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- Report n°2: An integrated approach to economic and social contestability in business
Report n°2: An integrated approach to economic and social contestability in business
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Table of contents
- The contestability of an economic operator: a multi-dimensional strategic variable
- Between economic contestability and social contestability
- The contestability of an economic operator: a multi-dimensional strategic variable
Between economic contestability and social contestability
Social contestability on environmental or health issues
Taking the theory of contestable markets as their main inspiration, and the regulatory effect of a threat of potential competition, Hommel and Godard (Hommel, 2001; Hommel and Godard, 2001, 2002) highlighted the implications of phenomena of social protest grounded in environmental and safety matters. According to their model of Contestable Management, a firm's contestability is characterised by its exposure to two types of threat: economic contestation from competitors and contestation of its social licence to produce and innovate, based on environmental or health-related risks to the community (or "collective risks") attributed to the firm's products or processes.
The link between the theory of contestable markets and the Contestable Management model is first established on the basis of the characteristics of the productive assets used. The authors propose the notion of time horizon of economic engagement(3) (the time taken to see a return on investment into the productive asset in normal conditions) to characterize an operator and its assets which is the pivotal idea determining the sensitivity to the threats of contestation. Premature withdrawal from the activity before reaching that horizon would result in a net loss, preventing easy recourse to an exit strategy from the market in the event of severe contestation: choosing such a strategy would result in high unrecoverable costs. In this context, the objective characteristics of the assets (degree of specificity, amount of investment, scale of production required to break even) determine the horizon of engagement, which coincides with the horizon of sensitivity to a threat of social contestation.
Then, considering in the classic manner that assets or technologies are generally subject to phenomena of obsolescence, the Contestable Management model takes into consideration a second characteristic of the productive assets, which is moral obsolescence. Technical obsolescence is a critical determinant which, over time, reduces the residual market value of a productive asset and renders a portion of the investment costs irrecoverable (Hommel, 2001, p.91). With the notion of moral obsolescence, the Contestable Management model takes into account the economic effect of the agents' beliefs regarding the effective horizon of engagement of a productive asset, when those beliefs concern the legitimacy of a process or an asset. Moral obsolescence may be strong when a firm's processes or products are discovered to have negative impacts on health or the environment. The degree of social contestability of an established firm on a market expresses the measure of that firm's exposure to a risk of moral obsolescence resulting from contestation of the legitimacy of its economic activities because of potential risks to the community.
(3) In the sequel we will use alternatively use "time horizon of economic engagement", "time horizon" or "horizon of engagement/commitment".
From economic contestability to social contestability
From the strategic standpoint, the two forms of contestability identified are not independent: when an established operator on a market seeks to reduce his exposure to a threat from potential competitors, he may do so by acquiring specific assets or assets requesting to spread amortization over a significant level of production that would be difficult or even impossible to access for a newcomer tempted by a "hit-and-run" strategy. Such assets are by definition less easily recoverable than standard assets, which fact in itself increases that operator's exposure to a threat of social contestation for environmental or safety reasons.
The graphs here below (Hommel, 2001; Hommel and Godard, 2001) illustrate the relationship between the two forms of contestability for a firm well-established on a market.
In the first case (graph 1), a firm attempts to reduce its exposure to threats from new potential competitors on a highly contestable market. Actions aimed at reducing that economic contestability may increase its exposure to a threat of social contestation when those actions imply extending the horizon of engagement and increasing the irrecoverable short and medium-term costs.
Graph number 2 illustrates the case an established firm on a market whose extent of economic contestability by potential competitors is low. Among the various strategies the firm could use to reduce its exposure to protest on environmental or health fronts, some have the direct effect of increasing the credibility of threats from potential newcomers, since they aim to reduce the horizon of engagement and increase flexibility: reducing the extent of environmental contestability would result in increasing the extent of economic contestability.
