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Deregulation and privatization—two major trends in the new market economy—have generated numerous surprises for the many industries involved, writes Willis Emmons, associate professor at Georgetown University's McDonough School of Business, in The Evolving Bargain.
Gone is the notion that increased liberalization will automatically foster competition, reduce prices, and generate service improvements. Instead, consumers are faced with telecommunications megamergers, higher electric rates, and increased air traffic delays, while companies strain to make sense of the government's role in their strategic agendas.
The problem for many struggling business executives, says Emmons, is their view of deregulation and privatization as the retreat of government, when in fact, the state continues to shape opportunities and risks in significant ways following liberalization.
In the new market economy, he writes, firms are engaged in an evolving relationship—a bargain—with government institutions (the state) and with society at large. In this excerpt, he shows managers the general lessons and strategic implications of the dramatic change in government's role and the growing scope of private enterprise.
Throughout this book we have seen that the new market economy does not represent a complete break with the past. One critical lesson is that government continues to play a significant role in shaping commercial opportunity and risk, even in sectors experiencing extensive deregulation and privatization. Reforms affecting the rules of entry and action within a market, as well as changes in the structure and ownership of individual players, alter the terms of the firm's bargain with the state, but the bargain remains in place and continues to evolve. Paradoxically, new obligations often accompany increased freedoms following reforms. New regulatory institutions and even ongoing government ownership stakes characterize many sectors supposedly liberated from state control.
A second lesson is that context matters in the design and evolution of an enterprise's bargain with the state and the broader society. In sectors in which the products or the production processes are seen as affecting the basic health and welfare of buyers and other parties—including goods and services viewed as integral to national security and cultural identity—firms tend to face more restrictive and often more volatile bargains. This tendency is accentuated when production involves significant, long-term investments in specialized assets. A nation's social, political, and economic context shapes the evolving bargain as well, affecting, for example, the specific rights and obligations of foreign-owned enterprises and private corporations following liberalization.
A third important lesson is that reform bargains create winners and losers as changes in market power and incentives alter market dynamics. "Losing" can be absolute or relative, full or partial, real or perceived. Residential electricity users in the United Kingdom, for example, regarded themselves as losers following power sector deregulation and privatization. Frustrated entrants in the New Zealand telecommunications sector were seen as losers following in the industry implementation of reforms. Losers typically strive to improve their position through efforts in the political arena, leveraging political power as a substitute for market power to shape the evolution of the reform bargain.
A final general lesson is that bargains, including reform bargains, inevitably evolve over time in response to market dynamics and political dynamics. While external events play a role in shaping these dynamics, the actions of affected parties in both the commercial and political arenas exert critical influence on the bargain's evolution. Given the newness of the terms of the reform bargain at the time of its adoption, one can expect the associated rights, obligations, and enforcement mechanisms to be tested, interpreted, and clarified over time. Depending on the relative political power of the losers, and the strength of the enforcement mechanisms, the terms of the reform bargain may undergo significant evolution. In some cases, such as that of Paragould Cablevision Inc., the reform bargain may evolve in ways highly unfavorable to the initial winners.
These general lessons have several important strategic implications. The first is that firms must recognize that the "devil is in the details" when it comes to evaluating business opportunities associated with reform bargains. Rather than simply equating deregulation with greater commercial freedoms, and privatization with reduced government ownership and control, firms should analyze the rights, obligations, and enforcement mechanisms associated with any reform bargain under which they conduct or plan to conduct business. A thorough assessment involves not only an evaluation of the firm's own enterprise bargain with the state, but also the web of interrelated bargains affected by the reforms. In addition, the analysis should pay close attention to the impact of contextual factors at the national and industry level on the firm's opportunities and risks under the reform bargain.
A second implication is that firms should not view reform bargains as fixed or predetermined, but instead should explore and take advantage of opportunities to shape the terms of the reform bargain before, during, and after its adoption. Firms should not restrict their vision of the means for shaping the bargain merely to traditional lobbying or public relations activities. Given the important linkages between market dynamics and political dynamics, firms should design their commercial strategy with conscious attention to the implications for the reform bargain and its subsequent evolution. This approach should be used proactively, to improve the terms of the reform bargain to the firm's advantage, as well as defensively, to protect the firm from adverse changes in the bargain.
In devising an appropriate strategy for shaping the terms and evolution of the reform bargain, the firm should work to identify the likely winners and losers from the reform process and assess their power to affect political dynamics. One option for reducing the negative impact of politically influential losers is for the firm to encourage the state to provide subsidies or other benefits to actual or potential losers following reform. The British government, for example, provided over £400 million to fund severance packages for workers laid off by National Power following privatization. As an alternative, the firm may find it beneficial to share with these parties some of the value it would ordinarily capture under the reform bargain. New England Electric System, for example, agreed to price cuts of 10 percent to Massachusetts residential electricity users to gain the support of this critical constituency for the terms of the Massachusetts Energy Act of 1998. Firms also should explore opportunities to cooperate in the political arena with reform bargain winners to preserve favorable aspects of the reforms and promote mutually beneficial changes over time.
Firms should also recognize the strategic importance of the expectations and perceptions of participants in the market and other parties affected by reforms. Unrealistically optimistic expectations at the time of the reform bargain tend to produce self-identified losers and generate backlash to the reforms. In effect, perceptions become reality. Overselling the short-term benefits of private management of public schools, for example, backfired on Education Alternatives Inc. In general, firms should strive to offset unrealistic expectations at the time of reform, while subsequently accentuating the benefits that flow to each of the affected parties.
Shaping the terms of reform is particularly important for firms whose business activities entail significant long-term investments in specialized assets. Since these firms are highly vulnerable to unfavorable changes in the bargain over time, they should pay close attention to shaping the formal and informal enforcement mechanisms upholding their rights and obligations in the marketplace. In addition, where feasible, they should stagger investments over time so as to reduce the prospect of being held hostage at a later date.
Finally, reform bargains pose strategic challenges in the creation and management of collaborative ventures, whether in the form of alliances, joint ventures, or consortia. As we have seen, multifirm ventures often provide a means for rapidly assembling diverse resources to purchase state-owned enterprises, enter deregulated markets, or bid on concessions. Yet the different objectives and constraints of the venture's participants tend to create tensions in the governance and stability of these organizations. These tensions are typically underestimated and are exacerbated by the rapidly evolving market and political dynamics normally associated with reform bargains.
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