J U N E 2 0 11s t r a t e g y   p r a c t i c eWhy good companiescreate bad regulatorystrategies                      Andr...
2                            Too few ask themselves, “Why would                            anyone agree with us?”         ...
3                        often undermines efforts to engage productively with regulators. For                        evide...
4all the time. For example, until recently most leading smartphonesoftware players seemed to be taking a “less said, best ...
5 A good question for companies to ask is,“Why would anyone listen to us?” Leadership teams should subject themselves to t...
6                      implausible to outsiders. It also may provide a common vocabulary                      for communic...
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McKinsey QuarterlyWhy good companies create bad regulatory strategies

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The field of behavioral economics is rapidly making its way
into the tool kits of regulators.1 In stark contrast, we’ve rarely heard,
in our work with more than 300 companies over the past three
years, a senior executive consider the impact that cognitive biases
might be having on his or her company’s regulatory posture. That’s
understandable—people don’t like to think about the mistakes they
could be making—but it’s also a missed opportunity. Our sense is
that looking at regulatory strategies through the lens of behavioral
economics can help clarify the missteps corporate leaders make and
the corrective measures they should pursue.

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McKinsey QuarterlyWhy good companies create bad regulatory strategies

  1. 1. J U N E 2 0 11s t r a t e g y p r a c t i c eWhy good companiescreate bad regulatorystrategies Andre Dua, Robin Nuttall, and Jon Wilkins
  2. 2. 2 Too few ask themselves, “Why would anyone agree with us?” The field of behavioral economics is rapidly making its way into the tool kits of regulators.1 In stark contrast, we’ve rarely heard, in our work with more than 300 companies over the past three years, a senior executive consider the impact that cognitive biases might be having on his or her company’s regulatory posture. That’s understandable—people don’t like to think about the mistakes they could be making—but it’s also a missed opportunity. Our sense is that looking at regulatory strategies through the lens of behavioral economics can help clarify the missteps corporate leaders make and the corrective measures they should pursue. We’re not suggesting that leaders are downplaying the importance of setting an effective regulatory strategy. On the contrary, in a survey of roughly 1,400 global executives we conducted in January 2011,2 more than half of all respondents agreed that governments and regula- tors will be among the stakeholders with the biggest economic impact on their companies over the next three to five years (exhibit). An even larger proportion expects governmental involvement in their industries to increase over that period—all this despite recent conservative shifts in the United States and the United Kingdom. Nonetheless, a surprising number of corporate leaders and companiesArtwork by Sandra Dionisi continue to take positions that may seem credible internally but are totally incredible to outside observers and regulators. Simply put, there’s a disconnect between external perceptions and internal beliefs that 1 For example, University of Chicago behavioral economist Richard Thaler and Harvard Law School professor Cass Sunstein’s book, Nudge (Yale University Press, April 2008), provides a behavioral-economics playbook for regulators. Thaler is now helping the government in the United Kingdom apply these principles, and Sunstein is serving as the administrator of the White House Office of Information and Regulatory Affairs. 2 “Managing government relations for the future: McKinsey Global Survey results,” mckinseyquarterly.com, February 2011.
  3. 3. 3 often undermines efforts to engage productively with regulators. For evidence of this disconnect, consider some other results from our January 2011 survey. Seventy-six percent of global executives responding said they believed that regulators would rate their companies’ repu- tations as positive. Yet less than a quarter said that their companies frequently succeeded in inf luencing regulatory decisions. These executives think they’re doing right in the eyes of regulators, but their own, self-reported results say otherwise.Q3 2011 Biases in actionRegulatory strategyExhibit 1 of 1 The inflated view many executives hold of their companies’ reputations with regulators is consistent with the well-known cognitive bias of excessive optimism, which tracks with actions we see companies takeThe economic impact of governments and regulators islarge and growing, according to global executives.Expectations for the next 3–5 years, % of respondents1 Expected change inStakeholders expected to have the greatest effect on level of involvement witheconomic value of respondent’s company respondent’s industryCustomers 74 GovernmentGovernment and/or Increase 61% 53regulators2 Stay the same 27%Employees 49 Decrease 12%Investors 28 Regulators Increase 64%Suppliers 17 Stay the same 25%Media 9 Decrease 9%Nongovernmental 3organizations (NGOs)Organized labor 21 Respondents who answered “other” or “don’t know” are not shown.2Respondents could select multiple stakeholders; 36% selected government, and 29% selected regulators, which weredistinct categories. Altogether, 53% of respondents selected government, regulators, or both.Source: Jan 2011 McKinsey survey of 1,396 executives representing the full range of industries, regions, functionalspecialties, tenures, and company sizes
  4. 4. 4all the time. For example, until recently most leading smartphonesoftware players seemed to be taking a “less said, best said” approachto the thorny issue of tracking user locations over mobile networks.They have adopted a posture similar to that of Internet companies,which have remained confident that their services’ value to usersmore than offsets privacy concerns. Observing positions like these,it’s been natural for us to reflect on the experience of several Europeanairport operators, which were so convinced they would neverbe broken up that they simply didn’t entertain the possibility—untilit happened.A related challenge for companies in regulatory strategy is putting them-selves into the shoes of policy makers. Consider the proposals manycompanies made for grants, loan guarantees, or other governmentfunding as part of the American Recovery and Reinvestment Actof 2009. A surprising number didn’t mention job creation! Similarly,many companies fail to use the “budget math” of entities such as theUS Congressional Budget Office to discuss the impacts of proposedlegislative or regulatory changes. Others fail to take into accounthow the cost–benefit functions of government agencies operate or thebest way to communicate with them.Another issue for regulatory strategists is the prevalence of “stability”biases that create a tendency toward inertia. The impact of suchbiases is acute in regulatory settings because the typical career trackof successful executives in many industries—save highly regulatedones, such as telecommunications or electric utilities—doesn’t involveexposure to government issues. As a result, those executives oftenare personally ill-prepared for shifting political winds that boost theimportance of regulatory issues and are prone to underinvest inthe regulatory skills of their organizations or to delegate without exer-cising sufficient oversight. That’s one explanation for the frequencywith which companies must rapidly scale up their government-relationsfunction when they or their industries enter the crosshairs ofregulators—a phenomenon we saw during 2009 and 2010 as the UShealth care reform debate heated up.Countering biasesAddressing cognitive challenges like these is hard because executivescan’t change how their brains work. What they can do is put inplace processes for challenging entrenched beliefs and approaches.
  5. 5. 5 A good question for companies to ask is,“Why would anyone listen to us?” Leadership teams should subject themselves to this question on a regular basis. Drafting outside directors or a rotating group of senior managers from inside the company to argue for contrary positions sometimes helps. One European telecommunications company we know created, while it was still a quasi monopoly, a process for generating contrarian scenarios, such as complete breakup. These scenarios helped it recog- nize the potential for, and successfully pitch to regulators, a milder form of separation. A good question to ask during sessions like these is, “Why would anyone listen to us?” Leadership teams should subject themselves to this question on a regular basis—perhaps by conducting war games in which they explicitly put themselves in the shoes of other stakeholders or “voice of the stakeholder” exercises in which they interview (and figure out what is most important to) regulators, political actors, and the public at large. Such initiatives boost the odds of taking positions that are well received. Several companies we know used approaches like these to frame their proposals for contracts related to the US stimulus package, and they won five times the funding of counterparts that did not. There also are steps companies can take to ensure that regulatory strategy is not ignored. One large European telecommunications com- pany has a monthly “reg-watch,” led by the CEO, in which senior managers review emerging issues and a wide range of plausible scenarios, including their financial implications. Getting regulatory strategy on a board’s agenda also helps. And to strengthen organizational muscle, companies should build an exposure to government relations into talent development and job rotation for high-potential managers. The disciplined embrace of processes like these can help executives avoid embarrassing themselves by taking positions that seem
  6. 6. 6 implausible to outsiders. It also may provide a common vocabulary for communicating with regulators as they increasingly employ the tools of behavioral economics. Most important, it should help leaders navigate today’s choppy regulatory waters and achieve outcomes that are sustainable and that serve as a source of competitive advantage against less adroit—and self-aware—competitors. Andre Dua is a director in McKinsey’s New York office, Robin Nuttall is a principal in the London office, and Jon Wilkins is a director in the Washington, DC, office.Copyright © 2011 McKinsey & Company. All rights reserved.We welcome your comments on this article. Please send them toquarterly_comments@mckinsey.com.

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