When one thinks of regulatory compliance, the obvious things that come to mind are more headaches and more work. However, compliance keeps consumers safe and the environment healthy, and companies tend to create strong regulatory compliance functions, especially in industries that are highly regulated. Even strong regulatory-compliance functions within organizations tend to struggle because of lack of visibility and in some cases lack of authority. The situation is further complicated in emerging markets, where companies are entering an uncharted regulatory environment with little to no knowledge about local compliance issues.
A.T. Kearney recently completed a study of the regulatory organizations of several companies in highly regulated industries such as automotive, health care, aircraft and heavy equipment manufacturers. The study found that many companies struggle with the area of regulatory compliance in emerging markets.
Regulatory non-conformance in its worst form can lead to product recalls that can have significant financial impact on an organization. Toyota, for example, recently had to recall a large number of vehicles due to brake problems and appropriate quality standards not being followed.
What are the key business risks and challenges companies face from a regulatory perspective as they push the boundaries of growth in the emerging markets?
1) Regulatory often is not at the table for key strategic decisions.
The regulatory group is viewed as a "necessary evil" in many organizations and is more of a reactive than a proactive organization. In some organizations that we interviewed, key strategic decisions such as market entry are bereft of regulatory counsel from the onset, and the regulatory function is brought in only to play a more tactical role of compliance.
A case in point was a large automotive company that was looking to enter the Indian market and did not have its regulatory function involved in the process. The regulatory function in this particular case was not a strategic function but a more tactical, reactive organization. As it turned out, the length of the homologation process for certifying a particular type of vehicle for the Indian market was not factored into the project plan, resulting in significant risk to the launch date. Also, lack of visibility by the regulatory function into future market entries often led to the creation of a different model variant to satisfy each market's individual regulatory requirements. This limited the ability of the company to develop a multi-regional product and greatly increased the internal cost of complexity (e.g., number of tests required, documentation requirements, number of SKUs/models and associated inventory, customer support, etc.).
2) Uncertainty of regulations in emerging markets.
Regulations in emerging markets can be tricky, both from the standpoint of interpretation and compliance. Several companies interviewed complained about the lack of uniformity in interpretation of regulations in emerging markets. In one example, a medical device company established a manufacturing presence in China to serve both international markets and the Chinese market. The company later realized that the regulatory pathway to serve the local Chinese market was much longer than it had initially been led to understand.
Another challenge is getting visibility into future regulatory requirements. Whereas markets such as the United States and the European Union often publish a clear regulatory roadmap -- e.g., Euro 6, published in June 2007, outlines requirements for vehicle emissions beginning in September 2014 -- some countries have given less than three months between publishing future requirements and the date for the regulatory requirements to be effective in the market.
3) Knowledge management within the organization.
With expansion, a company's knowledge on regulatory matters becomes often stretched across the firm. Nearly 80% of companies interviewed indicated that they struggle with knowledge management at some level. A common issue is when information is spread across the organization. For an automotive client, we identified key regulatory information located in no less than 30 different systems and locations. To exacerbate the problem, much regulatory information can be of the "tribal knowledge" variety, residing in the minds of engineers, product testers, regulatory professionals and others. While "tribal knowledge" may have been manageable at one time, it becomes difficult to keep track of this information as companies grow, and especially dangerous during employee attrition or layoffs as an organization can unknowingly lose key knowledge.
Dissemination of knowledge is a related challenge when a company has to process masses of information to identify what is important from a regulatory perspective and to whom is it important. For example, a client experienced a nearly three-fold increase in the number of engineering changes per model year that the regulatory group had to review and approve. This occurred over a period of just three years as a result of the company's aggressive expansion into new markets and the number of new models required. The company indicated that at the time, the risk involved by "letting something slip through" was much higher, as the regulatory group simply did not have the bandwidth to review each engineering change to determine if it had regulatory implications in the different markets that the model was sold.
"Where we struggle is dissemination -- how to sort through the masses of information we have collected." -- Senior executive, Fortune 20 company
How Leading Organizations Operate
These challenges can create large risks for organizations if not addressed. However, we have found several consistent themes within leading organizations:
1) The regulatory function has a clear role in the organization. The study identified that the organizational structure of the group typically supports one of three regulatory strategies:
- Risk-averse model, seen commonly in aircraft manufacturers and health care companies where safety is a large aspect of regulatory compliance and consequences of product-compliance failures can be catastrophic. In this model, the regulatory group usually has a direct reporting structure into the CEO or general manager of a business unit. Products tend to be designed to the most stringent regulatory standards that facilitate homologation in the different markets.
"Regulatory function for us is paramount, and we adhere to the most stringent of all regulations on a global platform. For example, we would adhere to the FDA-set standards in an emerging market where local regulations are more relaxed. In essence, we are very conservative in our approach to health and safety regulations." -- Senior executive, global health care company
- Speed-to-market model, seen in some automotive and health care companies. In this model, the regulatory group usually is closely linked with the R&D organization. The core competency of regulatory is getting products approved efficiently and quickly to allow fast product launches. The regulatory organization is completely integrated in the product-development process from the early strategy and concept-development stages. This allows the regulatory function to identify and include regulatory requirements for new markets into the product-development plan early. It avoids the reactive scramble and design changes when country-specific requirements are identified after the early design already is completed.
- Compliance model, seen in heavy equipment, and some automotive. In this model, the regulatory organization is usually several layers down in the organizational chart. In one example, regulatory reported to the director of Environmental health and safety. This model suits companies in which the product-development cycle is longer and the risk of compliance failure is less catastrophic.
Regardless of the strategy, the regulatory organizations of leading companies are active participants in the long-term strategy plans and have forward visibility into future target markets. In return for a seat at the table, the regulatory group is expected to identify risks with the future strategy and quantify the business impact and likelihood of occurrence.
2) Establish a presence in emerging markets. While it may seem obvious to have resources on the ground to monitor regulations in emerging markets, many companies have found that this by itself is not enough to avoid getting caught off-guard. As one regulatory manager put it: "You need to have eyes and ears where it counts." One strategy used by leaders is to map the key stakeholders in the market by function, role and sphere of influence (e.g., chief minister of health and environment), and assign someone who has the right skill set to engage them, and understand their agenda. In certain cases, it also may be appropriate to influence them. For example, where regulations are undefined and government regulators are not as familiar with the various technologies, these regulators sometimes look for technology partners to help them define the regulations for their countries.
3) Managing uncertain regulations. Managing regulatory risk exposure, especially in the face of uncertain regulations (e.g., environmental regulations around carbon emissions), in a more proactive manner as compared with a do-nothing scenario tends to be financially beneficial to organizations. One client uses forward-looking scenario modeling to assess levels of shareholder value creation or destruction based on carbon-taxation levels, minimum performance requirements, product-recycling responsibilities and future fuel/energy costs.
4) Proper knowledge-management codification and dissemination. Knowledge management is one of the most significant challenges for regulatory functions within organizations. Proper capture of knowledge and centralization of information sources yield process efficiencies. A few actions taken by companies for proper codification and dissemination of knowledge include:
- Creating an "expert tracker" database for knowledge that resides within individuals of the organization and attempting to centralize and disseminate information.
- Disseminating information through multi-level training at different stages of careers of regulatory affairs personnel and affiliated functions.
- Creation of customized reports on "interpretation" of regulations and ensuring that the regulatory function is the ultimate authority on any aspect of regulatory compliance.
- Tracking regulatory KPIs with a balance of lagging indicators (e.g. issues generated after sales) and leading indicators (e.g. revenue at risk from potential regulation changes)
In essence, regulatory functions within organizations -- especially those that have global ambitions -- should not be merely reactive and tactical, but more proactive and aligned with the global product strategy of the organization. Doing so will ensure that there are minimal regulatory-compliance challenges and there is timely mitigation of non-conformance risks.
Joachim Ebert is a partner with A.T. Kearney based in Dallas. Omar Hafez and Amiya Setu are managers with A.T. Kearney based in San Francisco.