The Rise of Private Regulation in Global Commerce
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Social Impact Policy Feb 3, 2014

The Rise of Private Regulation in Global Commerce

Here’s how business leaders can address the resulting risks

Yevgenia Nayberg

On April 24, 2013 an eight-story garment factory building in Bangladesh collapsed, killing more than 1,100 workers, most of whom were women. The tragedy came just months after 112 workers lost their lives due to a fire at another Bangladesh garment factory.

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In both cases, building safety and fire standards were sorely lacking, leading to global outrage fanned by extensive media coverage. Advocacy groups used coordinated campaigns to call for independent inspections of Bangladesh factories and pressure large Western garment buyers—mostly retailers such as Gap, Walmart, and Swedish fashion retailer H&M, but also Disney—into paying for needed safety improvements. In response to the pressure, some companies, such as H&M, committed to improving safety standards, while others, such as Disney, withdrew their accounts from Bangladesh altogether.

The fallout from Rana Plaza is not an isolated case. This year Apple and its main manufacturing contractor, Foxconn, agreed to improve labor conditions in Chinese factories. This decision followed months of controversy regarding alleged illegal overtime and poor-quality housing for workers, as well as a string of reported suicides.

These instances illustrate a broader, more important phenomenon: the rise of private politics in global commerce. Private politics refers to actions by private stakeholders, such as activists and NGOs, that harness public sentiment to target private agents, typically companies. This new reality creates complex challenges for business leaders. Of course, business activity has always been both enabled and constrained by formal and informal norms and regulations. These “rules of the game” vary across countries, are subject to change, and significantly affect competitive positioning, as well as the profitability of companies and entire industries.

Traditionally, such rules are determined by public entities such as legislatures, executive agencies, courts, and the like. But the rise of private politics has introduced new options for the regulation of global commerce.

Three Factors Have Transformed the Global Business Landscape

Until recently, many multinational companies conducted business with little fear that they might be held directly accountable for their global network of vendors and suppliers. The public typically had little visibility into a corporation’s far-flung operations, and when a disruptive event occurred, news might never reach consumers in other markets. In the past few years, however, three key developments have combined to present executives with a host of new challenges.

1. The dramatic rise in media coverage (both traditional and social). Companies now live in an ever-faster news cycle, driven by intense competition between 24-hour news channels, wire services, and online news providers. Even an isolated incident or concerns over business practices in distant areas of the world can go viral in minutes. Activists are well positioned to take advantage of this dynamic and have become increasingly adept at using social media to disseminate information and organize protests against companies.

2. The globalization of supply chains. As executives have sought to reduce costs and improve efficiency by working with foreign providers, the ability of individual governments to regulate commerce has fallen. Absent an international governing body, each country has implemented its own laws and guidelines, resulting in a regulatory patchwork that can vary dramatically between developed and emerging nations.

3. A change in values and expectations. In years past, companies could fulfill their obligation to shareholders and society simply by maximizing profits while complying with local laws. In today’s business climate, the baseline is much higher. Modern consumers and the public—particularly members of the younger generations—expect companies to not only do no harm but also have a positive social impact in a range of areas, from animal welfare to sustainable business practices. Activists and NGOs now view companies as the main engine of social and political change. (For more on how changing expectations might affect the strategies of activist stakeholders and NGOs, read Brayden King’s article, “Can Private Politics Effectively Replace Government Regulation?”)

The Shifting Role of Public Politics

The impetus for change to regulatory regimes frequently originates with concerned citizens motivated by social or ethical concerns, such as safety issues for garment workers. Traditionally, concerned citizens have used public institutions such as legislatures, executive agencies, and courts to advance their agenda.

“Companies were more responsive to public opinion than certain legislatures were. We felt we could create more democracy in the marketplace than in the government.”

The Rana Plaza tragedy illustrates how dramatically the regulatory environment has changed. Public institutions—that is, Western governments or the United Nations—played virtually no role in the case of Bangladesh. Rather, companies changed their business practices in response to activist pressure and hostile media coverage. (To read about the contrasting North American and European responses to—and the legal risks presented by—the Rana Plaza tragedy, see Caroline Kaeb’s article, “Going Beyond the Letter of the Law: Lessons from Europe on Corporate Accountability.”)

These developments are not unusual. In recent years many activists have concluded that public processes respond too slowly and can be blocked too easily by special interests. In response, they have turned to private politics instead to address key issues such as environmental protection, human rights, discrimination, privacy, safety of employees and customers, endangered species, and animal-welfare testing. As Michael Brune, executive director of the Rainforest Action Network, a leading global activist group, commented, “Companies were more responsive to public opinion than certain legislatures were. We felt we could create more democracy in the marketplace than in the government.”

How Companies Can Address the Risks of Private Politics

In such a fluid environment, companies may be tempted to monitor events and assume a reactive stance. However, given the potential volatility of a single event—and its potential to upend current business strategies—executives are better served by taking concrete actions to mitigate the risk from private politics and resolve emerging issues preemptively.

Be proactive. In private politics, the explicit or implicit goal of activists is the corporation’s voluntary adoption of rules that constrain company conduct without the involvement of public agents. Rather than waiting for activists and NGOs to set the ground rules, companies can get in front of potential issues by implementing self-imposed guidelines. Walmart, for example, has transformed its supplier base—and by extension entire industries—by embracing sustainable practices throughout the supply chains. Such proactive measures need to be commensurate with the company’s risk profile and its competitive positioning in the marketplace. A common activist strategy is to target a specific, high-profile company through a corporate campaign. Good targets are companies that generate extensive media coverage, which may lead to public outrage. Executives must assess such reputational risk and take proactive steps.

Consider industry-wide solutions. The rise of private politics does not only affect isolated companies. Often activists attempt to regulate entire industries, as in the case of global retailers after the Rana Plaza disaster. To address these efforts, companies should consider implementing industry-wide codes of conduct, which avoid imposing competitive disadvantages for isolated companies and ensure a level playing field. Often, NGOs can play an important role in designing and implementing such private standards.

Reassess supply-chain risk. As these recent high-profile examples of supplier failures demonstrate, companies are now held accountable for the actions of vendors throughout their supply chain. Executives can ill afford to wait until disaster ensues to reexamine their supplier base. The reputational risk associated with supply chains must be incorporated into the design and monitoring of supply-chain operations. Companies should conduct regular vendor reviews and confirm that suppliers meet or exceed all applicable workforce, safety, and environmental regulations. (For more on eliminating supply-chain risks, read Sunil Chopra’s article, “Protect Your Global Supply Chain from Costly Disruptions.”)

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As with any form of regulation, private regulation can burden companies, their suppliers, and customers; but it can also provide opportunities and at least partial solutions to social problems that otherwise would remain unaddressed. In a world of expanded media coverage, globalization, and the public’s rising expectations of companies, private regulation will only grow. Executives need to be ready for this challenge; simply ignoring this phenomenon will not make it go away.

Editor’s Note: For more insights from Daniel Diermeier, check out the upcoming Kellogg School / Aspen Institute Business and Society Leadership Summit.

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Faculty member in the Department of Managerial Economics & Decision Sciences until 2014

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