The Impact of Regulation on SME Performance-UK-2008

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The Impact of Regulation onSmall Business Performance

Report for the Enterprise Directorate of BERR

by

Small Business Research CentreKingston University

Kingston HillKingston upon Thames

Surrey KT2 7LBTel: 020 8547 7247Fax: 020 8547 7140

Email: [email protected]

April 2008

URN 08/806


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CONTENTS

Page

Executive Summary i

PART ONE: INTRODUCTION 1Chapter 1:Introduction andResearch Objectives 21.1.Background and Aims 21.2.Defining Regulation 31.3.Defining Business Performance and Growth 51.4.Research and Policy Context 51.5.A New Approach to Studying the Impact of Regulation on

Small Business Performance6

1.6.Structure of the Report 7

Chapter 2: Explaining the Impact of Regulation on BusinessPerformance

8

2.1. Introduction 82.2. Regulation Generates Enabling, Motivating and Constraining

Influences8

2.3. Direct and Indirect Regulatory Influences 92.4.The Necessary Role of Agency in Mediating the Influence of

Regulation on Business Performance12

2.5.Internal and External Conditions Mediate the Impact of

Regulation on Business Performance

12

2.6. Summary 13

PART TWO: BUSINESS OWNER RESPONSES TOREGULATION

Chapter 3: An Explanatory Account of Regulation andBusiness Performance: Face-to-face Interviews

3.1. Introduction 153.2.Methods, Data and Sampling 153.3.Regulation and the Market Mechanism 17

3.4. Enabling and Motivating Regulatory Influences 183.5. Constraining Regulatory Influences 223.6. Regulation Generates Multiple Influences 263.7. Adapting to Regulatory Change 273.8 Summary 33

Chapter 4: Attitudes to Regulation and BusinessCharacteristics and Performance: Evidencefrom the Telephone Survey

4.1. Introduction 354.2.The Telephone Survey: Sampling Approach and Sample

Characteristics

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The Impact of Regulation on Small Business Performance

4.3.Owner-managers Perceptions of Regulation 394.4.Managing Regulation 414.5.Regulation-Handling Capacity is Crucial 434.6.Sources of Advice on Regulation 454.7.Regulation and Innovation 50

4.8.Regulation and Business Growth: Does RegulationConstrain or Enable Business Growth?

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4.9.Regulation and Management Characteristics 594.10. Summary 65

PART THREE: THE IMPACT OFREGULATION ON BUSINESSPERFORMANCE: A MULTIVARIATEAPPROACH

Chapter 5: Unravelling the Relationship between Regulationand Business Performance

5.1. Introduction 67

5.2.Multiple Voices on Regulation: a Clarification 675.3.Revisiting the Bundle of Regulation Questions 705.4. Developing Measurement Models of Regulation,

Management and Performance73

5.5. A SEM Model of Regulation, Management and Performance 765.6.Summary 81

PART FOUR: PROJECT OVERVIEWChapter 6: Conclusions and Policy Implications6.1. Summary of Argument and Key Findings 836.2. Policy Implications - Informing the Better Regulation Agenda 85

References 90

Appendix 1: Business Performance Pro Forma (Face-to-Face) 94Appendix 2: Telephone Survey Questionnaire 99Appendix 3: Regulation Question Descriptives 123

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Executive Summary

Research and Policy Context

The purpose of the study is to investigate the impact of government regulationon small business performance outcomes. The received wisdom arising fromprevious studies often assumes a rather narrow view of regulation focussingon the burdens, costs and constraints that regulation imposes on smallbusiness. This report presents an alternative but fundamentallycomplementary view, constructed from a broader understanding of the diverseways regulation contributes to business performance outcomes.

Our approach was specifically designed to capture the complexity and inter-related nature of the factors that underpin differences in small business

performance. And within this to explain why and how small businesses tend toexperience different performance outcomes despite a common regulatoryenvironment.

Our findings suggest that although regulation clearly does impose costs andaffect businesses performance, the performance outcomes experienced inpractice are not simply a function of the regulation involved. Rather they alsoreflect both the capacities and motivations of particular businesses and thewider contexts they operate. The research findings can add to the establishedbetter regulation agenda. In particular, they provide a basis for thedevelopment of new forms of business support that will enable the better

regulation programme to more completely achieve its core aims of improvingbusiness performance. The research can also be used to further develop theSmall Firm Impact Test on the effects of new regulation.

How we Approached the Task

The first stage of the research was to develop our understanding of theregulation-performance relationship on the basis of detailed studies of 124small businesses in England. The second stage used the findings from thefirst to design a series of questions on regulation which we then used in a

telephone survey of 1,205 small businesses in England. This quantitativecomponent of the project was designed to provide a larger dataset that couldbe used to develop a multivariate model of the relationship between regulationand small business performance.

Key Findings

Our analysis of the interviews with the 124 small business owners leadus to conclude that regulation generates multiple influences which canbe enabling and motivating as well as constraining.

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These influences, operating simultaneously, shape the activities ofsmall business owners and other stakeholders whose actions underpinsmall business performance. These influences operate whether or notowner-managers (and other actors) are explicitly aware of them.

The impact of regulation on business performance is not simply areflection of the properties of regulation (for example, the scope ofobligations or their complexity), important though these are. Theperformance outcomes experienced in practice also depend on howbusiness owners, and other stakeholders respond to specificregulations. Agents adaptations to regulation, and thus the businessperformance outcomes that result, depend on firms internal resourcesand capabilities, and on the external context in which they operate:particularly product, labour and capital market conditions.

Business owners vary in their capacity to discover, interpret and adaptto regulation. Those with greater resources finance, equipment,management capability, workforce knowledge and skills are betterplaced to deal positively with regulation. Where businesses lack theresources to develop new practices and products, their capacity toadapt to regulation is constrained. Businesses also vary in thebusiness objectives they seek to achieve and these also shape howthey adapt to regulation.

Whether regulation motivates changes in practices and productsbeyond minimum compliance, and the consequences for business

performance, also depend on the wider context within which particularbusinesses operate. For instance, where businesses perceive productor process innovation as essential to maintaining competitiveness,regulatory change will likely motivate, whether acknowledged explicitlyor not, the search for new products and processes. Moreover, externalconditions shape how successful adaptations to regulation are in termsof business performance. If competitors adapt better or more quickly toregulatory change, adaptation by the focal business might not suffice toimprove performance.

The findings from this survey of 1,205 small businesses can be

summarised as follows:

o The results confirm that regulation is enabling and motivating for

small business owners as well as constraining. Although thecosts and constraints associated with regulation were at theforefront of business owners minds, the data also suggest thatmany business owners were aware that regulation offersopportunities to develop more efficient ways of working and/or ofincreasing income.

o Almost a half of the sample claimed their businesses were able

to deal with new regulations and sizeable minorities reportedimpacts on their firms that provide benefits.

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o A key correlate of many of the core regulation variables is

owner-manager knowledge. Those owners reporting being well-informed about the range of regulations affecting theirbusinesses tended to adapt more dynamically and to experiencethe best business performances. This suggests that knowledge

of regulation, coupled with the internal capacity to respondpositively can and does enable business owners to adaptbusiness practices and products to overcome some of theconstraining influences of regulation.

o Owners of fast growth enterprises were significantly more likely

to report that the introduction of new regulations hadencouraged them to take action to ensure their businessesremain competitive and to claim that that they were able toadapt more quickly than competitors. Fast turnover growth firms(but not fast employment growth firms) were more likely to reportregulation as being beneficial for their business. This is furtherevidence that it is not simply the regulations themselves thatcause business performance outcomes but rather, it is howbusinesses adapt to new regulations that is the major influenceon performance. As with other aspects of the businessenvironment such as increased input prices, changingtechnologies and patterns of consumer demand it is thosegoods and service providers best able to adapt quickly andeffectively to the changing landscape that are most likely toprosper.

o A key finding from our multivariate analysis is that the response

to the question on costs to what extent would you agree thatthere are costs to your business of meeting the minimumregulation requirements is clearly unrelated statistically toowner-manager responses to the other regulation questions.The implication here is that owner-managers hold strong viewson the way regulations imposes costs upon their business butthat they simultaneously hold strong views about other aspectsof regulation which do not impact on business outcomes in quitethe same way. We believe that this dis-association is important

in a number of respects. Not least is how it might inform theconduct of future research which seeks to capture somemeasure of the costs of regulation or administrative burden.

o The survey also collected data on business attributes and

growth performance and we developed a model of therelationships between the three latent constructs of regulation,performance and management. The outcome is a statisticallysignificant multi-layered model of this complex relationship, withmany significant direct and indirect connections.

o What this means is that there is a mutually interlockingrelationship between regulation and performance which in

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simple terms does not allow us to draw the conclusion that oneconstruct (regulation) causes another (performance). The twoconstructs move together, yet as we noted above this does notinclude the dimension which relates to the costs of regulation.

o In summary, we are confident that this way of viewing regulationhas both conceptual meaning and statistical robustness. Wenow have significant conceptual and empirical depth to theconstruct of regulation as viewed in the context of smallbusinesses.

Policy Implications

Our research has provided an in-depth analysis of the nature of therelationship between regulation and small business performance andthis understanding allows us to set out some policy implications. At theoutset we must be clear that the analysis does not allow us to sayanything about how many regulations nor what they should be.Neither do these findings detract in any way from the established betterregulation agenda. Rather, our findings suggest the possibility ofcomplementary policy measures which have the potential to enhancethe performance of at least some businesses over and above thatstemming directly from the establishment of better regulation.

In particular, we develop two inter-related policy areas which are setout in more detail in Chapter 6. The first concerns the realm ofbusiness support and builds on our findings that knowledge andcapacity are important dimensions of how regulation impacts uponbusiness performance. We argue that there needs to be a greateremphasis upon familiarising small business owners with the regulatoryenvironment and a need to build internal capacity to deal withregulations. An extension of this argument would be that as theregulatory environment is simplified the outcome for small businessmay well be less than optimum without support to enable them to adapteffectively.

The second policy area relates to Impact Assessments and, morespecifically, the Small Firms Impact Test (SFIT). Policymakers mustrecognise there will not be a single small business effect but manydifferent ones and that part of the reason why the effects of regulationmay vary relates to the internal capacity to cope with them. Theobvious implication here is that regulatory exemptions need to bebased on aspects of this capacity rather than on the more easilyaccessible areas such as size. Size on its own is not always a goodindicator of the capacity of a business to cope effectively with theintroduction of new regulations.

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If there is to be a greater emphasis on familiarisation and capacitywithin the business support framework to help small businesses copebetter with the regulatory environment then the associated range ofcosts need to be built into the ex ante impact assessment of theevolving regulatory environment. In brief, there is a need to

acknowledge the costs of building capacity within small businesses.

Indirect regulatory influences are a major source of dynamism amongstsmall businesses, though perhaps largely unacknowledged, in thecompetitive market system. In developing Impact Assessments, moreemphasis should be placed on indirect influences on small businessperformance. Recognising that regulations that constrain smallbusiness owners by placing obligations upon them might also enableand motivate them andother small businesses to adapt products andprocesses in order to reduce costs and/or increase trading revenues isimportant.

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PART ONE

INTRODUCTION

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1. Introduction and Research Objectives

1.1 Background and Aims

Regulation and its impact upon businesses are major topics of public debate.

Small businesses are argued to suffer disproportionately from regulationbecause of higher fixed compliance costs and their lower resilience to externalshocks due to limited resources (e.g. Chittenden et al., 2002). One recentestimate, derived from the Governments own regulatory impact assessments(RIAs)1, suggests that implementing new legislation has cost UK businessesmore than 55bn since 1998 (BCC, 2007). Other sources, in contrast, notethe business friendliness of the UK regulatory regime; the World Bank (2007)ranks the UK sixth out of 178 countries in terms of the ease of doing business.Critics of regulation ignore the fact that in spite of the regulatory framework or is it because of 4.5 million businesses operate in the UK, a number that

has continued to rise in recent years despite claims of increasing regulation.

Creating better regulation is a key policy objective of the UK Government(Cabinet Office, 1999) and has been one of the seven key strategic themesrunning through small business policy (SBS, 2004). In 2005, the Governmentlaunched the Better Regulation Action Plan to reform the regulatoryframework (HM Treasury, 2005) and created the Better Regulation Executiveto drive forward the agenda. The Action Plan was strongly influenced by theHampton report (2005) aimed at improving inspection and enforcementprocedures and the Better Regulation Task Force (2005) report, Regulation -Less is More: Reducing Burdens, Improving Outcomes, which proposed

measurement of administrative burdens imposed by regulation and settingtargets for their reduction.

Reducing and simplifying regulation is not, however, an end in itself but ameans to enhancing national economic performance and living standards forthe UK population. The acid test of regulation, therefore, is whether itcontributes to these broader policy objectives by producing the relevantoutputs and outcomes at the firm level.

Our analysis is designed to capture the various factors that interact withregulation to shape the business performance outcomes actually experienced

in practice. Because it moves beyond seeing business outcomes as a directand simple consequence of regulation, it has the potential to offer new pointsfor intervention; interventions that will allow businesses to cope morepositively with whatever regulatory environment they operate in and therebyachieve enhanced performance. Such an approach is fundamentallycomplementary to one which seeks to reduce and simplify regulation; indeedit has the potential to significantly enhance the effectiveness the betterregulation programme.

Research in this area, necessarily, rests on the approach taken to explaininghow regulation influences business performance. Rather than starting with a set

1 These have been renamed Impact Assessments since May 2007.



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of quantitative research techniques for collecting data on regulation andperformance and making statistical inferences, and simply presuming theirappropriateness, we do something different. We begin by inquiring into thenature of the object under investigation and then design a methodological toolbox that is appropriate for dealing with it.

The research, guided by a realist methodology, started by probing a little deeperinto the nature of the relationship between regulation and small businessperformance2. We did this in two distinct stages. First, we developed a causalanalysis of the regulation/performance relationship on the basis of qualitativedata derived from detailed studies of 124 small businesses in England3.Building on this analysis, we undertook a second stage, designing a series ofquestions on regulation to use in a telephone survey of 1,205 smallbusinesses in England4. This quantitative study was used to estimate amultivariate model of the relationship between regulation and performanceusing a larger dataset. The analytical toolkit chosen - Structural Equation

Modelling (SEM) - assumes many aspects of regulation are unobservableand, therefore, difficult to quantify. Regulation is treated, therefore, as alatent construct. To begin, we define key concepts, review the evidence baseon the causes of small business performance and growth, includingregulation, and provide details of our research approach.

1.2 Defining Regulation

The research and policy literature tends to define regulation narrowly interms of the particular obligations placed on business owners to act (or notact) in particular ways, for example, to provide information to Government;alternatively, studies do not define regulation, allowing business owners todraw on their own meanings (SBS, 2006). These approaches are limitedbecause they do not cover the full range of regulatory influences on smallbusiness performance. In the context of this study, therefore, we defineregulation as:

..the legal and administrative rules created, applied and enforcedby Government regulatory authorities at local, national andtransnational level that both mandate and prohibit actions by

individuals and organisations, with infringements subject tocriminal, civil and administrative penalties.

Government regulatory authorities are bodies with responsibility for creating,implementing and enforcing regulation, including those with tax-raising andtax-collecting powers. The activities of all sub-national, national andtransnational bodies possessing such powers fall within the remit of the study.This includes the 63 national regulators, 203 trading standards offices and408 environmental health offices in 486 UK local authorities covered by the

2 We are grateful to Professor Steve Fleetwood for helping us clarify our thinking about the conceptual

and methodological design of the research project.3Undertaken by the Kingston research team between September 2005 and March 2006.4Carried out by OMB Research between January and March 2007.



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Business performance can be defined both in terms of processes (start-up,resource acquisition, development and deployment (i.e., the strategic directionof the business) and outcomes (sales, profit, asset value, intrinsic worksatisfactions).6 Regulation impinges upon all of these activities. Growth is a

narrower concept, denoting a particular type of change in performance. Inthis study we address growth by using a number of dependent variables. Forexample, we have continuous data on employment and output growth fromthe face-to-face interviews and the telephone survey. Alongside this weconstruct additional variables which re-classify small businesses into thosewhich have grown rapidly and those which have not in order to provide anassessment of how regulation is perceived by the owner-managers of thesefirms.

1.4 Research and Policy Context

For almost three decades small business performance and growth has beenan important research topic (Storey, 1994; Barkham et al., 1996; Delmar,1997; Davidsson et al., 2002; Davidsson, 2004). Studies typically identify anumber of potential influences on growth:

firm characteristics (e.g. size, age, sector and ownership);

owner-manager characteristics (e.g. experience, education, ethnicity,gender, size of management team); and

strategic priorities (e.g. innovation, R&D and technical capability,

internationalisation; staff development and formal training) external environment (e.g. market conditions, regulation, public policy

support)..

Although there is no consensus on the precise, and indeed consistent,influence of particular factors on the performance of small businesses, theseform an important foundation to our research framework.

Much of the evidence regarding the impact of regulation on small businessperformance adopts a somewhat one-sided view of regulation and isconstrained by various methodological limitations (Kitching, 2006). Most

studies adopt a static approach, identifying regulation solely or primarily as acost to, or constraint upon, business owners. Surveys typically ask businessowners whether they perceive regulation as a burden (or other synonym) onbusiness performance (or similar indicator) (e.g. Cosh and Wood, 1998; SBS,2006). Such surveys tell us what business owners thinkabout regulation butnot what they do about it. Other surveys focus on the impact of regulation, forexample, on business start-up, with mixed results as to whether it is adeterrent (Djankov et al., 2002; Ho and Wong 2007) or not (van Stel et al.,2007). Nor do such studies allow for respondents to misperceive the impactof regulation. Prospective and actual business owners often over-estimate

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No assumption need be made regarding the priority owner-managers attach to variousobjectives, though repeated failure to achieve a profit is likely to set in train a sequence ofevents that will bring about the dissolution of the enterprise.



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the extent to which regulation constitutes a real burden (Allinson et al. 2005,2006); a finding at least partly explicable in terms of the pervasiveness ofanti-regulation discourses in the wider society. Such discourses exert agenuine constraining influence on business start-up and performance in theUK.

Compliance cost studies adopt more sophisticated methods but, on the whole,reinforce the view of regulation as a cost or constraint (e.g. Chittenden, 2002).The benefits of regulation and its dynamic influence on small businessowners activities and performance are often neglected. Qualitative studieshighlight small business owners variable awareness of regulation (e.g. Yappand Fairman, 2005), distinct attitudes to compliance (e.g. Petts et al., 1999;Vickers et al., 2005), the benefits of regulation (e.g. IpsosMORI, 2007) andprovide deeper insights into the dynamic effects of regulation on businessdecision-making and competitiveness (e.g. Arrowsmith et al., 2003; Grimshawand Carroll, 2006).

Current policy initiatives have necessarily been constructed around thisestablished, and in some respects partial, body of evidence (e.g. HMGovernment 2006; BERR 2007a). We believe that this has limited the scopeof initiatives available to policy makers and may well have limited the overallimpact of the better regulation agenda.

1.5 A New Approach to Studying the Impact of Regulation on SmallBusiness Performance

We applied a new approach to exploring the influence of regulation on smallbusiness performance explicitly drawing on a realist perspective (Figure 1.1).We address two main questions:

1. How does regulation causally influence business performanceoutcomes, and why do they vary between businesses?

2. What conditions support/hinder the exercise of these causalmechanisms, thereby shaping the outcome realised in practice?

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RegulatoryMechanism

BusinessPerformance

Outcomes

Conditions(Other mechanisms)

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Figure 1.1: Realist View of Causation (adapted from Sayer 2000: 15)

Our approach goes beyond studies focusing on small firm ownersperceptions of regulation as a burden on business and compliance cost

studies that present a static picture of regulation as a cost or constraint.Instead, we propose a model explaining the dynamic impact of regulation onsmall business performance. The model specifically allows for variation inbusiness owners adaptations to regulation due to differences in theircapacities and motivations, and to differences in performance outcomes dueto the influence of the wider contexts within which businesses operate. Thisopens up space for policy to intervene to enhance business ownerscapacities to discover and interpret regulation and to adapt to it in a mannerlikely to improve business performance. Start-up and business developmentprogrammes could incorporate learning about regulation and how to adapt toit. This might also help overcome the undoubted hostility of some business

owners who perceive regulation as totally unrelated to conducting businessactivities.

1.6 Structure of the Report

Chapter 2 sets out the analytical approach adopted, Chapter 3 presents thequalitative findings and provides the basis for the construction of a set ofregulation statements investigated further through the large-scale telephonesurvey of small business owner managers. Chapter 4 reports on this surveyand develops a profile of the range of attitudes to regulation and how theyrelate to particular types of small businesses. Chapter 5 provides amultivariate analysis of the relationship between attitudes towards regulationand performance variables using primarily Structural Equation Model (SEM)techniques. Chapter 6 concludes with a summary and identifies theimplications of the study for policy.



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2. Explaining the Impact of Regulation on BusinessPerformance

2.1 Introduction

This chapter presents a model to explain how regulation causally influencessmall business performance. Our focus is on the micro level, on theperformance of individual enterprises, rather than on the macro level of theUK economy. First, we make two distinctions regarding how regulation exertsits causal influence derived from our broader definition of regulation. Second,we examine the necessary role of agency in producing regulatory effects;regulation only influences business performance through the actions ofbusiness owners and other stakeholders. Third, we consider the widerconditions of agents adaptations to regulation that shape their impact onbusiness performance. Understanding the properties of regulation, agents

adaptations to it, and the wider contexts of action are all essential to providinga causal explanation of the impact of regulation on business performance.

2.2 Regulation Generates Enabling, Motivating and ConstrainingInfluences

Regulations vary in the number of agents to whom they apply, the ease withwhich they can be interpreted, the demands they make of those subject tothem, and in the sanctions available with respect to non-compliance. Thesecharacteristics shape business owners perceptions of, and adaptations to,

regulation, including whether they choose to comply at all. Individual agents,including small business owners, might, of course, misperceive thesecharacteristics, all of which influence agents capacities and motivations toadapt, and, ultimately, business performance outcomes.

Regulation causally influences business performance by enabling, motivatingand/or constraining the projects of business owners and other stakeholderswhose actions causally affect them. Regulation enables agents to achievetheir aims by making certain actions possible; it motivates by incentivisingagents to act in particular ways rather than others; and it c onstrains agents bylimiting their scope for action. Regulation is not enabling, motivating and/orconstraining in general but only in relation to agents specific goals, forexample, growing a business by 10% during some specified period.

Regulations trigger multiple influences (enabling, motivating and constraining)simultaneously for the same business owner. For instance, the NationalMinimum Wage (NMW) constrains employers by requiring them to pay atleast the minimum rate to employees. But by restricting their capacity tocontrol labour costs, it also motivates them to implement product and processinnovations, or to raise prices, in order to cut costs and/or increase tradingrevenue. The NMW might also be enabling in so far as it increases labour

supply and/or forces competitors to increase prices to adapt to their higherlabour costs and thereby make their products less attractive to consumers.



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There is no necessary correlation between regulation and performance.Identifying an enabling regulatory influence does not mean businessesachieved a high level of performance; similarly, to identify a constrainingregulatory influence does not mean firms performed poorly. Regulationgenerates multiple influences, simultaneously, in combination with other

causal influences. It is not possible a priori to predict which of theseinfluences on performance will be the most powerful for any particularbusiness. We can say that regulation tends to inhibit performance, but wemust recognise that this is a tendency; not all businesses will be constrainedto the same extent; some may well struggle but equally others may wellachieve high levels of performance.

2.3 Direct and Indirect Regulatory Influences

From the point of view of a focal business owner, direct and indirect regulatory

influences can be distinguished, although in practice, they operate together.Direct influences relate to small business owners adaptations to regulationthat mandates or prohibits action by them for example, the NMW - either byconstraining them to comply, or by enabling and motivating them to adaptbusiness practices and products in order to maintain or improve businessperformance. Most small business research focuses on these directinfluences, particularly the constraining ones.

Indirectinfluences refer to changes in small business owner behaviour arisingfrom adaptations to regulation by other stakeholders whose behaviourcausally affects the focal business owner, either through market relations(with competitors, customers, employees, suppliers and some infrastructureproviders), or non-market relations (with infrastructure providers andregulatory authorities). For example, where suppliers increase pay rates andproduct prices as a result of the NMW and this causes the focal small firm toadapt their business practices and products, then regulation is a causalinfluence on that focal business. Indirect influences will be experienced mostcommonly by business owners as changes in the cost or availability of wantedresources, or in product sales. Given the inter-dependent nature of firmsrelations with other stakeholders, indirect regulatory influences on businessperformance are potentially very complex and far-reaching, whether business

owners are aware of them or not.



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Small business owners, like other people, are more likely to report direct,rather than indirect, regulatory influences because they are moreknowledgeable about their own behaviour and motivations than they are ofothers. This does not, however, mean that indirect influences are less

important. Indeed, regulation might exert a greater indirect influence onbusiness performance than directly. Direct and indirect enabling regulatoryinfluences operate simultaneously, causally contributing to businessperformance outcomes. The black arrows in Figure 2.1 indicate directregulatory influences on small business owners and other stakeholders; thewhite arrows indicate indirect influences on a focal business owner operatingvia market and non-market relations with other stakeholders.



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Figure 2.1: Direct and Indirect Regulatory Influences on Business Performance

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SuppliersCustomers

MARKET SYSTEM including regulatory framework

Competitors

Infrastructureproviders

FOCALSMALL

BUSINESS

I n d i r e c t e f f e c t s

d i r e c t e f f e c t s

Employees

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2.4 The Necessary Role of Agency in Mediating the Influence ofRegulation on Business Performance

Regulation only influences business performance through the exercise ofhuman agency, that is, through business owners and other stakeholders

adapting their behaviour to the regulatory framework; agency mediates theimpact of regulation on business performance. If business owners and otherstakeholders do not change their behaviour as a consequence of regulatorychange, its effect is nil. Business owners and other stakeholders vary in theircapacities to discover, interpret and adapt to regulation and pursue differentstrategic priorities. Regulation does not, therefore, have uniform effects onsmall business performance.

The capacity of small business owners to discover and interpret regulationdepends not only on how well it is communicated to business owners - boththe message and the media used but also on firms capacities to

comprehend the meaning of regulation. Intermediaries such as businessadvisers, consultants, insurers, trade bodies and friends and family as well asregulatory inspectors play a crucial role in shaping business ownersunderstandings of regulation and their responses to it (e.g. IpsosMORI, 2007;BERR, 2007b).

Business owners always have some discretion regarding how to adapt toregulation from non-compliance, through minimum compliance andincremental change to far-reaching reform of business practices and products.Adaptation need not entail detailed knowledge of regulation; indeed,regulation can exert an indirect influence on a focal business without anyknowledge of regulation at all. Non-compliance due to ignorance or wilfulevasion risks legal penalties (e.g. fines, business closure, and imprisonment)and economic sanctions (e.g. threat to commercial reputation) but somebusiness owners may feel more constrained to avoid compliance than others,for example, those operating in highly competitive markets. Adaptationdepends, therefore, in part, on the wider context.

2.5 Internal and External Conditions Mediate the Impact of Regulationon Business Performance

For simplicity, internal and external conditions of action can be distinguished.Internal conditions refer to the resources, capabilities and motivations ofagents internal to the enterprise owners, managers and employees todiscover, interpret and adapt to regulatory intervention. Business ownersmight, for instance, be unaware of particular regulations or interpret regulatoryobligations incorrectly. Some might choose to create a dedicated regulation-handling post in order to improve their ability to deal with regulation. Businessowners might decide to implement major innovations as a response toregulatory change; others will adapt minimally, while others will choose not tocomply at all. Discovering, interpreting and adapting to regulation all require

resources to develop the required capabilities; because firms possessdifferent resources, such capacities are, therefore, necessarily variable.

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External conditions refer to the actions of stakeholders beyond the enterprise,including product, labour and capital market agents. Markets distributeresources and rationales for action for instance, to acquire inputs cheap, tosell products dear, and to adapt business practices and products in order to

cut costs and/or increase trading revenue. Whether particular regulationsproduce specific performance outcomes for particular firms depends, in part,therefore on the actions of other stakeholders as well as their own efforts.What is a constraint for one business owner is anothers enablement becausethey are in competition for resources and markets. If other stakeholdersadapt better or more quickly to regulation, then the focal business mayexperience a decline in performance.

2.6 Summary

The analytical framework presented in Figure 2.1 enables us to identify andstylise the different types of regulatory influence (enabling, motivating,constraining) that causally contribute to business performance outcomes.Regulation only produces its effects through the agency of business ownersand other actors with whom they causally interact (actual and prospectivecompetitors, customers, employees, suppliers, infrastructure providers,regulatory authorities). We stress the variety of business owner responses toregulation founded on their variable resources, capabilities and motivations toadapt. Chapter 3 presents a detailed analysis of our 124 cases to examinethese regulatory influences and the conditions that support or hinder theircausal impact on particular small business performance outcomes.

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PART TWO

BUSINESS OWNER RESPONSES TOREGULATION

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3. An Explanatory Account of Regulation andBusiness Performance: Face-to-face Interviews

3.1 Introduction

This chapter provides a more comprehensive causal explanation of the impactof regulation on small business performance than previous studies haveoffered hitherto. It takes account of the dynamic, multi-faceted influence ofregulation on performance. Data from the sample of 124 face-to-facebusiness interviews is drawn upon selectively to illustrate the enabling,motivating and constraining regulatory influences that contribute to, but do notdetermine, small business performance.

3.2 Methods, Data and Sampling

Data were obtained from face-to-face interviews using a semi-structuredinterview topic guide with 124 small and medium-sized business owners (ormanagers) in a range of business settings (see Appendix 1). Samplebusinesses were identified using a commercial database and satisfied thefollowing criteria:

Independence not part of, or owned by, large companies;

Employment employed 1-249 people;

Sector businesses operated in a range of sectors;

Location mainly located in London, the South East, South West,Leicester and Leeds.

A sample was constructed to incorporate businesses with a range of size andsector characteristics (Table 3.1). The purpose of the qualitative study wasnot to achieve a representative sample in order to generalise statisticalrelationships to the broader UK small business population. Rather, our aimwas to explain howregulation contributes to particular performance outcomesin particular contexts. By selecting businesses with a range of features, wehoped to uncover a wide range of regulatory influences on businessperformance. Sample size is not of central importance in this type of research

methodology. The regulatory influences we identify shape, though do notdetermine, the performance of all businesses, their precise impact inparticular business cases varying with the conditions within which theseinfluences operate.

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Table 3.1

Interview Sample Businesses

Number ofFirms

%of Sample

Micro (< 10 employees) 53 42.7

Small (10-49 employees) 55 44.3

Medium (50+ employees) 16 13.0

Manufacturing 23 18.5

Construction 12 9.7

Retail/wholesale 13 10.5

Hospitality 20 16.1

Transport/communications 11 8.9

Finance/business services 36 29.0Health and social care 5 4.0

Other 4 3.3

ALL 124 100.0

Several features of our methodological approach are worthy of mention. First,business owners were approached on the premise of investigating thedeterminants of performance - notto assess the impact of regulation. We didnot assume regulation was a principal influence on performance. Second, the

topic guide was constructed to identify the influences on, and barriers to,business performance before raising the thorny issue of regulation. Third, thetopic guide was used flexibly, with interviewers exercising discretion inquestion sequencing where respondents raised regulatory issues prior to theirposition in the guide. Fourth, the method of data collection permitted deeperprobing into business owners actions and motives beyond that usuallypossible using more structured research instruments such as postal ortelephone survey formats.

Fifth, owner-managers accounts provide the starting point for understandinghow regulation influences business performance but they do not, and cannot,constitute the whole regulation/performance story. Many studies treatrespondent reports as causal explanations in their own right rather than asdata that contribute to an explanation. Regulation shapes business ownersactivities without necessarily explicitly entering their motivations or reasoning;indeed, over time, particular regulations are likely to become absorbed intobusiness routines such that they become a taken-for-granted, barely visible,condition of conducting business. Few, if any, business owners reportproperty or contract rights as important regulatory influences on theirbehaviour, yet these are necessary for trading.7 Business owners lack ofawareness of particular regulations does not mean they have no effect.

7 Property and contract rights also constrain business owners, of course, by restricting theunauthorised use ofothersproperty and by binding contractors to the agreements they make.

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Owner-manager hostility to regulation is not synonymous with constrainingregulatory influences being paramount for business owners activity or withpoor levels of business performance. Similarly, favourable respondent viewsof regulation do not necessarily correspond to the importance of the enablingand motivating influences of regulation or high levels of business

performance. Owner-managers perceptions of regulation, particularly theirinitial responses, need not reflect regulatory influences or businessperformance outcomes in any obvious way (see Case 1).

We begin by outlining the fundamental and necessary role of regulation inenabling a complex market economy to function. This is crucial becausewithout regulation, market activity and relations of the scale and complexityprevalent today would simply be inconceivable. We then present argumentsand evidence to illustrate the enabling and motivating influences of regulation,before considering cases highlighting the conventional constraining view ofregulation. Next we consider cases that illustrate the multiple, and oftencontradictory, influences generated by regulation. Because regulation is soall-encompassing of business activity, managing multiple and contradictoryregulatory influences is the normal condition of doing business.

3.3 Regulation and the Market Mechanism

The regulatory framework is a key component of the market mechanism,shaping buyers and sellers actions and relations. Although regulation is oftenperceived as a Government response to market failure, for exampleasymmetric information, arguments counterposing the market or the stateignore the fact that market exchange in advanced economies necessarilypresupposes the existence of a state regulatory framework. The market is notindependent of the regulatory framework. Regulation does not interfere with aprior, independent market mechanism or distort market signals; rather,regulation is a necessary institutional precondition of the adequate functioning

of an advanced market economy.

Case 1: Fund manager investing in early-stage technology enterprises. Founded in 1981.Employment: 22 employees. Extremely profitable business (6m profit out of 12mturnover).

Regulation was NOT reported until prompted but very strong critical views were expressedonce the issue was raised. The owner reported regulation to be unnecessary for the vastmajority of businesses as most operated honestly. Hostile to UK and EU increase inburden of regulation, despite their claims to be deregulating. Reported impacts included

employing one person full-time to deal with Financial Services Authority (FSA) matters.The owner suggested it might influence the business to relocate offshore if regulationbecomes much worse!

Having said this, the owner recognised that some regulation to clarify what people can andcannot do was essential to do business. The owner felt that Governments were over-regulating to prevent another Enron but this was having detrimental effects for the honestmajority.

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Private property, contract and money are essential preconditions for anadvanced market economy, enabling transactions between agents over largedistances and across time; all presuppose an active Government role asregulator (Sayer, 1995). Without these institutional supports, the economysimply would not function in the way it does involving chains of buyers and

suppliers separated across time and distance who will never meet. Withoutregulation, buyers and sellers would have neither the will nor the means toengage in market exchange. Clear and enforceable property rights arefundamental to market exchange and business investment. The World Bank(2006) identified investor protection as a key indicator of the ease of doingbusiness; the higher the level of regulatory protection the easier it is to dobusiness. Excessive or ill-considered deregulation would not lead to a puremarket uncontaminated by regulation, but instead would lead to a crisis of themarket system because buyers and sellers lacked the confidence and thecapacity to engage in trade.

3.4 Enabling and Motivating Regulatory Influences

Government regulation enables and motivates business performance invarious ways, for instance, by making it easier for actual and prospectivegoods and service providers to access and deploy resources, and by creatingmarket opportunities. Two points are worth repetition. First, the creation ofthese opportunities is enabling and motivating for business owners but thisdoes not guarantee the opportunities enabled are commercially exploited.Human agents must act on the basis of these enablements if these influencesare to be realised. Second, business owners themselves might not perceiveregulation as enabling or motivating in the manner described; the examplesgiven have often been reconstructed from owner-manager accounts, withoutthem necessarily making the same connections between regulation andbusiness performance as the research team.

Regulation enables and motivates business performancethrough licensing, registration, prior approval

Regulatory authorities sanction agents as business owners through theallocation of tax statuses (as self-employed traders or incorporated bodies),company registration and, where relevant, licensing or registration to

undertake particular trading activities. These prior approval practices regulatemarket entry and the supply of particular goods and services for instance,professional services such as medicine, law and architecture as well as foodproduction and distribution, entertainment and leisure, health and careservices, and transport all require licensing. These regulatory influencesoperate directly on focal small business owners by permitting or notpermitting them to trade lawfully and indirectly, by permitting or notpermitting others to do the same. Everything business owners dosubsequently and the business performance outcomes achieved - isshaped, though not determined, by these fundamental regulatoryenablements. This is true whether or notbusiness owners actually recognise

this. The extent of such impacts depends upon the number of approved

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operators, the nature and extent of competition between them and the level ofaggregate demand for their goods and services.

Regulation enables and motivates business performancethrough attribution of preferred supplier status

Public and private sector organisations are often mandated to purchase inputsfrom a preferred, approved or certified supplier. The use of preferred supplierlists is enabling for those businesses on the list and constraining for thoseexcluded, with implications for subsequent business performance. Preferredsupplier status motivates R&D and innovation to take advantage of the marketopportunities enabled (Case 2).

Regulation enables and motivates business performancethrough deterring market entry/motivating competitor exit

Regulation, by raising the perceived or actual costs of operating, may determarket entry and/or encourage exit by existing providers. For thosebusinesses that choose to operate, such regulatory influences are indirectlyenabling by reducing the number of competitors. One company, a travelinsurance provider subject to FSA regulation, provides a good example (Case3). One of the objectives that lay behind the creation of the Financial ServicesAuthority in 2001 was to allay public fears following the endowment mis-selling and other scandals that have beset the financial services industry in

recent years. Ironically, falling within the orbit of the FSA was one of thereasons why the respondent had been recruited to his position of companydirector a few months prior to interview. FSA regulation and scrutiny had not,however, prevented the business from achieving a high sales and profitperformance.

Case 2: Aerospace Engineering design/manufacture of helicopter composites turbinecowlings, operating since the mid-1970s, Employment: 45 employees. Currently 3m

turnover, an increase on 2.2m the previous financial year.

The industry is heavily regulated by both the International Air Transport Association(IATA) and the Civil Aviation Authority (CAA). Due to the origins of the company in the1970s the company got, and has continually renewed, maintenance, manufacturing anddesign approvals for its products. This gives it a significant advantage over competitorswho usually hold only one of these three approval certificates. CAA certification enablesthe business to exploit a profitable market niche by adopting the quality standards setdown by the regulators. These quality standards drive the R&D and innovation activity ofthe business & enable sales.

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That Government regulation creates or protects a market does not mean thatbusinesses necessarily achieve high product sales. Competitive pressuresoperate to influence performance outcomes with some businesses out-performing others. The point is to recognise this obvious role of regulation inmarket creation and the stimulus to trading activity, which is enabling forbusinesses willing and able to exploit the opportunity.

Regulation enables and motivates business performanceby mandating customer purchases

Regulation often requires consumers to purchase particular goods andservices if they wish to undertake a particular activity, either in the context ofcommercial or leisure activity (Case 4). Such regulation by creating, or raising,demand for particular goods and services creates market opportunities foractual and would-be providers of those goods and services; these areindirectly enabling for such businesses. Regulation enables policymakers toachieve social policy objectives e.g. public safety, environmental protection,education while at the same time stimulating economic development.Examples from the sample include: requiring buildings to meet environmentaland safety standards; requiring boat-users to purchase safety equipment;requiring property developers to meet environmental waste management

standards, requiring schools to purchase IT equipment to meet theireducational obligations.

Case 3: Financial services, primarily retail travel insurance. Founded in 1998(respondent joined 2005, partly to take on responsibility for regulation). Employment: 25employees. The business is growing rapidly. In 2004, the company turned over 3.5m(profit of 900k) and projects an estimated 4.5m for 2005.

Business has been regulated by the Financial Services Authority (FSA) since January2005, a major irritant for the respondent as travel insurance products are perceived as notsufficiently complex or risky to justify regulation. Regulation also enabled certain activities.The owner acknowledged that the FSA had led to the creation of new market opportunitiesin the cargo insurance market and had encouraged some competitors, mainly those forwhom insurance was only a part of their business, to exit the travel insurance market toavoid regulation. ABTA, the travel agents association, had negotiated a 2-year exemptionfor their members but when this expires, this might lead to further withdrawals from themarket-place. He also anticipated potential benefits from having the requireddocumentation of business practices in place should a trade sale ever be sought.

Case 4: Geological Survey company, founded in 1967, employing 68 staff. Thebusiness has grown rapidly to 3.4m sales, up 14% p.a. in the 2000-05 period.

Work for commercial and residential housing developers to ensure their sites aredeveloped in accordance with EU and UK environmental legislation especially in thearea of waste management licences. They have developed a specialism in working withcontaminated sites (testing/assessing the risk and advising on actions for specialistcontractors before development work can begin). They are in fact the interface betweenthe developer and the regulator (e.g. County Council Environmental Health Officers and

Ofwat .

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These examples could be multiplied many times. For example, regulationrequiring business owners to submit annual accounts provides marketopportunities for accountants and financial advisers and, in this sense, isenabling for those businesses. By requiring those engaging in a particularactivity, commercial or leisure, to purchase particular goods and services,

regulation can further both economic and social policy objectives. Manybusinesses thrive on the back of Government regulation by providingregulatory advice and support to small business owners; many of thesebusinesses, of course, are themselves small enterprises (see ACCA, 2006 forfurther evidence).

Regulation enables and motivates business performance bymotivating customer purchases

Regulation can be indirectly enabling for small business owners, for example,where it encourages, but does not compel, consumers to purchase certain

goods and services. A good example of this would be food regulations thatassure customers of the quality of food products; frequent food scares mightreduce consumer confidence in foodstuffs. An interesting example from thesample relates to the indirect impact of the US Sarbanes-Oxley Act, whichaims to protect investors in US companies, on the activities of recruitmentagencies. The Act encourages companies to hire staff in order to ensurecompliance with the Act and thereby creates market opportunities forrecruitment businesses (Case 5).

Regulation enables and motivates business performance byenabling customer purchases

Government regulation authorising subsidy payments to particular customersto purchase particular goods and services is enabling for actual andprospective providers. One example is health services (Case 6). Without thesubsidy, the market would be much smaller as few patients would be able toafford the service. Again, policymakers can facilitate the achievement ofvalued social objectives while simultaneously stimulating economic activity.

Case 5: Recruitment agency, founded in 2003, placing IT staff into the financial

services sector. Employs 13 in UK and Bahrain offices. Makes a small profit on 1.1mturnover but looking for 50% growth next year, and aiming for a trade sale in a few yearstime. The company seeks to provide value added services (non-preferred supplier listwork) to raise margins.

Regulation has stimulated an increase in client demand for temporary staff. The USSarbanes-Oxley Act, whose purpose is to restore investor confidence in largecorporations financial practices post-Enron, imposes harsh penalties for failure topresent truthful financial accounts. This has motivated companies to recruit additionalstaff to ensure compliance. This has raised demand for recruitment agency staff.

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Regulation motivates process innovations

As with increases in the cost of factors labour, raw materials and premises,

the costs of handling regulation can act as a stimulus to seeking alternativesources of supply, more efficient methods of deploying resources, and newways of generating revenue. Process and product innovations, though costlyto introduce in the short-term, might actually constitute a long-term investmentfor the business and lead to an improvement in performance. Whetherbusiness owners perceive regulation as a causal influence on decisions toadapt business practices and products is an empirical question - its impact onbusiness activities and performance might go unrecognised.

Process innovations include changes in equipment, work organisation and

working methods. Such changes causally influence business performanceoutcomes by generating reductions in costs and/or improving product quality.A steel supplier adapts to health and safety legislation by implementing a widerange of improvements in working practices that lead to a marked reduction ininsurance costs and working days lost through accidents (Case 7).

3.5 Constraining Regulatory Influences

In this section, we examine how regulation constrains business performance.

As previous studies have found, business owners often focus, initially at least,

Case 6: Domiciliary eye care service. Founded 1990. Employment: 43 employees.Operates a high street retail optician (founded 1961) from the same premises. Earns a lowprofit on 1.5m turnover. Mainly NHS funded patients with approx 12% private sales. Long-established and one of the first into home eye-care so has a good reputation for a high-quality service. Price unimportant as the vast majority of customers pay nothing.

Government decided to subsidise domiciliary eye care services in 1990. This enabled theprovision of eye care to patients unable to travel to receive the service, creating marketopportunities and restricting them to licensed practitioners. The business had previouslyprovided some eye care in patients homes without the subsidy. Having generated thedemand by subsidising the service since 1990, the owner believed the Government nowfinds expenditure to be increasing rapidly and is looking to control it.

Case 7: Steel supplier founded in 1976, bought out by two directors in 2002 onretirement of previous owner. Current sales of 34m. Employment has risen from justover 100 to 159 staff since 2002. The product market is volatile with fluctuations in steelprices. The customer base has been widened to avoid dependence on a small number oflarge clients.

The new management team used Health and Safety legislation to increase efficiency byreducing days lost to accidents. A health and safety officer was hired to tackle the largeinsurance bill of 200k per annum. This increased internal management capacity to dealwith regulation and facilitated change in working practices (e.g. wearing hard hats andtraining for fork-lift truck drivers). As a consequence, the number of accidents droppeddramatically with a corresponding drop in the insurance premium to 85k.

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on the direct costs or constraints associated with regulation, including themoney, time and psychological costs of handling regulation:

Discovering and interpreting regulation;

Licensing, registration and other fees;

Documentation and record-keeping practices; Inspections, audits and monitoring practices;

Fines, penalties and other sanctions for non-compliance;

Psychological costs refer to the felt anxiety and stress experienced bythose who perceive regulation requires them to change their behaviour.Such costs might deter start-up, investment and businessdevelopment.

Again, one needs to recognise that the constraining influences of regulationneed not be manifested in low levels of business performance. First,

constraining influences operate alongside the enabling and motivatinginfluences identified above to generate a net impact on particular businessowners. Second, regulation produces business performance effects throughits impact on what business owners (and other stakeholders) do. Agentsadapt to regulation in different ways and these diverse adaptations feedthrough into performance outcomes for particular firms. Those able to adaptbetter and/or more quickly to regulation are more likely to achieveperformance improvements (or limit the performance decline), even whereregulation-handling is perceived as onerous.

Regulation constrains business performance by raising the

administrative costs of regulation-handling

Regulation increases the costs of operating a business by placing demandson owners to supply information to Government bodies or third parties suchas employees and shareholders. All of these can be described as directconstraining influences. The five areas that impose the highest administrativecosts on businesses are planning law, employment law, company law,taxation law and health and safety law (BERR, 2007a). The primary thrust ofthe Better Regulation policy agenda is to reduce the administrative burdens ofregulation. There were many examples of such burdens reported by businessowners (Case 8).

Case 8:Insurance Brokers, founded in 1963 (current owners were involved in a MBOin 1995). The business has increased turnover from 1.5-1.8 million in the last two yearsand staffing levels have increased from 22-25 people.

The owner reported the FSA & associated red tape as the major constraint on thebusiness. Less time has been spent managing the business (down from 50% to 20% inthe last two years). 50k has been paid out in FSA consultancy fees (not including extrafee income for the company accountant), training sessions to ensure compliance withFSA regulations on documenting work practices (especially the Retail MediationActivities Returnwhich has never functioned properly online and the 25 day requirement

to ensure there are sufficient funds to cover all financial outgoings). The owner iscontemplating employing a full-time FSA specialist at an estimated cost of 60k perannum.

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Several owner-managers, for instance, reported that employment lawrestricted their capacity to manage employees as they saw fit. Others reportedbeing unpaid Government tax collectors and subject to suspicion and punitivesanctions where the tax and regulatory authorities viewed them as not fulfillingtheir obligations correctly. Penalties for non- or late compliance were reported

by several respondents.

Regulation mandates changes in working practices

In addition to the administrative costs associated with discovering, interpretingand implementing regulation, there are also the substantive policy costs ofcompliance.8 These include changes in working practices. For example, onegarage owner reported the introduction of computerised MOT test proceduresas the major influence on business performance at the time of interview,estimating that the new procedure would increase the time taken to conductthe test and result in 30k of lost revenue per annum. Interestingly, when

asked about regulation directly, the new MOT procedures were not reported(Case 9).

One particular adaptation to working practices as a consequence of regulationthat was deeply resented by several respondents was the recruitment (orredeployment) of staff specifically to deal with regulatory issues. The majorconcern of employers was the cost of an annual salary on what werecommonly perceived as unproductive workers. Yet, it could be argued thatemploying a dedicated regulation-handler might also be enabling forbusinesses, particularly in the longer term. It might enable a superiorregulation-handling capacity and/or a proactive orientation towards managing

regulatory change that could generate future benefits, particularly in relation tocompetitors who do are unwilling or unable to employ such a person.

These examples illustrate the key point that regulation is not solelyenabling,motivating or, most commonly perceived as, constraining but rather thatregulation generates multiple influences, which are enabling, motivating andconstraining simultaneously. Regulation that constrains business owners byplacing obligations upon them, for example, to submit annual accounts, alsooffers opportunities to develop managerial skills which, over time, cancontribute to enhanced business performance. Business owners frequently

8

Sometimes, the policy costs and the administrative costs are synonymous where theregulatory requirement is simply for businesses to record or supply information to thirdparties.

Case 9: Garage business bought in 2000 (founded 1973), where the owner had been anemployee since 1990. Employment: 7 employees. Annual turnover has more than doubledfrom 220k to 550-600k and has traded at a profit every year since 2000.

A new national computerised MOT procedure introduced from April 2005 increases MOTtest times and was estimated as likely to reduce sales by an estimated 30k per annum.Since price ceilings for MOTs are set by Government, the additional costs cannot bepassed on to customers. Satisfactory business performance enabled the owner to absorbthe lost sales.

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adapt business practices and products in response to perceived externalpressures for example, falling competitor prices, increased input prices - inorder to maintain or enhance competitiveness; regulation is a major, if oftenunacknowledged, source of such pressure.

Indirect Regulatory Constraints on Business Performance

Regulation can impact on the performance of a focal business in an almostinfinite variety of ways. Where regulation influences prospective customersnot to buy, job-seekers not to look for work, or suppliers not to sell to the focalbusiness owner then these are indirect constraining influences on that focalbusiness. This contrasts with regulations that enable or motivate customersto buy (more), increase the supply of labour by motivating individuals to seekemployment, or encourage suppliers to trade with the focal business.

Examples of indirect regulatory constraints include: alcohol licenses that

forbid sales to minors; traffic regulations that restrict the number of motoristsable to pass by, or park near, businesses in order to stop and buy goods (e.g.congestion charge, red lines, parking spaces); credit card regulations thatprotect card-holders; employment rights that prohibit employment of certaincategories of people (e.g. minors, foreigners); switching from analogue todigital television broadcasting; and tax payments to Government inevitablyreduce consumer spending power. A common complaint is that VAT ratesare too high and should either be reduced or abolished. This would enablebusiness owners to reduce their prices and, so the claim runs, achieve highersales. But if all businesses could do this, it is not obvious that any individual

provider would be any better off, particularly if the reduced tax revenuescaused Government to supply less infrastructure and public goods securityfrom crime, transport, energy, education etc - that supported market activity.

Regulation constrains business performance by motivatingemployee turnover

Regulation can impact on small business performance indirectly through itsinfluence on employee behaviour (Case 10). In this small electrical contractor,regulation influenced five employees to quit the firm simultaneously in order tostart their own businesses, causing major labour shortage problems for the

employer. Had the employer taken action to pre-empt the mass quit or hadsuitably qualified workers been easily accessible in the labour market, someof these problems could have been mitigated. This example highlights theunpredictability of regulatory effects, particularly indirect ones that depend onthe actions of important stakeholders in this case, employees.

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3.6 Regulation Generates Multiple Influences

So far, our analysis has focused on illustrating specific regulatory influences whether enabling, motivating or constraining and their impact upon businessperformance. Yet business owners experience multiple, and oftencontradictory, regulatory influences simultaneously. For instance, businessowners are simultaneously enabled by property and contractual rights todeploy assets they own or control as they wish, by consumer rights that givecustomers the confidence to buy goods and services, by employment lawsthat grant employers a general right to command employees, and by fairtrading laws that aim to prohibit anti-competitive behaviour.9

To illustrate how business owners manage these multiple and conflictingregulatory influences, data are presented from two cases, although manyother examples exist within our dataset. The first is a highly successfulstorage services company that had expanded from 2-160 people since theearly-1990s (Case 11); the second, is a much smaller plant hire business(Case 12). Both owner-managers report the diverse influences of regulation.In the first case, the owner was highly critical of regulation once the issue wasraised in the interview but subsequent probing revealed a more nuanced,even contradictory, picture in which the owner-manager acknowledged howregulation had enabled market opportunities for the business. Without further

probing, the research would have over-estimated the impact of regulation inmost cases. Such contradictory influences were evident in many businesses.

9 None of these rights, of course, are absolute; all are circumscribed.

Case 11: Document storage and self-storage business, founded in 1991. Expandedfrom 2-160 people in 11 major city locations and annual sales are up from 180k to 6m.

Growth has come from existing clients requesting new services (electronic storage,scanning, destruction). Profitability peaks and troughs depending on the timing ofinvestment in new premises to expand the business. Competitive advantage initiallyderived from being a prime mover in storage services in the home city during the early-1990s. Price is much more important now as larger rivals have entered the market andcompetition has intensified.

Regulation constrained business activity in many ways - high business rates limited thefinance available for business development; the compliance cost of time, thoughunmeasured, was a 'pain in the arse' (tempered by the knowledge that other companieshave to deal with the same regulations); and employment law made it difficult to dismissemployees. Pressed on these issues, the owner reported that impacts were difficult to

measure and were perhaps more of an irritant than a major impediment to performance.Impacts seem to refer to less tangible aspects such as eroding personal responsibilityand lack of trust rather than having direct effects on owners' decisions and actions. Anyadditional costs arising from regulation are passed onto the consumer wherever possible.

Initially unacknowledged, the owner agreed that regulation creates market opportunitiesby placing a statutory obligation on certain businesses to maintain records (e.g. health,law businesses). For businesses occupying expensive high street locations, contractingout document storage can help achieve economies.

Case 10: Electrical Contractor. Company bought in 1990. Employment: 10, plusoccasional subcontractors for peaks in work.The business had enjoyed steady growth inturnover and profits prior to last year (900k sales per annum) with the owner expecting tobreak even this year.

The introduction of Part P regulations in January 2005 stipulating that residential electricalinstallations be tested by competent persons had encouraged five qualified employees toquit the business on the same day in order to set up their own businesses. This mass quitcaused major business disruption. To service existingcontracts, the employer personallyhad to go 'back on the tools' and also use labour subcontractors, a practice previouslyavoided on quality grounds. Moreover, theemployers focus on servicingexisting contractsrestricted time spent on winning new work; consequently, there had been a decline in newcontracts obtained.

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3.7 Adapting to Regulatory Change

Case Study Sector: Residential Care

The residential care sector has undergone considerable change in recentyears as policy has reduced funding with serious consequences for both carehome operators and patients. Recent regulatory changes required care homeowners to adapt premises in order to meet new minimum care standards, forexample, patient numbers per room. Financial resources will influencewhether, and how, care home owners are able to adapt to the new policy andregulatory framework. Lack of resources might mean some owner-managers

are unable to make the changes necessary to comply with the new

Case 12: Plant Hire business, specifically to the utility contracting market. Employment:13 staff. Business is currently growing after the worst year (2004) since taking over thebusiness. Turnover now up to 1.6m per annum. The business appears to beprofessionally managed and since regulation is an integral part of their business,regulation is managed in the same way as all external relationships.

Regulation was reported as both enabling and constraining. Privatisation of the utilitieshad led to increased externalisation and this, indirectly, had increased businessopportunities. Although not acknowledged it seems very likely that contracting with largeutilities will make compliance with health and safety regulation a competitive necessity.

The respondent also reported some red tape issues, but nothing too serious, includingenvironmental regulations, impact of maternity leave and employment tribunalprocedures, and compulsion to pay the Construction Industry Training Board levy.

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regulations and/or they will have to reduce patient numbers to ensurecompliance.

Our first case illustrates how regulatory change can enable higher levels ofbusiness performance (Case 13). Businesses with substantial resources

possess the wherewithal to cope with any additional costs imposed byregulation and to be able to adapt to those changes. Competitors who cannotmight be forced to exit the market, leaving remaining operators in a strongerposition. High property prices had, the respondent believed, tempted many tosell homes to property developers. This had reduced capacity in the sectorbut offered greater market opportunities to remaining care providers.

Such options were not available to all care home owners. Another ownerreported that regulation had contributed to business closure (Case 14). Thenew national care standards had increased time spent on paperwork andreduced time for care. The greatest influence on business performance,

however, had been late payments by local authorities. The respondentbelieved that NHS reforms had made it more difficult for local authorities topay care homes. Late payment provoked a crisis of cash flow and eventually,the owner-manager was forced to close down.

Case 13: Residential Care home for elderly (2 establishments). Founded in 1984.Approximately 50 staff. Sales have increased dramatically in the past few years to 1.4mafter a period of loss-making. The homes were operated at a very high level of capacity

most of the time, currently 38.6 out of 40 beds. Block contracts with the local authority haveguaranteed revenue though this practice was about to change.

Regulation was increasingly perceived as an irritant, increasing costs to such an extentthat he would not start a care home today! New care standards since 2000 have forcedcare homes to provide more spacious facilities for patients. Existing homes have beenexempt from some new regulations but have been unable to replace patients until changeshave been made to meet the new standards. Regulation sets maximum prices that can becharged to NHS patients and patient-staff ratios that largely determine labour costs.Multiple inspections were perceived as time-consuming and unrelated to risk. Form-fillingwas perceived as a waste of time as no-one uses the information collected.

But: several regulatory influences though not reported, are clearly enabling for business

performance. First, care homes have to be licensed by local authorities, thus limitingcompetition. Second, the new care standards have encouraged some care home businessowners to exit the market, often selling to property developers, reducing the supply of carebeds but increasing opportunities for those that remain. Indeed, the owner felt thatstandards were already adhered to and so incurred no additional charges for him, therebyimproving business competitiveness.

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Under the same regulatory framework, care home businesses adapt indifferent ways depending upon the resources available to them, and theiradaptations generate various performance outcomes, in part depending onthe actions of other stakeholders, including major clients. It seems unlikely

that regulation in the form of National Care Standards - was anything morethan a minor contributory factor in the business closure decision in Case 19.Clients payment practices were clearly the crucial issue, although, ultimately,NHS payment practices are in large part shaped by regulation in this case,Government decisions on NHS funding. It is worth noting that the existenceof late payment regulation was of little use to the care home owner becausehe was either unaware of it or chose not to enforce it against a recalcitrantclient.

Case Study Sector: Taxi Services

Taxi services in London have become subject to greater regulation in recentyears. The Private Hire Vehicles (London) Act 1998 provides for the licensingand regulation of private hire operators, drivers and vehicles in London. ThePublic Carriage Office (PCO) undertakes day-to-day licensing activities onbehalf of Transport for London and sets license, application and inspectionfees. The declared purpose of regulation is to raise passenger confidencethat they are dealing with honest organisations, reliable drivers and safevehicles. Proprietors are responsible for maintaining vehicles, making themavailable for inspection, and keeping driver records. Drivers must undergo amedical and a Criminal Records Bureau check. All licensed vehicles must

meet certain minimum design criteria and undergo an annual inspection.There are approximately 25,000 licensed drivers10 and 20,000 vehicles11

licensed in London.

Two cases below are presented to highlight differences in operatorsadaptations to regulation and levels of business performance. Licensing,documentation and inspection all entail costs for operators and in that senseexert a constraining influence on performance. But, they also illustrate howregulation might enable improved business performance, for example, byencouraging customers to use taxis because they consider them safer to

10

http://www.tfl.gov.uk/businessandpartners/taxisandprivatehire/1366.aspx11http://www.tfl.gov.uk/businessandpartners/taxisandprivatehire/1380.aspx

Case 14: This 20 year old Residential Care Home was bought in 2000 complete with anexisting staff of 18 people. Turnover is 230k. The new owners inherited a 35k per annumloss and eventually late payments and bad debts by a number of local authorities forcedbusiness closure in 2004.

National care standards meant more paperwork and less care time with residents. Latepayments by local authority clients became a major issue and the business ran up a highlevel of bad debts. NHS reforms were viewed as affecting the ability of local authorities topay. The irony is that late payment legislation exist to penalise late payment practices.Employment law was perceived as making it difficult to dismiss abusive staff and this hadled the owner to engage an employment law firm to go to a tribunal case. The case waswon but at considerable additional expense.

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travel and by reducing the number of unsafe or unlicensed drivers andvehicles. The licensing requirement might deter entry by prospectiveoperators and/or exit by existing operators unable or unwilling to comply withthe new regulatory regime. By the same token, licensing might also make itmore difficult for firms to recruit drivers.

In the first case, the owner-manager reports that the intention

The Impact of Regulation on SME Performance-UK-2008

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Transcript of The Impact of Regulation on SME Performance-UK-2008