FMIB

52 Academy of Management Perspedives August

S Y P O S I U

Political Markets and Regulatory Uncertainty: Insights and Implications for Integrated Strategy by Allison F. Kingsley, Richard G. Vanden Bergh, and Jean-Philippe Bonardi

Executive Overview Managers can craft effective integrated strategy by properly assessing regulatory uncertainty. Leveraging the existing political markets literature, we predict regulatory uncertainty from the novel interaction of demand- and supply-side rivairies across a range of political markets. We argue for cwo primary drivers of regulatory uncertainty: ideology-motivated interests opposed to the firm and a lack of competition for power among political actors supplying public policy. We align three previously disparate dimensions of nonmarket strategy—profile level, coalition breadth, and pivotal target—to levels of tegulatory uncer- tainty. Through this framework we demonstrate how and when firms employ different nonmarket strategies. To illustrate variation in nonmarket strategy across levels of regulatory uncertainty, we analyze several market entry decisions of foreign firms operating in the global telecommunications sector.

F irms know that entering a new industry or geographic market involves market risk. Com- mitting to that investment may also suhject

flrms to a critical nonmarket risk: regulatory un- certainty. Firms entering new markets are often required to gain approval from a regulator, and once approved the firm's investments are typically suhject to ongoing scrutiny hy a regulator over issues such as product safety, pricing, rate of re- turn, competition, and access to distrihution channels. The uncertainty associated with changes in regulation or public policy can reduce the firm's profitability or block the firm from meeting other performance objectives.

This applies, of course, to developed countries but also to emerging economies. Consider for in- stance the case of the German wholesaler Metro Cash and Carry when it enteced India in 2003

(Khanna, Palepu, Knoop, & Lane, 2009). Al- though Metro's distribution processes could be of value in India, where getting fresh fruits and veg- etables was often challenging for local restaurants and hotels, the firm struggled to obtain regulatory approval. Several years after obtaining initial reg- ulatory approval to enter the market, shelves in Metro's large stores were still half-empty because of local governments' interpretation of the Agri- cultural Produce Marketing Committee Act. This act, in effect, prevented the company from sourc- ing from farmers directly. Metro also faced much stronger local opposition, particularly from local retailers, than it had expected. Overall, regulatory uncertainty was the major reason a multinational like Metro struggled in India.

In a similar spirit, more than 300 multinational executives from diverse firms, industries, and host

* Allison F. Kingsley ([email protected]) is Assistant Professor of Management at the University of Vermont School of Business Administration. Richard G. Vanden Bergh ([email protected]) is Associate Professor of Management at the University of Vermont School of Business Administration. Jean-Philippe Bonardi ([email protected]) is Professor at the Faculty of Business and Economics of the University of Lausanne.

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2012 Kingsley, Vanden Bergh, and Banardi 53

countries were asked in July 2011 to assess the salience of political risks in their emerging market investments (World Bank, 2011). Among the re- spondents, 54% rated adverse regulatory change as a political risk of most concem, a significantly more pressing concem than either risk of expro- priation (34%) or risk of war (31%). About one in five executives regarded war (23%) and expropri- ation (18%) risk as having "no impact" on their risk perception; fewer than 1 in 25 regarded reg- ulatory uncertainty as such (3%). Indeed, 35% of multinational companies have experienced finan- cial losses in the past three years due to adverse regulatory changes. In the past 12 months alone, 43% of surveyed multinationals withdrew existing or canceled planned investments due to unfavor- able changes in regulation. To manage ongoing investments with regulatory uncertainty, execu- tives closely monitor the risk (27%) but also find that the most effective strategy relies on engaging with local public entities (10%), local enterprises (14%), or key political leaders (25%). Nonmarket strategies matter to executives. When firms fail to align nonmarket strategies to the regulatory un- certainty they face, struggles like those experi- enced by Metro Cash and Carry in India occur.

Understandably, both market and regulatory un- certainty will vary from one industry or geographic region to the next but are not exclusive to any one industry or region. Thus firms need to develop an understanding of the key factors affecting both types of uncertainty, and from this understanding craft an integrated strategy (Baron, 1995a, 1995b) that min- imizes the costs associated with the regulatory un- certainty while complementing the firm's market investments. Crafting strategy to manage market uncertainty is important and highly developed in the business field. In this paper we focus our analysis on designing nonmarket strategies to manage regulatory uncertainty and discuss ways for firms to integrate this with their market strategy. Our empirical con- text centers on firms' market entry strategies, al- though our analysis can be applied across multiple market strategies.

We propose a practical and novel framework for managers to predict the level of regulatory uncertainty. The framework we develop builds from what are referred to as "political markets," a

term first coined by Nobel laureates in economics James Buchanan and Gordon TuUock (1962) and later applied to the study of firms' nonmarket activities (Bonardi, Hillman, & Keim, 2005). Ac- cording to the framework, political markets con- sist of demanders of public policy such as firms, consumers, and special-interest groups. Demand- ers have a stake in regulatory policy. For example, a firm's stake reflects the incremental effect a regulation will have on profitability, while a con- sumer's stake reflects the effect a regulation will have on the value-to-price ratio of the product. Political markets also consist of suppliers of public policy such as legislators and the executive, regu- lators, and courts. Similar to demanders, suppliers also have interests in regulatory outcomes. Sup- plier interests, in contrast to firms', are assumed to reflect their own ideology and/or the interests of their constituents (Kalt & Zupan, 1984).

Demanders and suppliers interact with each other by exchanging information, votes, and/or other valuable resources. Erom this exchange be- tween demanders and suppliers a regulatory policy emerges; predicting the level of regulatory uncer- tainty, however, remains elusive. Whereas the po- litical market approach has already been used to study firms' ability to influence policy-making, we propose that a similar approach can be used to predict regulatory uncertainty and how firms can manage the regulatory uncertainty through the design of an integrated strategy.

In jointly analyzing political markets and regula- tory uncertainty, we make several meaningful con- tributions. We provide a flexible framework that applies to the range of nonmarket settings by trans- lating the political markets framework developed in more mature and formal institutional settings (e.g., the United States and Westem Europe) to the emerging-market and developing-country context. Specifically, we analyze the supply-side interaction among multiple political actors, including autocratic sovereigns. We also develop new insights into the key characteristics of demand-side interest groups. Eurthermore, we explore how the characteristics of both the demand- and supply-side actors interact with each other to affect the degree of regulatory uncertainty a firm faces.

We offer an innovative perspective on the

54 Academy af Management Perspetiives August

three dimensions of firms' nonmarket strategies, effectively synthesizing several previously dispa- rate nonmarket choices. In addition, we integrate this nonmarket analysis with one of a firm's most critical market strategies: market entry. In show- ing how firms can assess regulatory uncertainty in the context of entering new markets, we contrib- ute to several literatures on market, nonmarket, and integrated strategy. In addition, our insights on nonmarket strategies offer managers clear, ex- ecutable strategies with direct overall performance implications for firms.

The paper is organized as follows. Overall we propose a simple two-by-two framework in two parts. In the "Political Markets and Regulatory Uncer- tainty" section, we develop the first part of the framework, which derives predictions about regula- tory uncertainty. In the 'TSIonmarket Strategies" sec- tion, we propose the second part of the framework, which develops strategic implications for firms to manage regulatory uncertainty in the context of their expected and/or existing market investments. To create an integrated strategy, we suggest the dimensions of a nonmarket strategy that fit well with the characteristics of the political market, that is, activities and tactics in which market decisions such as market entries are aligned with nonmarket ones such as campaign contributions, lobbying, or coali- tion building (Baron, 1995a; de Figueiredo &. Ed- wards, 2007; Hillman & Hitt, 1999). In the "Discus- sion" section, we provide various examples from firms' market entry choices in the global telecom- munications sector that involve different nonmarket strategies; we argue that the observed integrated strategy fits well with our framework. Finally, in the "Gonclusions" section, we discuss our contribution and the critical open questions that need to be addressed to develop a deeper understanding of reg- ulatory uncertainty and the implications for firms as they develop their integrated strategy.

Political Markets and Regulatory Uncertainty

P olitical markets are different from economic markets (Boddewyn &. Brewer, 1994; Bonardi et a l , 2005; Bonardi, 2011; Buchanan & TuU-

ock, 1962; Hillman & Keim, 1995; Weingast & Marshall, 1988). This is why managers pursue market strategies to improve the firm's economic

performance and nonmarket strategies to improve the firm's political performance. For the best over- all firm performance, managers integrate market and nonmarket strategies (Bach &. Allen, 2010; Baron, 1995a, 1995b). In this section of the paper, we focus mainly on the nonmarket environment of business, specifically the political market for regulation, and we analyze a key nonmarket issue confronting managers: regulatory uncertainty.

The magnitude of regulatory uncertainty is critical to the performance of firms in many in- dustries, including oil, natural gas, electric utili- ties, airlines, pharmaceuticals, and telecommuni- cations. Research has shown that heavily regulated (e.g., banking, telecommunications, nu- clear power) and government-dependent (e.g., de- fense) industries necessarily spend the most cor- porate resources managing regulatory uncertainty (Baron, 1995a; Goates, 2011; Grier, Munger, &. Roberts, 1994; Stigler, 1971). However, the re- cent growth of social and environmental interest groups has spread regulatory uncertainty to indus- tries not traditionally considered highly regulated (Holbum & Vanden Bergh, 2008; King & Lenox, 2000). Such uncertainty is difficult for business (Ryan, Swanson, &. Buchholz, 1987), and execut- ing nonmarket strategies is increasingly seen as "the cost of doing business" (Kwak, 2012). That cost derives in part from regulators' leaming curve—their need to learn how to regulate new business models and/or technologies—and from the political games taking place among the various players involved in the regulatory process, such as firms, regulators, politicians, consumers, and in- terest groups (Holbum & Vanden Bergh, 2004, 2008). Whereas authors in the international busi- ness literature typically have focused on the bar- gaining power of multinational firms vis-à-vis lo- cal govemments (Blumentritt & Rehbein, 2008; Lecraw, 1984; Luo & Zhao, in press), we consider here the interactions among a much larger poten- tial set of institutional players.

Managers will find it useful to view regulation in the context of a political market where there are demanders of regulation and suppliers of regu- lation. See Figure 1 for an illustration. As expli- cated in the introduction of this paper, demanders are the regulated firm, other firms, consumer

2012 Kingsley, Vanden Bergh, and Banardi 55

Figure 1 Political Markets, Regulatory Uncertainty, and Integrated Strategy

Rivalry faced by the focal firm on the DEMAND SIDE of the political market (interest groups, activists, other firms)

Political Market Conditions

REGULATORY UNCERTAINTY

Rivalry among public players on the SUPPLY SIDE of the political market (regulators, politicians, courts)

Focal Firm's Integrated Strategy

groups, and other activist interests or stakeholders (Arrow, 1951; Black, 1958; Buchanan & TuUock, 1962); suppliers are the regulator, the executive, legislators, political parties, and courts (Downs, 1957; Riker, 1962; Stigler, 1971). Demanders and suppliers transact by trading regulatory policies for resources such as votes, finances, or information (de Eigueiredo & Edwards, 2007; Hillman & Hitt, 1999). Eirms can be strategic with political market transactions to maximize firm performance.

Indeed, the political market matters for firms. Scholars have shown that the nature of demand- ers can influencé the regulatory process. Eor ex- ample, in the electric utility sector regulators tend to reduce the allowed rates charged to consumers when a competing interest group advocates for consumers within the political market (Bonardi, Holbum, & Vanden Bergh, 2006). Researchers have also shown that the nature of suppliers shapes regulatory outcomes. In the political econ- omy literature, for example, scholars have shown that elected regulators tend to have a negative effect on tiie profitability of firms (Besley &. Coate, 2003). There are thus factors in the polit- ical market that tend to bias regulation in predict- able directions. However, there are also factors that create greater uncertainty for firms subject to regulation over their market investments.

To predict the relative magnitude of regulatory uncertainty, managers must understand their spe- cific political market context, notably the nature of demand-side rivalry and the nature of supply- side rivalry. Drawing from the political markets

literature we focus on two drivers of regulatory uncertainty: political motivation/level of ideology (on the demand side) and level of competition for power among political decision makers (on the supply side). Eurthermore, we argue that this reg- ulatory uncertainty makes political markets less attractive for business investment.

Nature off Demand-Side Rivalry

The political markets literature identifies demanders of regulation as firms in the industry, consumer groups affected by regulatory policy, and other activ- ist interest groups with a stake in the policy outcome (Bonardi et al., 2005; Hardin, 1982; Moe, 1980; Olsen, 1965). Demanders can originate locally or intemationally. In developing-country contexts, ex- ternal or foreign interests tend to assume a larger role, capitalizing on foreign firms' vulnerabilities and/or vocalizing local groups' interests. We exam- ine regulatory uncertainty from the perspective of regulated firms, whereby the focal firm is opposed by either another firm or an interest group representing stakeholders or affected interests. The firm's rival on the demand side is characterized by its motivation for regulatory change, either ideology or efficiency motivations.

Ideology-motivated interests generate the most regulatory uncertainty. Demanders with ideologi- cal agendas are difficult to manage (Bonardi et al., 2006; Bonardi & Keim, 2005) and tend to lever- age public pressure effectively through tactics such as mailings, campaigns, boycotts, reports, and/or advocacy advertising (Baron, 2010; Holbum &

56 Academy oí Management Perspectives August

Vanden Bergh, 2004). Nonmarket issues that have an ideological underpinning also tend to be uniquely partisan and widely salient, which corre- lates with more unattractive political markets (Bonardi et a l , 2006; Bonardi & Keim, 2005). Intensified rivalry among competing demanders makes markets even more unattractive. Research finds that rivalry increases with election issues, concentrated costs or benefits, and attempts to change existing regulation (Bonardi et al., 2005; Bonardi et al., 2006; Bonardi & Keim, 2005; Hill- man &. Hitt, 1999; Lowi, 1964; Wilson, 1980), all of which arguably accompany ideological opposi- tion. In addition, the coalition of voter interests tied to ideology-motivated opponents likely holds more strongly felt preferences with greater indi- vidual stakes, and thus they make more durable opponents than efficiency-motivated interests (Stigler, 1971; Weingast & Marshall, 1988).

Efficiency-motivated interests, by contrast, tend to be associated with narrower issues that are not defined along partisan lines but rather reflect bot- tom-line concerns. With efficiency-motivated ri- vals, the regulated firm is better able to identify rivals and has more substitute actions available to trade, which, in tum, lowers transaction costs of negotiation relative to ideology-motivated rivals (Coase, 1960). Thus, from the regulated firm's perspective, the political market is more attractive (Bonardi et al., 2006) when there is less intense rivalry among demanders (Bonardi et al., 2005; Bonardi et al., 2006; Bonardi & Keim, 2005) and less saliency in the eyes of suppliers. All else being equal, if demand-side rivalry exists, regulatory pol- icy outcomes are more predictable and regulatory uncertainty lower when the rival is an efficiency- motivated interest.

Nature of Supply-Side Rivalry

Suppliers of regulation are the regulator, execu- tive, legislators, political parties, courts, and other institutional decision makers. Previous work has tended to concentrate analysis on select roles. Eor instance, much of the literature on foreign invest- ment and bargaining power focuses on only one aggregate supplier: the host government (Brewer, 1992; Dunning, 1993). In the nonmarket strategy literature, Bonardi et al. (2005) focused on two

types of suppliers, bureaucrats and elected officials; Holbum and Vanden Bergh (2004) and Bonardi et al. (2006) focused on regulatory agencies, rep- resentatives and senators, and executives; and Spiller and Gely (1990) and Spiller and Vanden Bergh (2003) focused on courts. Eollowing this work, we focus on how the regulator supplies regulatory policy jointly with politicians.

Competition among political actors creates a more attractive political market for firms (Anso- labehere, de Eigueiredo, &. Snyder, 2003; Baron, 2001; Bonardi et al., 2006). Eundamentally this is because competitive elections increase rivalry (Bonardi et al., 2006), which makes politicians more willing to trade policy favors (Baron, 2001) and more responsive to satisfying constituent in- terests (Keim & Zeithaml, 1986). As Stigler (1971, p. 13) noted, "If entry into politics is ef- fectively controlled, we should expect one-party dominance to lead that party to solicit requests for protective legislation but to exact a higher price for the legislation." Thus competition among elected politicians creates opportunities for corpo- rate political strategies to work (Hillman &. Keim, 1995; Keim &. Zeithaml, 1986), including in a regulatory setting. We note, however, that in de- veloped countries such political actors are typi- cally elected, whereas in developing countries elections may be less potent or even nonexistent. There are fewer actors, potentially only one piv- otal decision maker, less delegation of power from the executive, and thus signiflcantly less compe- tition. We incorporate this important distinction explicitly in our framework.

Competition may be defined beyond rivalry for power. When competition among political actors is driven also by heterogeneous prefer- ences (Bonardi et a l , 2006; Vanden Bergh &. Holburn, 2007) instead of or in addition to checks and balances, the logic holds: More com- petition creates a more attractive (and oppor- tunistic) political market, which corresponds with less regulatory uncertainty.

The political markets literature uses several empirical measures to capture this idea of compe- tition among political actors. In Bonardi et al. (2006), the degree of supply-side rivalry is opera- tionalized as the margin of winning votes for the

2012 Kingsley, Vanden Bergh, and Banardi 57

executive (governor or president) or the legislator (or party). Rivalry is considered intense if there is a greater than 5% difference between votes. In. Holbum and Vanden Bergh (2012), legislative competitiveness is also measured by the degree of partisan control of the legislature. Rivalry is most intense when political parties hold equal shares of the legislative seats. In addition, a country's gov- emance environment has been measured by the political constraint index (POLCON) compiled by Henisz (2000) and tested successfully against intematiorial infrastructure data (2002) and across a wide range of developed and developing countries. POLCON measures the feasibility of policy change based on a simple spatial model of veto players, party alignment, and preferences across branches of government.^ The index ranges from 0 to 1, with higher scores indicating more political constraints. The more political con- straints there are, the less feasible policy change but the more potential leverage or pivot points. In political markets with no delegation of power from the executive (e.g., autocratic regimes), there are no constraints against the executive. In all measures of political competition, the funda- mental idea remains the same: Competition makes political markets more attractive and less uncertain for the regulated firm.

Predicting Regulatory Policy Uncertainty

I ntegrating these insights on the nature of de-mand-side rivalry and the nature of supply-siderivalry, we can predict regulatory uncertainty. Figure 2 suinmarizes these insights in the first part of our simple two-by-two framework.^

Figure 2 Predicting Regulatory Uncertainty

' POLCON I measures the feasibility of policy change, that is, the extent to which a change in the preferences of any one political actor may lead to a changé in govemment policy. The index is composed from the following information: the number of independent branches of govemment with veto power over policy change, counting the executive and the presence of an effective lower and upper house in the legislature (mote branches leading to more constraint); the extent of party alignment across branches of govemment, measured as the extent to which the same party or coalition of parties controls each branch (decreasing the level of con- straint); and the extent of preference heterogeneity within each legislative branch, measured as legislative fractionalization in the relevant house (increasing constraint for aligned executives, decreasing it for opposed executives).

We recognize that differences among political markets are more aptly represented as continua of competition and ideology.

I

Ideology- Motivated

Opponent(s) I

Efficiency- Motivated

Opponent(s)

Highly Uncerlairi

"NC/E"

Uncertain

uncertain

"C/l"

"C/E"

Least Uncertain

No Competition Competition Among Among

Political Actors Political Actors NATURE OF SUPPLY-SIDE RIVALRY

Using the insights on regulatory uncertainty from Figure 2, we can also make predictions about market entry and implications for investment. If the regulated firm is opposed by an efficiency- motivated interest and there is significant compe- tition among political actors (Cell C/E), there is less uncertainty. We predict that the regulated firm will enter the new market, potentially as a leader (Bonardi et a l , 2005). In hybrid situations (Cell C/I and Cell NC/E), there is moderate reg- ulatory uncertainty, which constrains the firm's entry decision. If the regulated firm is playing a political game with an ideology-motivated oppo- nent in the context of no or little competition among political actors (Cell NC/I), the regulatory outcome is highly uncertain. This uncertainty im- pedes investment, akin to a postpone strategy (Bonardi et al., 2005). The regulated firm is likely to not enter a new market (or further invest in an existing market) if it cannot foresee the value of its investment over time or anticipate opportuni- ties to influence the political market. Generally this results in a net loss for society but may be the best outcome for the individual firm. Accordingly, when considering entry into a new market and when regulatory uncertainty exists, firms have two stark choices: if uncertainty is too great, delay investment, or develop and implement a nonmar- ket strategy that sufficiently mitigates the negative effects of the uncertainty. We now focus our at- tention on the latter.

SB Academy af Management Perspedives August

Nonmarket Strategies

D ifferent types of regulatory uncertainty require different strategies (Bonardi &. Keim, 2005). As uncertainty increases so too does the cost

of implementing a nonmarket strategy. We iden- tify three dimensions previously treated dispa- rately in the literature to guide how a regulated firm should allocate incremental resources to mit- igate uncertainty. The strategies differ in terms of profile level, coalition breadth, and pivotal tar- get—and, ultimately, cost. Variation in firm strat- egies is driven by changes in the nature of both demand-side and supply-side rivalries, and we ar- gue that the demand side explains more of the variation. Eigure 3 summarizes these strategic im- plications for firms.

Profile Level

Corporate political strategies can be divided into low- and high-proflle strategies. Low-profile strat- egies occur without public involvement, whereas high-profile strategies engage the public. High- profile strategies are significantly more costly be- cause the firm needs to invest more in publicity and runs a greater risk of suffering reputational damage.

Using the taxonomy of political strategies iden- tifled in Hillman and Hitt (1999) and further discussed in Hillman (2003) and Bonardi and Keim (2005), low-profile strategies include but are not limited to information strategies such as lobbying, commissioning research projects and re- porting research results, and supplying position papers or technical reports; financial incentive strategies such as honoraria for speaking and paid travel; and constituency-building strategies such as political education programs. High-profile strat- egies can include information strategies such as testifying as an expert witness; financial-incentive strategies such as contributions to politicians and political parties and personal service (hiring peo- ple with political experience or having a firm member run for office); and constituency-building strategies such as grassroots mobilization (of em- ployees, suppliers, and customers), advocacy ad- vertising, public relations, and press conferences.

We can find numerous examples of high-profile

strategies in the literature. They include engaging in public corporate social responsibility programs to signal information to consumers and potential coalition partners (Siegel &. Vitaliano, 2007) as well as other demanders and suppliers, attending to political ties and personal relations between the multinational corporation (MNC) and its host government (evaluated at length in bargaining power and political connection theories); strate- gically increasing political connections between the firm and high-level govemment officials (Blu- mentritt, 2003; Blumentritt & Rehbein, 2008; Dieleman & Boddewyn, 2012; Faccio, 2006; Law- rence, 2010; Luo &. Peng, 1999); and preemptive self-regulation (Bonardi &. Keim, 2005; Maxwell, Lyon, & Hackett, 2000),

Firms tailor the profile of their strategy based on the nature of opposing demand. For example, if the firm is opposed by an ideology-motivated in- terest, it will deploy high-profile political strate- gies that actively engage the public as well as political actors. In cases of extreme regulatory uncertainty (Cell NC/I), the firm will also need low-profile strategies thai go behind the scenes to provide information and financial incentives to key decision makers. With efficiency-motivated opponents, and thus less uncertainty, the firm need pursue only low-profile strategies.

Coalition Breadth

Much work on market strategy centers on the question of corporate scope, whether a firm should integrate vertically and expand horizontally (Por- ter, 1985). For nonmarket strategy, the question of coalition scope can be equally important in deter- mining performance. Managers must evaluate whether to build "horizontal" coalitions among interest groups and stakeholders outside of the flrm's "vertical" chain o: production where more natural coalition partners often reside (Baron, 1995b; Porter, 1985). This vertical rent chain includes factor inputs (employees, suppliers and their employees, capital, communities), the value chain (inbound logistics, operations, outbound lo- gistics, marketing and saies, service, support activ- ities, alliances), channels of distribution (whole- salers, distributors, retailers), and customers (consumers, locked-in customers) (Baron, 1995b).

2012 Kingsley, Vanden Bergh, and Bonardi 59

Figure 3 Nonmarket Strategies

Ci lu g

Q

<

m a u. O lU

oc

Ideology- Motivated

Opponent(s)

Efficiency- Motivated

Opponent(s)

Profile: Low & High

Coalition: Horizontal & Vertical

Pivots': Regulator, Executive,

Legislators, Party Leaders

"NC/E"

Profile: Low

Coalition: Vertical

Pivots': Regulator, Party Leaders

iProfile: High

|Coa//i/on; Horizontal

iP/Vofs; Regulator, Executive, ¡Legislators

"C/I"

"C/E"

Profile: Low

Coalition: Vertical

Pivots: Regulator, Executive,

Legislators

No Competition Among Political Actors

Competition Among Political Actors

NATURE OF SUPPLY-SIDE RIVALRY

*ln extremely uncompetitive contexts (e.g., strong autocracy). Pivots: Executive $$

Horizontal coalitions can include any interest group that wants the same regulatory policy out- come the focal firm seeks.

Our framework helps firms determine the breadth of their nonmarket coalition based on the nature of opposing demand. With ideology-moti- vated opponents, regulated firms must find allies and advocates outside of their conventional coali- tion of business-related groups with aligned inter- ests. This makes horizontal coalitions more costly to implement. With efficiency-motivated oppo- nents, firms pursue less costly vertical coalitions. Situations with the highest uncertainty (Gell NG/I) require both horizontal and vertical coalitions.

Pivotal Target

Based on the political markets' structured models, demanders will invest incremental resources in influencing pivotal institutions or actors (Grose- close, 1996; Groseclose & Snyder, 1996; Holbum & Vanden Bergh, 2004; Krehbiel, 1998, 1999; Snyder, 1991).^ The target of the regulated firm's

•* Because we combine executives and legislatures into one category of "political actors," our framework can be translated from presidential to parliamentary systems or corporatist and pluralist systems as explicated in Hillman and Keim (1995) and Hillman (2003). Specifically, there is an elective affinity between our model and the predictions in the literature on presidential versus parliamentary systems. Presidential systems that are

nonmarket strategy will depend on the relative policy preferences and formal structure of the dif- ferent institutions (de Figueiredo & de Figueiredo, 2002; Hillman & Hitt, 1999; Holbum & Vanden Bergh, 2008; Vanden Bergh &. Holbum, 2007). Following the logic of Holbum and Vanden Bergh (2008) and Vanden Bergh and Holbum (2007), the pivotal political institution or actor is the one that represents, in essence, the swing vote.

In a competitive political environment, the focal firm will tend to allocate greater resources to pivotal legislators/executives to counteract pres- sure brought by opposing ideology-motivated op- ponents. In a less competitive environment, ap- pointed party leaders are pivotal, as they organize the politicians' preferences and constrain rivalry. Targeting party leaders is, however, more expen- sive than targeting legislators and the executive, as parties have ongoing costs of operation and costs of maintaining an organization and compet- ing in elections (Stigler, 1971). Again, the most uncertain or least attractive political market (Gell NG/I) requires regulated firms to allocate signifi- cant resources to comprehensively target multiple political actors (Vanden Bergh &. Holbum, 2007)

explicitly political, more confrontational, and legislator focused will group in Cell C/I, generally, whereas parliamentary systems will group in Cell NC/E due to their executive focus, long-term cost-benefit analysis, and more cooperative sensibility.

60 Academy of Management Perspectives August

(see Eigure 4, which outlines the costs of nonmar- ket strategies). While costly, jointly targeting the regulator, executive, legislators, and party leaders can serve as insurance or a majority protection strategy (Croseclose, 1996; Croseclose & Snyder, 1996). In extreme situations lacking competition (e.g., strong autocracies), the swing vote is the executive, and all resources must be directed to the single pivotal actor.

In sum, the most expensive nonmarket strate- gies are associated with the most uncertain polit- ical markets. Yet without a nonmarket strategy tailored to the level of regulatory uncertainty, a firm will not (or cannot successfully) invest in a new market.

Discussion le illustrate our nonmarket framework by an- 'alyzing several foreign entry decisions by firms operating in the global telecommuni-

cations sector. Our goal is to highlight variation in nonmarket strategy given different political land- scapes. We discuss general strategies used by for- eign investors and specifically address the market entry strategies of firms domiciled in the United States, Malaysia, Italy, and Luxembourg that in- vested in the host markets of India, Thailand, Russia, and the more risky emerging markets. At the end of the section, we discuss where we need to develop a better understanding of regulatory uncertainty, and we provide managers with key takeaways.

Foreign Entrants to Emerging-Market Telecommunications Markets

In global contexts, firms are keen to manage reg- ulatory uncertainty. Arguably, assessing the na- ture of demand-side rivalry and the nature of supply-side rivalry is most critical when entering new geographic markets, where success depends on navigating the new political landscape and where exit strategies are typically more compli- cated. To illustrate how our political markets and regulatory uncertainty framework applies to firms entering foreign markets, we focus on select cases from the telecom sector. In doing so, we keep variation associated with industry type constant, effectively isolating the effect of political markets.

The telecom sector also makes for a strong test of the proposed framework: Civen domestic con- sumption and government oversight of pricing and sector regulation, telecom markets are in- tensely political affairs. The sector also exempli- fies the tensions of entering foreign markets, as telecom investments are characterized by high capital intensity, significant asset specificity, and economies of scale and scope (Williamson, 1985). Our time period also covers the first decade of internationalization, which has been determined through previous research (Holburn &. Zelner, 2010) to be a critical and broadly applicable em- pirical framework.

When a telecom firm evaluates new geographic markets, it aims to predict the level of regulatory uncertainty it will face over the life cycle of its investment. Such uncertainty arises because the regulator can terminate exclusive rights, license new competitors, set new rate structures, change license terms, or intervene in consumer disputes or interconnection arrangements between service providers. To predict the magnitude of the uncer- tainty, the telecom firm anticipates the motiva- tions of its primary opponents and assesses the competitiveness of poli deal actors. Ideology-mo- tivated opponents are often labor unions fighting against job losses, nationalists opposed to foreign ownership of strategic state assets, or local and intemational development groups concerned with universal service requirements. Efficiency-moti- vated opponents tend to be consumers advocating for better service or local and intemational pro- liberalization groups opposed to anticompetitive practices like monopolies or supportive of opening the sector to foreign ownership. Because telecom regulation is jointly supplied by the regulator and other political actors (e.g., executive, legislators), telecom firms can benefit from competition among them. Where regulatory uncertainty ex- ists—due to an ideology-motivated opponent and/or lack of competitiveness of political ac- tors—telecom firms can implement a nonmarket strategy to mitigate the uncertainty or delay in- vestment in the country if uncertainty is too great.

We use information from a subset of telecom entry decisions that took place in 103 emerging markets throughout the 1990s, the first decade of

2012 Kingsley, Vanden Bergh, and Bonardi 61

Figure 4 The Cost off Nonmarket Strategies

E

Ut

o

à < UJ

o

3

Ideology-

Motivated

Opponent(s)

Efficiency-

Motivated

Opponent(s)

Profile: Low & High $S

Coalition: Horizontal & Vertical SS

Pivots': Regulator, Executive, Legislators, Party Leaders SSS

"NC/I"

"NC/E"

Profile: Low $

Coalition: Vertical $

Pivots': Regulator, Party Leaders $ $

; No Competition Among

i Poiiticat Actors

Iproff/e; High $$

lcoa//f/on,- Horizontal $$

IP/Vois,- Regulator, Executive, ¡Legislators $ $

j "C/i" "C/E"

Profile: Low $

Coalition: Vertical $

Pivots: Regulator, Executive, Legislators $$

Competition Among

Poiiticai Actors

i NATURE OF SUPPLY-SiDE RIVALRY

1 *ln extremely uncompetitive | 1 contexts (e,g,, strong | ; autocracy). Pivots: Executive $$ ;

internationalization in the telecom sector. Ana- lyzing cases during this time frame provides spe- cific insight into how firms integrate market and nonmarket strategy under extreme information constraints and in the process of new market openings. In the 1990s, 65 of the 103 countries experienced positive entry decisions by foreign firms into the country's telecom sector. In the other 38 countries, either the sector did not open to new entrants (e.g., China) or telecom firms chose to postpone investing (e.g., Colombia in 1992, Pakistan in 1996, Slovakia in 1999).

Eoreign investors strategically assessed their en- try options, specifically how well integrated strat- egies might work and thus which ones to employ. Eor instance, of the 597 individual foreign invest- ments, 39.5% used traditional vertical coalitions that involved foreign equity partners (49.8% of investors), intemational banks (29.2% of inves- tors), or joint ventures with locals or the govem- ment (14.9% of investors); 19.1% used more costly horizontal coalition strategies that involved home govemments through bilateral investment treaties (30.2% of investors), intemational orga- nizations and multilateral institutions such as the World Trade Organization General Agreement on Trade in Services (11.2% of investors), or the World Bank's Intemational Centre for the Settle- ment of Investment Disputes (15.9% of inves- tors). These findings align with the World Bank's

executive survey data discussed in our introduc- tion, thus suggesting that these telecom data are a reasonable candidate to illustrate the general im- plications of our framework without sacrificing external validity.

To further assess the applicability of our regu- latory uncertainty framework and control for the role of market strategy, we discuss three cases in relatively similar market contexts: Thailand, Rus- sia, and India in the mid-1990s (see Eigure 5). In each of these settings, the competitiveness of po- litical actors and the nature of opposing demand vary, thereby illustrating the key dimensions of our framework. Using the political constraint in- dex as our proxy for the competitiveness among political actors (Henisz, 2000), we see that both Thailand (0.56 out of 1.00) and India (0.57 out of 1.00) demonstrated more political constraints and thus more competition among politicians. Russia, by contrast, had a materially lower score of 0.15, suggesting that its political markets were less at- tractive. In terms of ideological political opposi- tion. Thai labor unions campaigned against for- eign investment in the sector, citing loss of jobs and depressed wages. Both Russia's and India's foreign investment opportunities were opposed predominantly by efficiency-motivated pro-liber- alization groups who fought against the lack of transparency and "worst" practices in the licens- ing and privatization process.

62 Academy of Management Perspectives August

Figure 5 Indicative Empirical Cases

DC

<

E UJ

M

à Z

UJ

o o UJ DC

H

Z

Ideology- Motivated

Opponent(s)

Efficiency- Motivated

Opponent(s)

Millicom, Multiple Countries 199O's

" N C / r

"NC/E"

Telecom Italia, Russia 1995

No Competition Among

Political Actors

Samart, Thailand

1997

"C/l"

"C/E"

US West,

India 1995

Competition Among

Political Actors NATURE OF SUPPLY-SIDE RIVALRY

India in the mid-1990s (Cell C/E) experienced significant competition among elected politicians, with preferences and control shifting often. US West, an American Baby Bell, entered the Indian market in 1995 by acquiring five licenses, most notably a 10-year pilot license to set up India's first private telephone network for basic phone services. The company pursued a baseline low- profile strategy of working with the Indian regu- lator almost exclusively. This involved informal bidding for licenses (often ahead of public ten- ders) in an attempt to manage opposition from increasingly vocal pro-liberalization groups, in- cluding key competitors such as NYNEX and Re- liance (Pyramid Telecom, 1995a). To secure li- censes and counter the efficiency opponents, US West also structured a vertical coalition that in- cluded its proposed equipment suppliers and the Cellular Operators Association.

In Russia in 1995 (Cell NC/E) politics were less competitive than in India, increasing uncer- tainty for foreign telecommunications firms. Much of the opposition to foreign investment was from media and business communities who were opposed to cozy sales lacking in transparency and efficiency. Investors generally used baseline low- proflle, vertical-coalition strategies as in India, but their political targets were the party and not the regulator, which was weak in the face of regime transition and liberalization. Indeed, Telecom Ita- lia found that investing in Russia required exten- sive and quiet backroom negotiations with party

insiders. In the privatization of Russia's state- owned local telecommunications firm, Svyazin- vest, foreign telecom investors such as Telecom Italia were "careful not to arouse Russian sensibil- ities by demanding 'control'" and often portrayed themselves "as a partner in Russia's development," all the while negotiating with key political elites and oligarchs (Pyramid Telecom, 1995b).

In Thailand (Cell C/I), the political environ- ment was different. Despite ideological opposition from labor and trade unions that feared job losses as the sector liberalized and state-owned enter- prises privatized (Pyramid Telecom, 1995a), Ma- laysian company Samart entered the Thai cellular market in 1997. The company strategically joined forces with the state-owned Thai Telecom. It pur- sued high-profile targeting of elected politicians in the Thai government and tried to leverage a hor- izontal coalition with the WTO, the IMF, and its home govemment. In the wake of the 1997 Asian financial crisis, the WTO and IMF had stepped in to advocate for both government austerity and liberalization. While not necessarily a natural partner for a Malaysian operator, the WTO's lib- eralization deadline and IMF's privatization de- mand as a condition for financial aid played into Samart's desire to manage regulatory uncertainty and enter the Thai market. Samart also rolled out high-profile advertisements aimed at the Thai public that advocated for privatization and foreign ownership. Indeed, many telecommunications flrms in the Thai market employed high-profile strategies: One firm put out explicit ads discussing how its acquisition would not change labor wages; another aired an advertisement claiming that its competitor's handset was a health hazard.

One particular firm based in Luxembourg was especially opportunistic and entrepreneurial in emerging-market telecom deals. Millicom Inter- national Cellular was a niche player in global telecom investing and proved the second most proliflc dealmaker in the 1990s. It pursued high- risk opportunities in smaller markets with more uncertain growth potential. By 1996, Millicom had amassed 29 cellular licenses in 30 countries covering 375 million people in Asia, Eastern Eu- rope, and Africa. Most of Millicom's investments

2012 Kingsley, Vanden Bergh, and Banardi 63

occurred (and continue to occur) in unattractive political markets (Standard &. Poor's, 1996).

To manage the regulatory uncertainty that comes with ideological opponents and the lack of competition among political actors (Cell NC/I), Millicom negotiated "lucrative deals behind closed doors, relying on the ability of its local managers to navigate Byzantine regional bureau- cracies and form lucrative partnerships with lead- ing local business interests" and telephone author- ities (Pyramid Telecom, 1996, p. 2). During its issuance of senior subordinate debt, even the rating agencies noted this nonmarket strategy: "Millicom's strategy is to develop mobile oper- ations by finding a local partner with local knowledge, expertise, and contacts to assist with legal and regulatory issues, such as obtain- ing licenses and organizing interconnection agreements with other market participants" (Standard & Poor's, 2004, p. 3). This is funda- mentally a low-profile vertical coalition target- ing the regulator. But Millicom also actively advertises its benefits to local consumers. Al- though Millicom charges high handset and monthly service charges, its service and cover- age benefits the consumer base, and Millicom publicizes this to engender greater support. Mil- licom also engages local partners and regional managers to assist with party and politician relations.

Conclusions

Properly assessing a firm's exposure to regulatoryuncertainty helps managers craft an appropri-ate integrated strategy. Our article suggests two primary drivers of regulatory uncertainty for firms: ideology-motivated interests opposed to the firm and a lack of competition for power among polit- ical actors such as executives and legislators. Be- cause managers would like to devise the most economical strategy to manage regulatory uncer- tainty, we identify three dimensions of nonmarket strategy—profile level, coalition breadth, and piv- otal target—to distinguish how a regulated firm allocates incremental resources beyond a basic low-profile strategy that engages the regulator and the firm's vertical coalition. We argue and find anecdotal evidence that managers use high-profile

strategies and recruit horizontal coalition partners to manage ideological opponents. Managers also target their strategy at the pivotal swing voter— the regulator, the party, the legislators, or the executive. In cases of extreme uncertainty, man- agers pursue a multifaceted nonmarket strategy.

While we derive our two-by-two framework from diverse, established literatures in political science, economics, and management, this study raises a number of questions that will need to be addressed in subsequent work. For example, we are somewhat agnostic about the relative effect of changes in demand-side rivalry versus changes in supply-side rivalry. Our matrix implies that changes in demand-side rivalry have a greater effect on the cost of nonmarket strategy, but why this is remains incompletely understood. In addi- tion, this piece has been silent about the nature of the regulator. Previous research has shown that appointed regulators create more attractive polit- ical markets for firms, and that knowing the reg- ulator's preferences relative to elected politicians and the regulated firm matters (Holbum & Vanden Bergh, 2008). We plan an extension of the current framework that conceptualizes the na- ture of the regulator more precisely and identifies how a change in the key characteristics of the regulator changes the level of regulatory uncer- tainty and firms' nonmarket strategies. We also aim to test the robustness of the theoretical frame- work to different empirical settings, including those with direct performance data.

This paper nonetheless makes important con- tributions to firms' understanding of integrated strategy. First, we provide a flexible framework that applies to a range of nonmarket settings. We translate the political markets framework devel- oped in more mature and formal institutional set- tings to incorporate the emerging-market and de- veloping-country context. In doing so, we differentiate ourselves from the traditional U.S./ Eurocentric political markets literature and ad- vance the theory. Specifically, we analyze the supply-side interaction among multiple political actors and decision makers, not just a select group of (elected) regulators and legislators. Our char- acterization of the supply side in our framework can also accommodate extremely uncompetitive

64 Academy of Management Perspectives August

political markets situations, notably an autocratic sovereign. Further, we unpack the nature of op- posing demand by providing a new categorization of interest groups based on motivation.

Second, much of the literature discussed in this article recognizes the importance of adjusting po- litical strategy as political uncertainty increases (e.g., Dieleman & Boddewyn, 2012; Hillman, 2003). Our research complements this literature by creating a framework that predicts when regu- latory uncertainty is likely to be greater for a firm. We accomplish this by focusing on how the key demand- and supply-side characteristics interact with each other to create regulatory uncertainty. How this interaction leads to predictions about the degree of uncertainty has not been explored in the nonmarket strategy literature that analyzes firms operating in different political contexts (e.g., Dieleman & Boddewyn, 2012; Hillman, 2003; Lawrence, 2010; Luo & Peng, 1999).

Third, we empirically pair this novel nonmar- ket analysis with one of a firm's most critical market strategies: market entry. In showing how firms can assess regulatory uncertainty in the con- text of entering new markets, we contribute to the literature on integrated strategy and, separately, offer an innovation to bargaining power theory. The latter argues that an MNG entering a new country has stronger bargaining power to the ex- tent that it has, for instance, technology, jobs, and political ties (Blumentritt, 2003; Blumentritt &. Rehbein, 2008; Dieleman &. Boddewyn, 2012; Lawrence, 2010). We build our framework from a similar insight that firms negotiate for the supply of public policy with host govemments, but we simultaneously focus on the institutional con- straints to firms' bargaining power and the other parties in the negotiation network in addition to the host government. We also provide clarifica- tion on when and how certain firm resources, such as political ties, matter and affect firms' market strategies.

Thus we are able to complement existing in- sights (e.g., Blumentritt, 2003) by explaining why and when we see MNGs employing different in- tegrated strategies as they enter different political markets. While this insight can be viewed as con- sistent with existing literature (e.g., Hillman,

2003), we also extend these insights by being able to explain why different firms, operating within the same country, employ different integrated strategies. The key characteristics of demanders and/or suppliers, within a given political jurisdic- tion, can vary across firms. Finally, our insights extend beyond market entry and can be applied to other market strategies, such as market consolidation.

Taken together, our nonmarket framework pro- vides managers with clear insights on regulatory uncertainty: Uncertainty is higher in political markets characterized by ideologically motivated opponents and less competition among suppliers of policy. From this assessment, we equip manag- ers with three discrete nonmarket strategy choices to execute alongside market entry or other market strategies. Synthesizing profile level, coalition depth, and pivotal actor, we advance previously distinct strategy arguments. Thus our insights from regulatory uncertainty yield meaningful im- plications for firms' integrated strategy and thus performance.

Acknowledgments

The authors would like to acknowledge helpful comments received from the editor and two anonymous reviewers on earlier versions of this article and from participants at the 2011 Strategic Management Society and 2012 Academy of Intemational Business annual meetings.

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Appendix 1

World Bonk (2011) Executives Survey

The survey was conducted on behalf of the World Bank's Multilateral Investment Guarantee Agency by the Econo- mist Intelligence Unit. It contains the responses of 316 senior executives (146 chief-level) at multinational enter- prises investing in developing countries. The geographic distribution of the respondents is Asia 62, North America 87, Europe 135, and the rest of world 32. The survey in- cludes 186 organizations with revenue over $500 million in the following industries (number of executives in parenthe- ses): primary (26), manufacturing (80), services (110), fi- nance (77), utilities/transportation/storage/communications (23). Quota sampling was used to ensure that the industry and geographic composition of the survey sample approxi- mated the composition of actual foreign direct investment outflows to developing countries. We used the following survey questions in this paper.

Question lOo. In your opinion, which types of political risk are of most concem to your company when investing in emerg- ing markets? Select up to three. Transfer and convertibility restrictions, breach of contract, non-honoring of govem- ment guarantees, expropriation/nationalization, adverse reg- ulatory changes, war, terrorism, civil disturbance.

Question 11. In your opinion, in the developing countries where your firm invests presently, how do each of the risks listed below affect your company? Rate each risk on a scale of 1-5 where 1 = Very high impact and 5 = No impact. Transfer and convertibility restrictions, breach of contract, non-honoring of govemment guarantees, expropriation/na- tionalization, adverse regulatory changes, war, terrorism, civil disturbance.

2012 Kingsley, Vanden Bergh, and Bonardi 67

Question 12. In the past 3 years has your company experienced financial losses due to any of the following risks? Select all that apply. Transfer and convertibility restrictions, breach of contract, non-honoring of govemment guarantees, expro- priation/nationalization, adverse regulatory changes, war, terrorism, civil disturbance.

Question 13. To your knowledge, have any of the following risks caused your company to withdraw an existing invest- ment or cancel planned investments over the past 12 months? Select one answer for each risk (see question 12). Withdraw existing investment, cancel planned invest-

ments, both withdraw and cancel, neither withdraw nor cancel, don't know.

Question 15. In your opinion, in the countries where your company invests, what are the most effective tools/mech- anisms available to your firm for alleviating each of the following risks? Select one tool for each risk (see question 12). Engage with local public entities, joint venture with local enterprises, risk analysis/monitor, relationships with key political leaders, political risk insurance, risk insig- nificant for projects, no existing tool can alleviate this risk.

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