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Value Creation: Use the Regulatory Frontier Strategy and the Regulatory Gap Strategy to Develop New Products and New Business Models

Value Creation: Use the Regulatory Frontier Strategy and the Regulatory Gap Strategy to Develop New Products and New Business Models
We’re now ready for the last piece in this module. A very important piece that relates to the strategy pillar of decision-making. And that is, how can you use regulatory law in a positive way to create value. Now this is very contrary to many people’s thinking. When you say regulations and law to a lot of business leaders they become very upset and they think very defensively about regulation rather than thinking about value creation. So one of the goals here is to try to change traditional thinking. And we’re going to be looking at three types of strategies. First of all, meeting stakeholder interests by anticipating regulation.
Then meeting stakeholder interest through something I call regulatory gap strategy and then finally trying to meet the interests of society. So look at the question of anticipating regulation. And McKinsey, the large consulting firm, calls this operating at the regulatory frontier. Here’s an example. Let’s say the Food and Drug Administration, the FDA, is considering a new regulation that requires you to add labels to your products showing the amount of trans fats in your products. How would you respond to this proposed new regulation? Now, I would assume first of all as we discussed earlier, you would want to comment on the regulation, but beyond the traditional approach, beyond risk management, how else might you respond to this regulation?
Please hit pause and write down your answer and then we’ll discuss a possibility.
Let’s take a look at what one company did. Pepsi’s Frito Lay division. They had a dual approach here. First of all they stopped using trans fats in potato chips and their other products, so they bypassed potential labeling requirements, and then second, they turned this into a marketing advantage. They obtained FDA approval to place prominent labels on their products showing that they had no trans fats. So rather than trying to fight regulation, rather than limiting the activity to shaping regulation, they anticipated the regulation in a very positive way that turned into a marketing advantage. So, you can use regulatory frontier thinking, not only in developing products that anticipate new regulations, but in other types and aspects of business operations.
So, for instance, in the United States we’ve had a longstanding debate over whether to raise the federal minimum wage. And so, with regulatory frontier thinking, many companies have decided, well, why wait for the regulation to be enacted? Why fight the regulation? Let’s just increase employee minimum wages on our own. So Walmart, McDonald’s, Ikea, Starbucks, etc., have increased minimum wages even when it’s not required by federal regulation in order to better meet the needs of their employee stakeholders. That illustrates how you can operate on the regulatory frontier and anticipate regulation in a positive way that creates value. A second strategy for meeting stakeholder interests, is to use what I call a regulatory gap strategy.
And what this strategy involves is searching for gaps in a regulatory structure, that allow you to develop new products and services for your customers. And here’s an example that relates to the formation of Southwest Airlines. The people who started Southwest Airlines, a lawyer and a business executive discovered that there was a gap in the regulation of airlines. A gap of federal regulation of airlines that allowed them to start an airline and operate within the state of Texas. So they did that. They faced court battles with the traditional powerful airlines but they won those battles. They met customer interest by offering low fares and on-time flights.
And then later they were able to expand by pushing for changes in the law that enabled flights elsewhere. So that’s a very traditional example of what I call regulatory gap strategy. That’s a phrase that I’ve coined. A more modern example is Uber. Uber discovered a regulatory gap. They argued taxi regulations don’t cover transportation service companies that simply connect passengers to drivers. Transportation service companies don’t own the cars themselves, they don’t hire the drivers, they argued. Here again, they were meeting an interest of customers. The customers, obviously, were interested in lower fares, and Uber’s strategy has been to shoot first and aim later. In other words, they enter markets without permission, trying to exploit this regulatory gap.
They then develop support from local citizens, from drivers and customers, and they’ve used this strategy in about 277 cities worldwide. Let’s look at the results as of 2015. After five years in business Uber is valued at over $40 billion. And over the years Uber has used traditional strategies in addition to regulatory gap strategy in order to achieve these tremendous results. For example, they do use lobbying for changes in the law. In the year 2014 alone, 17 US cities passed laws approving service. And Uber currently, is trying to create partnerships with European cities. And they use a compliance strategy. For example, currently in 2015 they’re applying to be a radio-dispatched taxi service in New Delhi.
By the way India is the second largest market outside of the United States. So they’ve combined regulatory gap strategy with traditional strategies in order to achieve these tremendous results. So, two important possibilities for using regulatory law for value creation. Are first of all, trying to meet state quota needs by anticipating regulation. By operating in the regulatory frontier. And second, by using the regulatory gap strategy. Find gaps in regulation that allow you to develop new products, do services, and even enter new industries. The other possibility for value creation is a little more controversial. And that is thinking about meeting the interests of society in general.
When you talk about meeting societal interests it brings into play the controversial topic called corporate social responsibility. Some people feel that there are problems with corporate social responsibility because it is not aligned with profit maximization and it is not aligned with mainstream strategy. This is the way an article by Porter and Kramer describe the result. A hodgepodge of uncoordinated CSR and philanthropic activities disconnected from the company’s strategy that neither make any meaningful social impact nor strengthen the firm’s long-term competitiveness. So, basically, what they’re saying is CSR activities are of doubtful value to society. And they are especially of doubtful value to the success of a company and it’s ability to produce profits. Now, why is this?
Well, I think that one reason relates to a very fundamental aspect of human nature. You and I have a fundamental bias in our human judgement that distorts our behavior. This bias, according to Max Bazerman in his book Judgement in Managerial Decision Making, is rooted in social norms that lead us to interpret most competitive situations as win-lose. Here’s an example, a statement by a member of the House of Representatives on treaty negotiations. If the proposed treaty is in Russia’s best interest it cannot be in our best interest. In other words, our interactions are win-lose in nature.
Well, the problem is if we have this win lose mentality and we bring it to corporate strategy, then it’s very difficult to engage in socially beneficial activities. It’s very difficult to align corporate social responsibility with profit, because of our attitude that if we give more to employees, for example, that means less for shareholders. We have a fixed pie. And therefore the challenge becomes building a larger pie that can benefit both society and our stakeholders and the company. That’s the challenge. And what this requires is what I’m calling an interest-based strategy.
It’s an alternative to fixed-pie thinking, and what this involves is first of all, finding out what your stakeholder interests are, finding out what society’s interests are, and then trying to build a larger pie that benefits both the company and the stakeholders. It’s a change in mindset from this win-lose mentality has dominated our interaction with individual stakeholders and the society in general. And a movement toward an interest-based approach that takes into account the interests of both sides. Here is an example from Porter and Kramer’s article, Creating Shared Value. You’ve got Johnson and Johnson invests in employee wellness programs. Now, often, companies are reluctant to invest in these programs. Because the cost of the program, they feel, is going to reduce profits.
However, think of this as an interest-based approach. Look at the benefits to both sides that actually isn’t a fight over a fixed pie. But it builds this larger pie that involves better benefits for employees. They have better health, lower out of pocket health care costs. Benefits for the company, they have a more productive and healthy workforce. The company actually saved $250 million in healthcare costs over six years and a benefit to society in general in the form of healthier citizens and lower health costs.
So, I think it is possible to meet societal concerns if there is a fundamental change in the mindset of decision makers, where the focus is not on the mythical fixed pie, and fighting over who gets the larger piece of a fixed pie. But building a larger pie that benefits all stakeholders. So that concludes our look at government regulation, a very important piece of business success. And in this module we have started by looking at various risk management strategies. We’ve looked at shaping the law and tactics for doing that. We’ve looked at complying with the law and finally using the law as method of gaining greater market share in battles with competitors.
And then we’ve moved on to the strategy pillar by looking at strategies such as operating at the regulatory frontier, looking at the ability to use gaps in regulatory strategy to create value. And finally on changing the mindset to one that focuses on interest-based strategy rather than traditional strategy that focuses on a fixed pie. So that concludes our look at government regulation.

Value Creation: Use the Regulatory Frontier Strategy and the Regulatory Gap Strategy to Develop New Products and New Business Models

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