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Olli Rusanen

By Olli Rusanen

The spaghetti-model of retail regulation

The Finnish retail industry is in a horrible shape. The market is arguably duopolistic – the total market share of the two largest retailers exceeds 80%. News frequently tells Finns the perils of our top retailers: grocers are creating welfare losses to society: prices are higher, quality is lower and the product variety is incorrect. Retail is to blame for global warming and a variety of social issues: our youth hang around in shopping malls rather than spending their time in productive pursuits such as doing homework; retailers make alcohol available for our society. Retailers are to blame for urbanization: ever-larger out-of-town stores are opened in metropolitan areas, forcing people to move into city areas. Hypermarkets are displacing local mum-and-pop grocery stores. Days are spent in cars driving to shopping malls rather than with families – luckily we can grab a greasy burger from McDonald’s on the way back, since we don’t have time to cook a healthy meal for our family. Top retailers have direct political connections with municipalities, where they plot and plot in order to gain an extra buck at the expense of poor customers. Retailers are creating only low-level jobs and they cannot help us in the middle of recession, unlike heavy industries that are actually producing real products. Someone has to do something about this, right? And someone has.

Just mentioning the central pieces of regulation, the Finnish government has changed multiple laws in order to prevent the horrors of those devilish retailers. We have strict alcohol and medicine regulation; store planning has been tightened three times during the last fifteen years; store opening times are heavily regulated in order to protect both small stores and workers’ rights. Recently, the government has attempted to change competition law in order to intervene with the top grocers’ duopoly. Surely we should support this favourable progress in tightening regulation?

Well, not necessarily. In this post, I will demonstrate that Finnish retail regulation is actually inflicting many of the problems mentioned above, while failing to deliver most of the intended goals. Also, retailers are blamed for issues that have nothing to do with retail. Sub-optimization and unintended consequences – those are two concepts that summarize pretty well the state of Finnish retail regulation. Well-meaning politicians are creating unworkable laws at the expense of industry and society. We just need to add multiple rounds of regulation changes over two decades and heat it up and we have our meal ready: welcome to the world of spaghetti-regulation!

Planning regulation has received a lot of attention and three rounds of tightening legal changes. I will focus on the large unit limit which was introduced over a decade ago. All stores over 2 000 square metres (approx. 21 500 sq. ft.) are considered as ‘large units’ and are more heavily regulated than smaller stores. Stores or shopping centres which are likely to have a region-level impact or promote inter-municipality competition are subject to added scrutiny. In the last decade, there have been multiple large shopping centre projects with the largest shopping centre exceeding 110 000 square metres (approx. 1 200 000 sq. ft.). Some of these projects became highly contested in the media, given that they were located in small towns. These shopping centres (especially Ideapark) clearly targeted customers from other towns and favoured car-based shopping. Additionally, they were exploiting legislative loopholes in order to secure these locations which were clearly against the spirit of the existing law. Planning regulation attempts to salvage city centres; protect smaller retailers (and/or smaller units); reduce environmental toll; and protect minorities. In practice, this intention means that Ideapark-styled projects are to be prevented and out-of-town hypermarkets will become exceptions. The idea is to move retailers into city centres where they can be easily accessed through public transport, by biking or walking. The intention is admirable but there are many unintended problems that have emerged and it is unlikely that the law will reach these goals.

From a competitive perspective, the planning legislation and related municipal-level regulatory practice is problematic. Firstly, by adding obstacles to the planning of large units, the existing hypermarkets become harder to imitate. This is one of the VRIN/O (valuable, rare, inimitable and nonsubstitutable + organization) conditions for sustainable competitive advantage of the resource-based view. Indeed, large unit regulation favours only the two large retailers that already have hypermarkets and works as an effective barrier to market entry in Finland.

Secondly, it is not only large units that have become regulated, since small units are subject to heavy regulatory process too. Lidl had an intriguing entry to the Finnish market in 2002. Depending on criterion, it took Lidl 6-8 years to build a profitable store network (122-133 stores). In the process, Lidl had cumulative nominal net loss of 70 million euros. Lidl’s stores are below the large unit size, but still the municipalities’ regulatory practice is in many cases arbitrary, time-consuming and costly. Some municipalities clearly favoured Lidl’s stores and attempted to speed the process of Lidl’s entry, while others attempted to prevent it. Agency is a source of arbitrariness to the planning process due to municipal gatekeepers – especially for entrants with de-legitimacy. The legislative entry barrier due to planning regulation has received criticism from the Competitive Commission also.

Thirdly, existing retailers have created coping-capabilities in order to continue current practices despite regulatory pressure. Existing retailers are able to cope with this regulatory practice since they already have legitimacy and they have learned to avoid obvious mistakes. It seems that these coping-capabilities are routine-based. As a result, the number of large supermarkets, hypermarkets and large shopping centres has continued to increase, despite the tightening of planning regulation. This is another form of entry barrier since new retailers lack such country-specific routine. For example, Lidl completely lacked legitimacy upon market entry, which is especially evident from massive non-market attack in the public media. Additionally, Lidl’s store acquisition is characterized by a gradual ‘learning-by-doing’ process which enabled Lidl gradually to secure locations also in less-enthusiastic municipalities.

In addition to at least partially causing market concentration through resource inimitability, entry barrier and coping capabilities, planning regulation is also problematic from a customer perspective. Nowadays the role of services is gaining attraction. Servitization is especially evident in large units and shopping centres: in addition to buying a physical product, one can also visit restaurants and consume other services. Planning regulation is clearly designed with the idea that retail is an industry for selling physical products. Thus, we are guided to move our business into smaller no-frills stores, which suffer from lack of space for complementary services.

I am not an environmental engineer. Thus, I will not comment on details of emissions caused by retail. However, I will briefly evaluate which issues are discussed both in the media and in the Environment Ministry’s report, and which issues are ignored in decision-making. It is striking to notice that retail regulation is justified solely on private transportation emissions. However, there are other issues which are not considered at all. Retail logistics has developed considerably since the 1970s. Through a combination of new technological solutions and movement into larger and more efficient stores, retailers have managed to increase the efficiency of logistics. This can be measured in many ways – for example, inventory turnover. Essentially, there are fewer inventories on the shelves or in distribution centres and unnecessary transportation has continued to be eliminated. No-one knows exactly the effect of intervening in this optimization behaviour in logistics. Additionally, smaller stores cannot utilize servitization to its full potential, so the consumption of emission-free service is interfered with. It seems that public officials are naively optimistic that customers will change their shopping patterns to support their planned intention. Movement into smaller unit size might mean consumption in multiple locations to satisfy the need for product and service variety – at least in some segments. Additionally, a less dense hypermarket portfolio means for some segments just greater driving distances – contrary to the view held in the environment ministry, where it is assumed that people will switch from cars to public transportation, biking or walking. To summarize, the Environment Ministry’s report has a narrow understanding about different customer segments. Customers are understood essentially as a homogeneous mass which is fluid to conform to planned intentions.

An interesting question has received only limited attention: is Finland able to develop internationally competitive concepts? I am not entirely prepared to answer this, but perhaps I can map some directions for future research. Regulated industries and economies are not known for their innovative abilities. In fact, Ideapark was a new concept in many ways, and its expansion was eventually prevented, so we have at least one example of hindered concept development. Furthermore, many internationally successful concepts (for example, Walmart Supercenter, Ikea or even H&M) are clearly larger than the large unit size (2 000 square metres). Sorry, Mr. Kamprad, but your new polluting car-based concept is clearly just another example of the recent trend into American-styled retailing, so it is unwelcome here. Clearly, such stores cannot be a source for economic growth, right? While I am a strong advocate for ‘born global’, still the usual approach is that firms innovate domestically and then export these innovations abroad. In the latter form, there is a grave risk that the innovations are dependent on a specific regulatory environment. Indeed, Finland has not been able to produce globally competitive retail innovations even if the concepts are successful in the domestic regulated economy. Hopefully Stockmann will prove me wrong. Nevertheless, it would be interesting to compare for example Swedish and Finnish institutional environments and their effects on retailers’ innovative abilities.

Opening times is an interesting form of regulation that has been deregulated during the last decades. In the 1990s, kiosk and gas station opening times were relaxed. Also, larger units have gradually been allowed to be open for longer. In my view, the essential rationale in opening times regulation is (a) to protect smaller units and family-owned stores and (b) to protect working conditions. Nielsen’s reports show a decreasing trend in small units so if the law has had any effect, it is has not been enough. Given their minor role, one can question how feasible the protection of this endangered species is in the current situation. The opening times regulation does have its role in distorting competition. This is evident in the case of ABC which is owned by S-group, the largest retailer in Finland. ABC is an interesting concept: it combines a gas station, a supermarket and a restaurant. Larger ABC’s are usually located out-of-town near highways. In some instances they are complementary with large shopping centres. ABC clearly leverages servitization and is a fresh, innovative idea from Finnish retail. While not being solely dependent on regulation, it clearly benefits from regulatory loopholes: first, ABC is subject to gas station opening times regulation, being the only supermarket chain with flexible opening times; second, ABC has been able to grow organically at a remarkably fast rate and to out-of-town locations that are clearly against the objectives of planning regulation. I would argue that ABC enjoys a state-protected competitive edge. Again this is an interesting case that demonstrates the unintended consequences caused by the current state of regulation.

In Finnish retail, workers’ rights are quite well protected. There are multiple regulatory components and agreements between the labour union and employers’ association that ensure this. There is ample evidence that even Lidl has adapted due to the institutional pressures: for example, nowadays Lidl’s conflict rate is similar to other retailers in Finland. Generally binding collective agreement ensures that full-time workers receive adequate salary (1 600 – 2 300 euros per month). Retail is also a major employer in Finland. All of these jobs are real, high-quality jobs. Shouldn’t retail be considered as a real industry that actually matters in the Finnish economy? Why then does retail enjoy such a second-class citizen status when compared with ‘real’ industries such as ICT, paper & pulp or, for example, ship building? Certainly these industries are producing new products and are competitive industries globally, but service industries matter too. Additionally, modern retailing ensures that a considerable part of globally produced goods’ value stays in Finland – especially due to modern logistics and vertical integration of the value chain.

Planning, opening times, and employment regulation are not the only major regulatory elements in Finnish retail. Alko is a state-owned alcohol monopoly. There is some early evidence that Alko’s expansion is related to the market share of grocers. Additionally, it seems that Alko stores are usually located close by to S- or K-group’s stores. This is rather problematic, given that Alko is a complementary store type that adds sales of adjacent retail units from 6% to 15% – a considerable competitive edge. This is a feedback loop: strong retailers keep on getting stronger while smaller retailers such as Lidl and Suomen Lähikauppa suffer from a disadvantaged position.

I set out to write about the unintended consequences of retail regulation. These are caused by a mixture of law and practice. Some of these laws have lost their original meaning; some are compromises formed over time; and some are recently renewed. A common element of all of these laws is that they are formed narrowly based on a handful of criterion, and are sometimes even contested by other ministries. Such a sub-optimal approach to regulation has caused a serious mess – spaghetti – where no-one can actually determine the exact consequences and outcomes of regulation. Taken together, these laws and regulatory practices are at least partly responsible for causing many of the problems that they intend to solve. In other issues, they fail to have reasonable effect. Some regulation, such as workers’ protection, seems to be reaching its goals. However, the central pieces of regulation do not: some formats are exploiting regulatory loopholes; hypermarket-strategy has become harder to imitate; there are considerable exit barriers; and, finally, a complementary Alko-operation feedback loop provides support for the strongest.

How does the recent proposal to change grocery retailers’ competitive legislation fit with the above line of reasoning? I am not yet able to give a straight answer. The proposal for competitive law change means that, in practice, S- and K-group are considered to be in a dominant position. The effects of this legal change are contested but, in practice, the Competitive Commission will gain more authority. As a researcher, I am in favour of added transparency and reporting duties. However, I am not confident that publicly discussed ideas, such as intervention with customer cards, will have the desired effect. Unfortunately, the root causes of market concentration have not been subject to rigorous analysis by public offices. Is it possible to fight regulation-caused problems by further tightening regulation? Perhaps the desirable path can be found from de-regulation, rather than re-regulation.

Maybe we should start to consider Finnish regulation as a cause of market concentration, and not the solution to it. Indeed, when competition is being restricted, the rule of thumb is that competition becomes less fierce.

All of the above claims are rooted either in theories, published reports, or interviews; I did not double-check the data and most claims need to be triangulated. The intention of this post is to open up discussion among researchers and map future lines of research.

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