My Say: Industry overcapacity and the consumer interest

This article first appeared in Forum, The Edge Malaysia Weekly, on November 22, 2021 - November 28, 2021.
My Say: Industry overcapacity and the consumer interest
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The recent Budget 2022 announcement included a plan to financially support companies listed on Bursa Malaysia that are affected by the Covid-19 pandemic through equity injections or other financial instruments, with a fund size of RM3.0 billion earmarked for this purpose.

Putting aside for now the risk of moral hazard and any debate surrounding the government becoming even more deeply involved in the private sector, identifying companies that could qualify for this support will no doubt be complicated. Factors presumably to be considered include a company’s performance record prior to the pandemic, whether any subsequent drop in financial performance can be attributed to Covid-19 and whether there is a history of scandal associated with the company. The scheme appears business-friendly, yet could easily backfire if its implementation is not premised on appropriate principles.

Our policymakers likewise need to deftly handle another separate, though related matter. In recent years, several industries in Malaysia have flagged themselves up as being plagued by overcapacity. Those sectors include steel, property, airlines, cement and even rubber gloves.

The narrative generally goes that the supply of goods within their industries far exceeds demand because there are too many players operating in those spaces or that capacity is relatively high, resulting in decreased prices and asset turnover, ultimately affecting profitability and the financial health of the companies within the industries concerned. Competition is seen as excessive and as a consequence, destructive. Shareholders lose out, investors are frightened away, cost of debt increases, employees are laid off, supply chains are disrupted, companies may eventually drop off the scene altogether and the government would be denied tax income.

For instance, in September 2021, the Housing and Local Government minister revealed over 27,000 houses worth RM18.4 billion remained unsold in the first quarter of 2021, attributing the excess to a demand-supply mismatch and uncertainties arising from the pandemic. In 2020, the Malaysian steel industry pointed out that total steel consumption in 2018 was 9.77 million metric tons (MT) while total installed capacity was 24.64 million MT, crudely translating into an estimated capacity utilisation of 39.7%. This is far lower than the 70%-80% needed to be sustainable.

Until recently, the cement players had also struggled with depressed prices as a series of capacity expansions were undertaken by the major local cement producers from 2013 to 2016, resulting in an increase in new clinker capacity by 25%, while domestic demand declined following delays or cancellations of infrastructure projects.

Overcapacity is also famously cited as a key reason the country’s local passenger airlines have performed so poorly financially, especially in the recent past. In 2019, seat capacity was higher than it had ever been, while the average load factor of Malaysian carriers in 4Q2019 was 78.3%, lower than it had been versus the prior eight quarters bar one. Average fares for Malaysian carriers in that same quarter stood at RM283, in keeping with a steady decline in average fares in the fourth quarters of previous years, which were RM314, RM302, RM287 in 4Q2016, 4Q2017 and 4Q2018 respectively. None of the Malaysian passenger carriers were profitable in 2019.

Overcapacity is rendered more awkward by the significant capital outlay necessary in these sectors. The removal of capacity when the market takes an adverse turn is difficult to be immediately effected. Supply, in other words, is inelastic. Shutting down production facilities, demobilising an ongoing property development or removing aircraft from a fleet are costly, if not, time-consuming affairs. Coordination of capacity amongst different companies in an industry is also unfeasible as that is plainly anti-competitive behaviour and would fall foul of competition rules.

Shouts have been made to the government to take on a more interventionist role in managing overcapacity situations. Amongst measures proposed are raising the bar for entry into an industry, say, by increasing safety standards or capital adequacy thresholds, or even an outright moratorium on the granting of new licences while incumbents in the industry sort themselves out.

The steel industry last year appealed for the government to impose an immediate freeze in new manufacturing licences for the production of long and flat steel products in Malaysia. One property development association recently called for the country’s affordable housing policy to be reviewed in light of the number of unsold houses, while at least one airline has publicly called for the government to act on the sector’s demand-supply mismatch.

The question facing the government therefore is, should it intervene? And if yes, how?

On the other side of this discussion, particularly in consumer-facing industries, is of course the consumer. In theory, competition benefits the consumer as it facilitates choice, improves quality of services, incentivises innovation and results in market pricing. Companies which do not adequately meet customer needs will eventually exit. New, potentially more efficient and customer-centric players, previously crowded out, would enter the sector. Some incumbents may consolidate, assuming competition regulators do not view the move as resulting in a significant lessening of competition. In the long run, this competitive dynamic benefits consumers and rewards entrepreneurship.

Any government policy to address intervention in industry capacity must therefore be considered from the standpoint of the consumer. Failure to do so results in the government detaching itself from basic principles of regulatory economics and places it at risk of being pro-incumbent, even endorsing whatever baggage it may carry, whilst ignoring the consumer interest.

In considering whether overcapacity warrants state intervention, the government should ask itself at what point competition proves to be excessive from the standpoint of the consumer, and in what way intervention in the market serves the consumer interest. How does an increase in price resulting from intervention in the market benefit the consumer? An overcapacity situation is certainly injurious to companies in the industry concerned, but does it warrant intervention at the expense of the consumer?

There are, however, situations where competition can become so excessive that consumers actually become worse off. For instance, companies whose revenues or profitability are affected by overcapacity could decide to reduce their spending on maintenance, thereby compromising the safety and quality of services delivered. Or worse, the collapse of companies as a result of overcapacity could have systemic repercussions, snowballing into a wider crisis, ultimately placing the consumer at risk, as in the case of a bank that files for bankruptcy.

In such cases, government or regulatory intervention is arguably defensible. State interference in the market structure or capacity to protect the consumer interest is nothing new of course, certainly in Malaysia. Following the Asian financial crisis of 1997, Bank Negara Malaysia directed the merger of Malaysia’s local banking institutions into 10 anchor banks. The controlled award of air traffic rights by the Malaysian Aviation Commission (Mavcom) to local airlines is also intended to lessen the risk of flight cancellations and merging of flights which inconvenience passengers.

Even so, it does not necessarily follow that restraints on new entrants or pricing are the correct remedies. For instance, overcapacity in the airlines sector is caused by an excessive number of seats, rather than “too many” airlines, and therefore to cease the issuance of new airline licences does not necessarily address the root cause of any demand-supply mismatch. The regulation of service standards, such as that performed by the Malaysian Communications and Multimedia Commission and Mavcom, is probably more appropriate to reduce inconveniences to the consumer even as the industry resolves its capacity issues.

The government ultimately needs to be clear on its objectives, particularly on which stakeholders it wishes to assist and what public interest is served by whatever measure it may choose to take. It should also be clear on whose role it is to determine appropriate capacity levels — the state or the market.

Factors to be considered will likely differ from one industry to the next, but where consumers are concerned, perhaps non-intervention could work out best in the longer run. Consumer interests should be safeguarded. Employees whose livelihoods were affected by the pandemic should be assisted. Conversely, those at risk are companies which did not forecast their capacity properly, which wrongly chose to operate in an unprofitable market segment, or which have been inefficient. Surely no government policy or regulatory action would be designed to perpetuate that.

As things presently stand, consumer activism in Malaysia remains relatively undeveloped. Should government policy-making fail, consumers will then have to fend for themselves. They should be warned off from companies which have fleeced them or others before, have repeatedly failed safety or quality standards, or have a whiff of scandal or corruption about them. Quite frankly, we should add to that list consumer-facing companies whose language reeks of entitlement and which misguidedly overestimate their own importance to their industry and country.

Azmir Zain is a chartered accountant and a director of a family investment vehicle

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