The digital megatrend currently enjoys boundless freedom and economic benefits with a low level of social responsibility, but could all this be at a turning point? A new wave of regulation could easily rearrange the market. Who would be impacted?

Could regulation put the brakes on the digital economy? - TextImageModule

Two worlds of perception: digitalization can mean very different things depending on the viewpoint

Society and the economy are rapidly changing as traditional business models are being digitally transformed and entire industries turned upside down. Both the public and private sector celebrate digital innovation, efficiency and flexibility, but potential risks could also lie ahead.

Current risks range from the abuse of intellectual property or of patient data, to digital fraud within banking institutions, to hackers attacking energy networks and cyber terrorists that paralyze public institutions. These risks already exist. The threats are so severe that NATO has already prepared for cyber-attacks on member states as part of its collective defense.

To counter-balance these risks, governments and institutions are already legislating to protect economic interests and the public. The handling of data, for example, is already an area of intense scrutiny. The interests of businesses to rapidly expand need to be balanced against the interests of consumers and society at large during this digital transformation. It is here that regulation could disrupt or halt these new businesses and business models.

Digital at a turning point in its maturity

History has shown that great transformations are quickly celebrated but can also be viewed rather harshly with some reflection, as was the case during the industrial revolution. During the latter half of the 18th century, industrialized production methods quickly spread from England to continental Europe and North America. As the financial rewards were so great, there was little regard for pollution or social exploitation. However, this changed over time as did the impact of regulations that helped to shape the manufacturing industry.

A current example of the impact of regulation on an industry can be found in the recent banking crisis. The financial sector was barely regulated before the collapse of Lehman Brothers in September 2008. Post-2008, governments and institutions look to control the social and economic impact of unregulated markets and industries with regulators across Europe trying to make the financial sector crisis proof. This has gone so far that “over compliance” is attached to the sector. It is considerably more difficult to operate and remain profitable in this overregulated area, even for the biggest players in European banking. HSBC is even considering a move from London to Asia. A recent BearingPoint Institute study, “Bank sustainability reaches a tipping point,” explores this in-depth and concludes that the glory days of banking could be reaching an end.

The digital economy shows some signs of following a similar path. Operating in a wilderness of new tools, products and services, pure-play digital firms are creating new business models to challenge traditional players as they hunt for profits. Could this new digital ecosystem fall victim to regulation or overregulation in the same way that has affected other industries before, and could the digital economy be reorganized? What consequences could this have for businesses and consumers?

Up to EUR415 billion additional growth

Digital is a major driver of development and opportunity in many industries and sectors: connected cars are reshaping the automotive industry, smart grids are revolutionizing the energy sector, eHealth is transforming modern healthcare, mobile payments are disrupting banks, big data offers insurers unprecedented opportunity, online shopping still has not reached its vertex, digital media now dominates communication and the public sector, under pressure to provide digital services, is starting to operate as eGovernments.

Not only have processes been digitized, but also entire digital platforms and products have emerged from the digital economy as companies and organizations benefit from greater efficiency and lower operating costs. Digital is also attractive to consumers who enjoy almost instant access to products and services. In short, today’s economy has a digital heartbeat.

The European Commission predicts that a digital single market could create up to EUR415 additional growth and 3.8 million jobs within Europe. Simpler access to digital goods and services would benefit businesses and consumers throughout Europe. For this to become a reality, improvements in data and information security are needed, as well as a uniform body of law applicable to all countries. Only then could individuals be protected from the various threats posed by the digital economy. This also applies to cloud-based services that need to be standardized in all countries.

Proponents of a digital single market also call for a new telecommunication framework for companies to improve frequency coordination, as well as more modern, uniform copyright regulations within the EU so consumers can easily access digital content and businesses are protected. A reduction of the burden of administrative processes should enable start-ups to realize innovative and creative ideas more quickly and easily.

Goods, people, services and capital must be able to move freely across national borders and differences between EU nations in terms of data protection and internet law must be harmonized if there is to be a digital single market. Critics warn that being overly EU focused could drive a wedge between Europe and the rest of the world, with uniform regulations leading to digital isolation. Companies and organizations benefiting from a digital single market could also have the burden of new legal regulations to adhere to and implement internally. This would mean an expense, just as financial services have to manage the overhead of complying with ever more legislative reporting requirements. This could ultimately be costly for the digital economy. In order to promote growth, a balance must be struck.

About the Sharing Economy

The digital economy provides many challenges, and discussions around the digital single economy clearly exemplify this. The fact is, for the digital economy to thrive, uniform legal provisions are needed, and at the same time this uniform body of law must not hamper the spread of innovation and progress within the digital economy. The latest debates around the sharing economy show that this is indeed a balancing act.

Uber, the online platform for transportation services, and Airbnb, the community marketplace for rental accommodations, are the most popular but also the most controversial examples from the thriving sharing economy. They are based on the so-called peer-to-peer (P2P) principle: business is conducted directly between platform users. Uber, Airbnb and similar companies benefit from particularly low entry and exit barriers for service providers and customers. They anger not only traditional market participants, but even consumer and privacy advocates have spoken out and criticized practices, e.g., how they handle, or mishandle personal information, such as location data via GPS.

Resistance by the traditional taxi and hotel players to the digital newcomers is fierce and vocal. In a struggle for survival and market share, the traditional players are demanding more regulation. The growth of the digital newcomers is based partly on intangible assets, and they rapidly achieve a higher market value than their traditional competitors. In terms of tax burden and insurance coverage, platforms like Uber and Airbnb (still) do not have to play by the same rules as their analog competitors. However, digital newcomers are increasingly confronted with regulatory issues that could possibly lead to the disappearance or transformation of these platforms. Such a fate befell Napster, the first major P2P sharing platform for music that violated the copyrights of artists. As a result, the rights holders of the music industry and the RIAA (Recording Industry Association of America) filed a lawsuit against Napster and demanded the closure of the platform. Before its shutdown in 2001, Napster was the fastest growing Internet community with approximately 80 million members. Napster’s business idea, however, of downloading music, has prevailed, and is now part of the business of giants such as Apple and Amazon.

New laws should not stomp on the brakes of innovation, digital or otherwise. If digital innovators disappear from the market, it would ultimately not be beneficial for businesses or the economy. It is necessary that regulations give an equal footing to both analog and digital competitors while effectively protecting consumers and their data.

Foresight on both sides

The regulatory efforts have many facets. Examples range from the Australian government, which wants to regulate the sharing economy, to the EU, which is preparing for the regulation of “Silicon Valley” companies, to German regulators that have already looked into the activities of Google, and to a control structure for the Bitcoin, a cryptocurrency at the heart of the digital transformation.

Highly valued communications companies with a growing source of income, such as WhatsApp, also expose regulations that normally would have only impacted traditional telecommunications companies. There is interest in greater regulation of the market by not only public institutions and consumers, but by incumbent companies whose business is threatened by the new digital players. For example, reinsurers also have a general interest in greater regulation of digitization for clearer risk management when it comes to cyber-attacks and data theft. Overall, the complexity of regulatory requirements will grow significantly and will be here to stay. Regulators must know how the digital economy ticks and be knowledgeable about key networks, platforms and technologies to assess the need for regulation. They must also realize that technological developments are taking place at a much more rapid pace than that which they normally legislate. Regulating the financial sector has been the biggest challenge so far, but regulating the digital world is an even greater challenge. The problem encountered again and again is that it is not enough to regulate at the national level because there are hardly any borders when it comes to the internet. Plus a lot can still be done anonymously.

A question is whether regulation will only be reactionary and arise after challengers have conquered the market, or whether regulation in the future can be more flexible (e.g., through faster regulatory procedures or by general legislation that prohibits specific platform models that lead to market distortions). It is conceivable that the legislative process for all things pertaining to the digital domain will be shortened and simplified. For example, companies like Uber could be limited long before they are a question for larger investors and incumbent, traditional market players.

It is crucial that legislatures establish regulations that benefit both businesses and society. After all, our economy must remain competitive by international standards and allow consumers of digital processes - visible and invisible – to profit. For businesses, it is important to be able to respond quickly to the very dynamic and often difficult to predict legal requirements.

The digital economy is putting all industries and sectors to the test. The logical consequence is the call for a new legal framework. Giants like Google and Apple bear a social responsibility and must learn how to deal with cultural differences when it comes to personal data protection and privacy.

Recommendations for market participants in the digital era

  • analysis of digital trends and assessment of the potential threat by digital competitors
  • review of the current business model and the digital backlog
  • development and implementation of a sustainable digital strategy
  • evaluation of the existing know-how in the company and planning of technical resources
  • implementation of protective measures against network attacks and potential misuse of data

Bring digitization and regulation into harmony

Consultancies can be a part of both sides of the digitization and regulatory processes. They work for clients from both the private sector and the public sector. This gives consultancies an all-round view of the concerns and fears of both sides.

Consultancies help corporations find and implement the optimal solution for the new regulatory requirements. Consultancies also help traditional business models in various industries with digital transformation. Ultimately, the following will hold true: only companies and organizations with digital processes and solutions anchored in their DNA will be successful in the future.

There is no panacea for the regulatory treatment of new digital trends and players. One of the key challenges is that technologies advance at a rapid pace and legislation is always in danger of lagging behind. In this context, consultancies can bring the necessary digital economy know-how for sustainable regulation - regulation which balances the interests of companies with those of consumers and society.