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Compliance in tech and the cost of capital

Tech companies like to charge into new markets and disrupt the status quo. To heed compliance and regulatory issues, though, they may need to temper that approach.

Technology companies have long enjoyed a halo effect. They were lauded for smashing restrictive and outdated business models that were stifling innovation, restricting consumer choice and keeping prices high.  Politicians seemed very willing to rationalize almost any transgression a tech firm committed as growing pains.Society became used to technology companies’ Biblical-sized ambitions to save humanity from itself.

This is, to a degree, understandable.  Technology companies’ aggregate contributions have been quite significant.  In the case of Amazon, it enabled consumers to fully access a global long tail of suppliers from every corner of the earth.  Similarly, Amazon made it possible to think of almost anything, then check its price and availability, buy it within minutes and have it in-hand the next day.  With innovations like Alexa, it is now possible to do all of that without even opening the app!  To be very clear, that level of innovation is only achieved through courageous risk-taking, much investment and sourcing and combining many world-class talents.

A worker sorts packages at the Amazon warehouse in Leipzig, Germany.      REUTERS/Fabrizio Bensch
A worker sorts packages at the Amazon warehouse in Leipzig, Germany. REUTERS/Fabrizio Bensch

The best part: All the resulting innovation and convenience is available to all of us without any additional premium.  Incredibly, Amazon is able to set its prices to earn the thinnest possible margins.  However, it still wins because only competitors that can also operate at enormous scale can keep up based on volume.  It’s similar, in some regards, to what happened when giant suburban superstores swept away small family businesses with their scale economies – consumers may have lamented the loss of the traditional high street but nonetheless were happy enough to permanently switch their shopping habits. However, this time around, few if any worry over the decline of the brick-and-mortar superstore.  Provided prices are kept low, and they don’t do anything especially egregious with gains largely made at the expense of their competitors, both the public and public servants were enthusiastic cheerleaders.  Similarly, when hoteliers complained they, but not Airbnb, had to comply with extensive and costly regulation, the public was generally unmoved.  When London’s black cab drivers succeeded in convincing transport regulators that it was unfair that they, but not Uber, were expected to fully comply with licensing requirements, 500,000 Londoners signed a petition within 24 hours to support Uber.

However, attitudes are beginning to change.  Technology companies are now facing increasing official scrutiny.  While they may not be approaching the levels of regulation and penalties that banks face, technology companies are now at least being held to the same standard as traditional companies.  And it is (or should be) changing how these companies approach and manage corporate governance and their compliance risk.  This is simply because institutional investors have recognized the clear shift and are now viewing compliance in a much more critical light. Put another way, they are now carefully assessing regulatory risk along with traditional operational risk factors when determining the cost of capital.  When assessing a firm’s growth prospects, as well how effectively the company can flexibly leverage and re-apply its superior technological strengths, they are incorporating evaluations as to how the effects of major failures and their reputational damage might prevent market entry or full revenue realization.  They (or their commercial and legal advisors) will now scrutinize much more carefully during due diligence how well the firm’s legal and compliance functions are identifying and managing a much broader range of regulatory risks and also, how effective is their overall corporate governance.  Investors will now seek to establish that where the investee needs licenses to simply operate, that it has sought to maintain good regulatory relationships based on transparency and good faith and as much as possible avoided unnecessary non-renewal risk.

Until recently, innovative technology companies could seemingly push into adjacent and entirely new markets at will, and convincingly challenge any incumbent they targeted.  In hindsight, it seems many of these firms didn’t always wait to methodically risk-assess and adapt their existing processes and systems, or extensively hire experienced industry veterans from incumbent firms to help inform them and navigate the new market’s landscape.  It suggests they may have felt there was no compelling need to wait to first grow their internal controls if they saw an opportunity to transform traditional markets through data and analytics.  It was simply enough that they empowered consumers to buy more for less, or do much more with what they know.

A banner against apartments for tourists hangs from a balcony as a woman pulls a suitcase at Barceloneta neighborhood in Barcelona, Spain, November 28, 2016. The banner reads “No tourists apartments”.  Companies like Airbnb have delighted consumers, but riled some neighborhoods and stymied regulators by upending the hospitality business. REUTERS/Albert Gea 

Now, however, transformative companies are being compelled by legislators (and their customers) to demonstrate that their compliance systems and controls are robust, and that they can react to both individual errors and systems failures.

As fast-moving technology firms expand and move beyond their core markets, as well as identifying and rapidly creating new revenue streams, developing appropriate risk management strategies should be an even more integral part of their business development strategy and overall corporate governance.  The good news is that if these concerns are approached and addressed appropriately in lockstep with its efforts to monetize their services and networks, they will better manage their reputational risk profile and enhance shareholder value.

Coming soon, we’ll explore some of the legal and regulatory challenges technology companies have faced recently and what lessons we can all (re)learn.


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