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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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- The dynamic of economic and social contestability applied to metal recycling
The dynamic of economic and social contestability applied to metal recycling
The analysis set out in this paper makes it possible to propose an overall model for the degree of economic contestability of a business operator occupying a central position in a branch, and to explain the relationship between the operator's economic contestability and his social contestability (see Diagram 3 below). The model is supported by stylised empirical evidence from a recycler who obtains supplies from scrap metal collectors in a defined geographical area, in order to satisfy the standardised demand of his principal downstream customer (a steel manufacturer).
The exposure of a historic recycler to a threat of economic contestation, arising either from competition from a new entrant (external contestability) or from the integration strategy of another operator in the same trading environment (economic contestability internal to the branch), has been evaluated based on the defining technical and economic characteristics of metal recycling, a business that must both be able to access an upstream market and meet the demands of a downstream market. The analysis based on these characteristics uses a dual assumption in which the two aspects are linked: the right business assets are required to enter the market initially; and sensitive exchange relationships with the two markets identified must be managed carefully for a continued presence.
What distinguishes a recycling business is that it buys, handles and processes waste material, the nature of which not all parties in the trading environment are fully informed about. Rightly or wrongly, a proportion of this material is considered to be potentially dangerous to health and to the environment. In the context of this type of activity, the analysis proposed here highlights and explains the link between a primary form of contestability, arising from competitive economic mechanisms, and a second form, arising from active social processes that are sustained by health and environmental considerations. The degree of health- and environmentally-based social contestability expresses the operator's exposure to the threat that the legitimacy of his business will be challenged in the name of collective risks affecting health and/or the environment.
According to the Contestable Management model (Hommel, 2001; Hommel and Godard, 2001), and in line with the economic theory of contestable markets, the assets on which an operator relies determine his objective exposure to the threats of internal or external economic contestation. The costs associated with acquiring these assets and the fact that they cannot be transferred during their useful life without incurring losses (they are sunk costs) are both exit barriers, and hence barriers to entry. At the same time both factors contribute to exposing the historic operator to a threat of environmentally-based social contestation, while simultaneously reducing his economic contestability.
Research into the problems for an operator recycling ferrous metals within a trading environment has shown that the operator relies on three categories of asset.
The first is the category of productive assets, defined narrowly as production equipment. Either these assets contribute directly to transforming scrapped assets that are partly recyclable into secondary raw material; or they are technical tools for treating the waste produced by the recycling processes themselves.
The second category comprises the intangible assets required to sustain transactions on the two markets of the branch, and to ensure that goods of the right quality are supplied. The asymmetry of information and expertise inherent in scrap recycling are often the cause of market failures and these assets help overcome those potential problems.
Lastly, the third category includes all assets linked to geographical location. Their relevance to metal recycling becomes clear when it is shown that, for a recycling activity, the geographic features of the site and the need to transport materials are strategic variables, both in collecting scrap to recycle and in supplying the downstream.
These three types of assets affect (i) the probability of a successful entry by a new operator challenging an incumbent one, (ii) the economic benefit there is to an upstream operator in integrating downstream (or to a downstream operator in integrating upstream) to compete with the historic operator, or (iii) the opportunity a historic recycler has to delocalise his activities.
The analysis suggested here has shown that these three categories of asset form a coherent structure necessary to the recycling business, but that they also form barriers to entry and exit. The line of reasoning can be summarised as follows.