Companies behaving badly?

Speakers: 
Mr Rod Sims, Chair
Conference: 
2018 Giblin Lecture
13 July 2018

ACCC Chair Rod Sims delivers a speech at the 2018 Giblin Lecture on the behaviours the ACCC has seen from companies, why the behaviours may occur and what should be done about it.

Transcript: 

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Good afternoon ladies and gentlemen, and thank you for inviting me to deliver the 2018 Giblin Lecture.

As you all know this economic lecture series is named for Lyndhurst Falkiner Giblin; a truly remarkable man. I studied in the Giblin lecture theatre at the University of Melbourne, many years ago, and so feel some sense of personal connection to the man.

Giblin was born in 1872, and died in 1951. To give an idea of the changes he experienced in his lifetime, consider this: when he was born convicts were still gaoled at Port Arthur, and when he died Australia had just celebrated its 50th anniversary of Federation.

At various times in his life he was a student at Cambridge, and then Kings College, a rugby player for England, a frontiersman in the Canadian Yukon, a lumberman, a sailor, a ju-jitsu instructor, a Tasmanian state MP, an officer in the Great War, a statistician for the Tasmanian government, a university professor, and an Acting Commonwealth Statistician for Prime Minister Joseph Lyons, and later for Sir Robert Menzies.

Giblin personally knew John Maynard Keynes, they were friends, and Giblin was at least partly responsible for coming up with the economic concept of the multiplier. Considering this, and his foundational work in economics at the University of Tasmania, it is most appropriate that this lecture series should bear his name, and I am certainly honoured to be here speaking to you today.

The title of my address today is ‘Companies behaving badly?’ and it is posed as a question. Not all companies, of course, behave poorly; hopefully the ones that do tend to be the exception, rather than the rule.

The ACCC’s experience, however, would suggest that hope may be misplaced, and this concerns me and should concern us all.

What is important to note, however, is that poor behaviour usually occurs on a spectrum, with few companies behaving badly often, but rather many engaging in occasional significant instances of bad behaviour, which remains unacceptable.

My thesis today is that the appropriate corporate desire to maximise returns to shareholders too often results in behaviour that sees the customers of companies lose out, and that the incentives to behave this way currently often outweigh the incentive to put the customer first.

To explain this thesis, today I will be addressing three topics, very much from the perspective of the ACCC.

  1. What behaviour have we seen from companies?
  2. Why do we think this behaviour is occurring?
  3. And finally, what should be done about it?

1. What behaviour have we seen from companies?

It is often said that companies succeed by looking after the needs of their customers. I have been surprised over very many years, however, at the way in which many businesses often do precisely the opposite.

That is, they appear to put immediate profit ahead of their customers either by engaging in misleading or unfair conduct, or even unconscionable conduct towards their customers, or they engage in cartel or other anti-competitive activity that raises prices for their customers.

By way of example, in reviewing our enforcement activity in April, in just one month alone we saw the following.

  • Ford was ordered to pay $10 million in penalties after it admitted that it had engaged in unconscionable conduct in the way it dealt with complaints about PowerShift transmission cars, sometimes telling customers that shuddering was the result of the customer’s driving style despite knowing the problems with these cars.
  • Telstra was ordered to pay penalties of $10 million in relation to its third-party billing service known as ‘Premium Direct Billing’ under which it exposed thousands of its own mobile phone customers to unauthorised charges.
  • Thermomix paid penalties of over $4.5 million for making false or misleading representations to certain consumers through its silence about a safety issue affecting one of its products which the company knew about from a point in time.
  • Flight Centre was ordered to pay $12.5 million in penalties for attempting to induce three international airlines to enter into price fixing agreements
  • a second Japanese shipping company, K-Line, pleaded guilty to criminal cartel conduct concerning the international shipping of cars, trucks and buses to Australia
  • proceedings against Woolworths were instituted alleging that the environmental representations made about some of its home brand picnic products were false, misleading and deceptive.

And unfortunately, this is just the tip of the iceberg.

Earlier this year, the Federal Court found that the food manufacturer Heinz had made misleading claims that its Little Kids Shredz products were beneficial for young children, when they contained approximately two-thirds sugar.

Who could forget the infamous marketing of Reckitt Benckiser who made misleading representations on the packaging of each of its four Nurofen Specific Pain products? They represented that each was specifically formulated to treat a particular type of pain when in fact each product contained the same active ingredient and was no more effective at treating the type of pain than any of the other Nurofen Specific Pain products. The key difference was that the specific pain products were near double the price of the standard Nurofen product.

Hotel giant Meriton was caught out recently taking deliberate steps to prevent guests it suspected would give an unfavourable review from receiving TripAdvisor’s ‘Review Express’ prompt email, including by inserting additional letters into guests’ email addresses so that their email addresses would not be correct. The Court found this to be a deliberate strategy by Meriton to minimise the number of negative reviews Meriton’s guests posted on TripAdvisor.

Recently Optus Internet admitted it made misleading representations to around 14,000 customers about their transition to the NBN, including stating that their services would be disconnected (in as little as 30 days in some cases) if they did not move to the NBN when under its contracts they could not force disconnection within the timeframe claimed.

Pental also recently admitted that it made misleading representations about its White King ‘flushable’ cleaning wipes saying that they would disintegrate in the sewerage system when flushed, just like toilet paper, when Australian wastewater authorities face significant problems because they can cause blockages in sewerage systems. We have a similar case against Kimberly-Clarke still being contested before the Court.

We have seen more bad behaviour in the education sector in recent years than you would hope to see in a lifetime. In one case, Acquire Learning and Careers was ordered to pay penalties of $4.5 million for its tactics in pressuring consumers to enrol in vocational training. The Court found its model was based on maximising the number of enrolments it was able to achieve for its clients and thereby maximising the fees payable to it. The judge said its activities resembled those of an unscrupulous ‘fly-by-night operation’ rather than those of a prominent and market leading provider of student recruitment services, as it described itself.

A few years ago the companies behind Bet365 paid penalties of $2.75 million for its ‘free bets’ offer in which it failed to make clear that in order to receive the represented $200 free bet offer, new customers were required to deposit and then gamble $200 of their own money first.

And too many large companies continue to mislead consumers about their fundamental consumer guarantees which provide for refunds, replacement or repair when a good is faulty.

For example, following the so-called ‘error 53’ which disabled some iPhones and iPads, Apple Inc admitted it misrepresented to a number of Australian customers that they were no longer eligible for a remedy if their device had been repaired by a third party, often with a low cost screen replacement. Apple Inc was ordered to pay $9 million in penalties.

At the end of last year, the Full Federal Court upheld the finding against Valve, one of the world’s largest online video game retailers, that it had made misleading representations about consumer guarantees.

And it is not just consumers who are subjected to bad behaviour from big companies.

In 2014, the Court imposed penalties against Coles of $10 million in relation to a number of allegations including demanding payments from its suppliers to which it was not entitled by threatening harm to the suppliers that did not comply with the demand, and withholding money from suppliers it had no right to withhold. The Court described the conduct as ‘serious, deliberate and repeated’ with Coles treating its suppliers in a manner inconsistent with acceptable business and social standards which apply to commercial dealings.

More recently, the ACCC has been taking action over unfair contract terms. In its first case under the new laws, the Court found that eight unfair terms in waste management company JJ Richards’ standard form contracts with small businesses included terms that bound customers to subsequent contracts and allowed unilateral increases in prices, and created unlimited indemnity.

On the competition side we have seen a range of cartel behaviours; this is behaviour where competitors agree to raise prices directly or restrict supply to achieve the same result, all of which hurts their own customers, and the wider economy.

In recent years we have seen cartel behaviour in laundry detergent, bottled gas, banking, aviation, travel, shipping, and we now have recent matters before the courts making important allegations in relation to health care products and again in banking. Many of the companies involved are household names.

We also alleged anti-competitive behaviour to boost petrol prices to their customers amongst the major petrol companies by each giving their near real-time pricing to a central source, so that the petrol retailers could almost immediately see how their competitors were changing their prices. We eventually settled the case on the basis that this near real time data was now made available to the public.

I could go on, and on, and with such lists. There is clearly no shortage of work for the ACCC. You will observe that the list includes well known and respected major Australian companies who have admitted, or been found, to have breached our competition and consumer laws. These same companies regularly proclaim they put their customers first.

Customers hearing this refrain have a right to think companies are hypocritical. This can make them question whether our market economy works in their interests.

2. Why is this occurring?

The perennial question that is always asked when improper behaviour comes to light is, ‘Why is this happening?’

A number of reasons are worth exploring.

Meeting customer needs may not be the main way companies succeed

Firm behaviour can be explained by the motive to earn and grow profits.

The pursuit of profits is fundamental to the success of capitalist economies, and in itself is not problematic at all; indeed, it is an extremely powerful tool to promote social welfare. It means that businesses that can best meet the needs of consumers over the longer term usually prosper and survive, and those that do not fail. It encourages innovation and progress. Measures that interfere with the pursuit of profits should be very carefully examined, and not taken lightly.

However, being the best at meeting the needs of consumers is not the only, or even the dominant, way firms succeed. Staying ahead of rivals through continual improvement is a difficult task for most companies; eventually someone works out how to do things better and cheaper.

Commercial strategy therefore is largely about building defences against the forces of competition. To make it more difficult for other firms to develop a better product. Or if they do, to limit their access to customers. This is all perfectly legal and appropriate, so long as it is conducted within the rules.

Harvard Business School economist Michael Porter, the doyen of corporate strategists, demonstrated that firms can best attain commercial success by reducing the number of competitors, by erecting high entry barriers, by keeping suppliers dispersed and weak, by creating strong consumer loyalty, often through brand building or by bundling products, and by reducing the likelihood of other firms being able to offer your customers products that they see as substitutable for your product.

Company executives are under considerable market pressure to grow short term profits

Companies strive to grow. Companies that continually grow profits can attract investors, increase in value and pay high bonuses.

Many companies set high profit growth targets to meet market expectations. Often these targets are higher than real GDP growth which is currently forecast to increase by 3 per cent over this financial year.

By definition, therefore, not all firms can meet or exceed market expectations. In some cases company executives push the boundaries to achieve short-term growth targets. Some appear to ignore the risk of reputational damage over the longer term to achieve short-term gains.

There is nothing wrong with pursuing profits, but it would be better if the focus was on longer term profitability.

In some markets poor firm behavior largely goes ‘unpunished’

The strongest constraint on firm behaviour is the risk of losing sales. The larger the number of customers that ‘vote with their feet’ in response to poor behaviour by firms, the more firms will do to avoid engaging in such behaviours.

Three conditions are important in this regard.

First, poor behaviour must be visible to the consumer. Generally speaking, consumers are oblivious to misconduct unless they are directly affected by it. Further, misleading behaviour and cartel conduct by their nature are hard for consumers to detect.

Second, consumers must have viable alternatives. Many markets in Australia are concentrated and customers have few alternatives. When issues are widespread among industries that are concentrated it becomes more difficult for consumers to respond due to a lack of relative choice. In concentrated markets, there is usually much less incentive to break ranks.

Third, switching to another provider must not be difficult or costly. In many retail markets, the offers available can be difficult and costly for consumers to collect and understand. In our Residential Mortgages Price Inquiry, we found that there is a considerable lack of transparency in the pricing of residential mortgages. Borrowers often have to lodge an application and hand over substantial information in order to confirm the interest rate an alternative provider is willing to offer.

It can be a race to the bottom rather than to the top

Poor behaviour can interfere with the competitive process and cause a ‘race to the bottom’. In well-functioning markets firms compete on their merits where firms that offer what consumers value displace firms that do not, but the opposite can occur if poor behaviour goes undetected and unpunished, as it can confer a competitive edge.

We have observed firms winning customers through misrepresenting their offers and employing high pressure selling tactics. In addition to hurting consumers, this type of behaviour hurts rival firms. In response to this conduct, rival firms can endeavour to protect their market share by improving the quality of their sales techniques or by employing the same questionable sales tactics to ‘level the playing field’.

We observed this ‘race to the bottom’ in door to door selling by electricity retailers. The leading retailers knew it was resulting in bad behaviour but refused to address it for fear of losing out to their competitors. In recent years we have taken six retailers to court for misleading and often unconscionable practices, and as a result the main three electricity retailers stopped door to door selling entirely.

Recently, a number of current and former bankers have in effect said their firms engage in behaviour they know to be inappropriate because they would lose out to their competitors if they did not.

I find such an approach, both by bankers and electricity retailers, appalling. Then you hear senior business executives express surprise at how they and their behaviour are perceived by the community.

Financial incentives are sometimes created without adequate safeguards

Companies use financial incentives to reward employees and agents who achieve or surpass sales targets. This is a legitimate and effective way of encouraging sales teams, especially in circumstances where it is not possible or is costly to observe effort. It can, however, have negative consequences when proper safeguards are not established to limit how staff or agents achieve their sales targets.

We have seen a number of company executives display surprise when confronted with the bad behaviour of some of their staff or agents. This in itself is surprising. By their nature financial incentives typically focus on outcomes in the short-term, and do not focus on how targets are met. This creates an environment in which bad behaviour and shortcuts may proliferate.

Company executives are no doubt aware of the imperfections of even well-designed financial incentive schemes. There are cost and benefits that companies must weigh up. The stronger the link between financial rewards and short-term outcomes, the greater the effort it is likely to encourage and the greater the risk of disreputable behaviours. Alternatively, the more auditing that occurs with clear and important consequences for bad behaviour, the less the risk. What is surprising is where some companies strike this balance.

The point about incentives, however, can be much broader. Companies can establish poor business models. We have recently had prominent examples of arrangements that left little room for franchisees to achieve a return on their investments and pay their workers award wages.

There are many examples we see of business models engaged in by major Australian companies that could be seen to invite bad behaviour towards their customers. Candidates include outsourcing key customer contacts and rewarding those involved only for winning new customers with poorly structured commissions, allowing third parties to use your systems and failing to put safeguards in place to protect your customers, and vertical integration in providing financial advice to gain more sales of financial products, to name a few.

There can be a mismatch in perceptions

It is important to recognise that companies can be seen by the public to be behaving badly when the company boards and senior managers think are doing nothing wrong, they are behaving rationally and, indeed, are benefiting the economy.

A great example is price dispersion, particularly between old and new customers. This occurs in many markets where customers purchase a continuing stream of services, such as in banking and electricity.

Economists often argue price dispersion is welfare enhancing. In a competitive market the excess rents made from the “sticky” customers will be likely offset by the low prices to new or switching customers. And lower prices to the latter group can increase overall demand for the product.

Companies simply see a chance to make money; why give a lower price to someone who does not ask for it, even if they are your loyal customer?

There are two problems.

First, the economics may not be so simple. Price dispersion can encourage extra search activity which represents a cost to society; and some people are less able to search which can increase inequality.

Second, the common reaction from loyal customers is outrage when they discover they have for years been paying more than they needed to.

I often get letters from people, including small businesses who, when they finally complain about their electricity charges, are told they can be moved to a lower rate. They then realise this could have happened years ago if, in their eyes, their loyalty had not been abused.

Company loyalty can be too strong

Finally, it often appears as if company executives behave differently when they are at work, than the way they would privately. I seriously wonder whether the company executives involved in the behaviour in section 1 would behave in that way if they were, for example, selling their own car privately.

Would they lie about past faults? Or at least push boundaries as hard?

Often it appears as if they feel their obligations to their company compels them to pursue profit to the maximum, even if their behaviour pushes too close to the boundaries of the law.

It also sometimes appears as if there is no other ethical standard being applied than adherence to some technical interpretation of the law. In many of the cases I mentioned in section 1 of this lecture the cases were heavily contested, on occasion all the way to the High Court.

Clearly the companies had legal advice that they had prospects of success in court given their particular behaviour and the letter of the law.

A question I think all companies need to address is what defines them?

Do not get me wrong. I am aware that our society is only as prosperous as it is because hard decisions need to be made; to close a business, reduce staff, or to buy from a better supplier. The profit motive is the key to all this.

These decisions can all be made, however, without pushing hard against the boundaries of the law.

3. What can be done about it?

So what can be done about businesses too often behaving badly?

As I have said, the profit motive is the key driver of economic prosperity and should not be interfered with lightly. The pursuit of profit and personal gain is at the heart of a market economy.

This is no better captured than by Adam Smith, who said:

It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.

This is possibly the most profound quote in economics; it, of course, came from a moral philosopher.

Some interpret this to mean we should not interfere with the workings of the market economy.

This is wrong in logic; and Adam Smith would not have agreed. Smith argued strongly that the discipline on the ‘invisible hand’ was competition, the promotion of which he felt was a key role of government, and he argued that a market economy was only there to benefit consumers.

So what can be done?

I believe that the first step is for Directors and senior management to give more consideration to balancing short and longer term profit considerations, to the interests of their customers and suppliers, and to the reputation of their company.

I will leave them to reflect on this. They may well resent being lectured on this by the regulator.

So let me then turn to what governments and regulators can do to improve competition and outcomes for consumers.

Increasing the private cost of bad behaviour is the key to reducing its incidence

In order to encourage companies to think more about the negative consequences of the incentive structures they create, we must do more to internalise those consequences. That is, the key to reducing the incidence of bad behaviour is to increase the private cost to companies of engaging in those behaviours.

There are a number of things that can be done in this regard.

Identify and shine a light on bad behaviour

Many businesses make significant investments in their brand reputation. A strong brand reputation is a signal to customers than the firm can be trusted to do what it promises to do.

Bad behaviour by a company can undermine its brand reputation. The greater the likelihood that bad behaviour will be exposed and made public, the more companies will do to guard against such behaviours

A key value of the Royal Commission has been to expose the poor behaviour of financial institutions to public scrutiny. The evidence about the conduct of AMP was particularly damning. The resulting damage to AMP’s brand reputation has been substantial.

Regulators need to be proactive in identifying bad behaviour and be transparent about what they see; it is not enough to simply take enforcement action after breaches occur.

In recent times the ACCC has increased its focus on market studies. These studies focus on markets that, on the surface, do not appear to be functioning as effectively as they could. It is often the case, in conducting these markets studies, that the ACCC has powers to compel firms to provide documents and other information. This enables the ACCC to assess the functioning of the market and to identify the behaviours of firms operating in the market.

The ACCC has recently completed inquiries into gas, beef, motor vehicles and electricity. Our retail electricity pricing inquiry exposed how companies increasingly relied on confusing consumers with discounts off varying bases, and inflated their standing offers so that discounts appeared larger.

Standing offers exist to be a safety net for vulnerable or disengaged customers, who suffer considerably from this behaviour.

The ACCC has current inquiries into gas (round 2), the financial services sector, and Northern Australia Insurance. The ACCC is also currently inquiring into the effect digital platforms, mainly Google and Facebook, are having on competition in media and advertising services markets. The digital platforms inquiry will particularly focus on the personal data Google and Facebook collect from users and how they use it.

Increase penalties to deter bad behaviour

Many of the bad behaviours of businesses breach our competition or consumer law. The ACCC regularly takes enforcement action against companies, large and small, for conduct that is misleading, unconscionable or anti-competitive.

The market economy is based on incentives.

When the incentives for misconduct are strong, and the penalties for misconduct, given the likelihood of detection, are comparatively weak, it is easy to understand that company boards and senior management do not act strongly enough to ensure such behaviour does not occur.

So from our point of view, stronger penalties are a key part of the answer. Accordingly, the ACCC strongly encourages the Parliament to approve changes to the Australian Consumer Law, or the ACL, bringing increased penalties for contraventions of the ACL. Increasing penalties for contraventions of the Competition and Consumer Act, and the ACL, has long been a priority focus of the Commission.

Continually look for ways to increase our ability to identify and pursue bad behaviour

The ACCC has around 60 people dedicated to investigating potential breaches of our consumer law in all sectors and in all states and territories. We have a similar number of people investigating potential breaches of our competition law, in all sectors of the Australia economy. These numbers has not changed much for many years, yet our economy has grown considerably.

We are continually looking for ways to improve our effectiveness in enforcing the Competition and Consumer Act. More important, we need to make hard choices so that we use our extremely limited enforcement resources most effectively. There are hard choices to be made about which matters to investigate, which matters to prosecute and on which matters to seek a speedy administrative resolution. Clearly we are not able to investigate or deal with all breaches of the law.

There are some areas where our laws are weak. Perhaps the clearest examples are in relation to product safety and unfair contract terms.

You may be surprised to know that there is no direct prohibition on selling unsafe goods. The key deterrence to doing so is that if consumers get hurt you will likely have to recall the product, often at considerable expense.

Nothing erodes public trust in our market economy as companies selling goods with insufficient thought given to the safety of consumers.

Also seriously eroding trust are unfair contract terms. In business-to-business contracts we see many examples of standard form contracts where major companies with strong bargaining power reserve the right to unilaterally change prices, remove all liability from themselves and are able to terminate contracts without reason. Under current laws there is little incentive to change such contracts because if the ACCC finds out about them you need only then change them as this is not a breach of the law, and no penalties apply.

Ensure markets are competitive as possible

The degree of competition in a market depends on a range of factors including the number and size of independent firms, barriers to entry, the strength of any countervailing power of buyers and the nature of the competitive interaction among firms.

Bad behaviour by firms is more likely to be ‘punished’ in competitive markets. The more alternatives consumers have, the greater their ability to avoid bad behaviour. The more firms in the market and the lower the barriers to entry, the greater the imperative for companies to look after their customers.

A key objective of competition law is to prohibit conduct that substantially lessens competition, whether it be mergers or acquisitions, unilateral conduct by firms with substantial market power or agreements among competitors or other parties.

Strong competition laws and rigorous enforcement of those laws is a key part of preserving and promoting competition.

Recent amendments to the Competition and Consumer Act have better equipped us to pursue conduct that is likely to substantially lessen competition, through a more straightforward and sensible misuse of market power law and provisions outlawing concerted practices.

Our market studies, mentioned earlier, are largely aimed at looking for ways to boost competition in markets.

Lower search costs

High search costs increase the economic cost of finding the best offer, and can increase inequality. Governments therefore have a role of play.

More price transparency will usually help markets, as the ACCC has or will argue in dairy, beef, electricity, and banking. We have proposed, or will propose, measures to achieve this.

The Government’s newly introduced Consumer Data Right (CDR), as recommended by the Productivity Commission will, I think, be a game changer here.

There will initially be Open Banking, with the right for consumers to have and send to potential new providers their relevant banking data history in a useable form so that, for example, this can be sent to potential new providers.

It will also then quickly apply in electricity, then communications, and eventually it will apply across the economy.

The ACCC is the lead regulator for the CDR.

Finally, many people instinctively think that more regulation is the answer, but in our experience more regulation can often be harmful to consumers, especially in sectors of the economy that are already heavily regulated.

We have seen examples of this in our Retail Electricity Pricing Inquiry. For example, when late fees for overdue payments were banned, some retailers responded by introducing significant ‘pay-on-time’ discounts. At first glance that may sound beneficial to consumers, but what it actually did was introduce a more significant penalty to late fee payers than existed under the previous late fee system; the discounts were so big, that the ‘full price’ of the bill that late payers were responsible for paying was quite large in comparison to the discounted early fee, and far exceeded the previous late fees. And this is just one example of a perverse policy outcome.

Concluding remarks

Are companies behaving badly? Sadly, too often yes. Sadly not only because consumers or suppliers get hurt, but also because such behaviour threatens support for, and the proper working of, our market economy.

I often meet senior company board members and management. Some of them say clearly that it is not up to the regulator to tell them how to behave. Their job is to maximise shareholder value, and decide how best to do this.

While pointing out that they should not then express surprise when they face a public backlash, I then acknowledge they are correct. How they maximise shareholder value, and how they treat their customers, is their call, not mine or the ACCCs.

What I as the ACCC Chairman can and should do, however, is to recommend to the Government and the Parliament that the penalties for breaching our laws are inadequate.

Fortunately, they took little convincing. I hope and expect that the higher penalties for breaching the Australian Consumer Law will be passed in the August sittings.

Just imagine if the penalties I mentioned in Section 1 were 10–20 times higher.

Then perhaps some companies would not be behaving so badly.

And then when they say they put their customers first it might have more validity than it does today.

All of the above has not at all changed my belief in the benefits of capitalism and a market economy. Look around you; it largely works.

But we need to avoid believing in absolutes such as ‘companies only succeed by looking after their consumers’, and we should not be naive.

Our market economy needs some intervention and it needs the higher penalties just mentioned.

And it certainly needs a strong ACCC.

Thank you for your time today.

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