can we forecast the new legislation that could be waiting in the wings.  So we focus on what we can control – the price we pay for an asset.”

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