Should Policymakers Encourage Industry Self-Regulation?

Here, I examine two cases of industries regulating themselves. In one case, to their benefit (and the detriment of consumers) in a cartel system. In the other case, to the alleged benefit of consumers to avoid government regulation.

The first case is that of the familiar AA battery. This is the most common consumer battery and used in everything from television remote controls to mobile videogame machines to torches. The industry argued for years that standardisation was necessary and that the output and capacity of a AA battery should be fixed. It also argued that this increased competition, since AA batteries were interchangeable and the consumer would know that even though his television remote control arrived loaded with Energizer batteries, a Duracell battery would do the job equally well.

However, though these industry-devised standards did lead to widespread standardisation and allowed AA battery manufacturers to compete primarily on price (rather than, for instance, mean amperage output performance or cycle performance or capacity, as car battery manufacturers compete), they also retarded the progress of the product. In fact, today’s AA batteries perform only marginally better in terms of characteristics that matter to most consumers (life in a typical device, shelf life at room temperature, likelihood to leak or malfunction or damage the device, etc.) when compared to AA batteries of the 1980’s.

Industry advocates will argue, of course, that many consumers may still be using devices from the 1980’s and that to eliminate the risk of consumer confusion (having different grades of AA battery performance) the AA battery must remain trapped in its 1980’s technological state. However, this allows the industry to essentially continue to sell a by-modern-standards inferior product indefinitely, requiring consumers to buy millions of additional AA batteries that would not be necessary with even a slight improvement in battery technology. In essence, the intra-industry gentleman’s agreement does standardise the product for consumers, but at the expense of product quality, requiring consumers to buy batteries far more often (and hence benefitting the parties to the agreement).

Gillette, which bought Duracell in 1997, has tried to destabilise the AA battery standard several times in the last fifteen years to allow the introduction of new technologies and longer-shelf-life batteries, but has been met with resistance from consumer electronics manufacturers who don’t want to have to design devices to work with two varieties of batteries. As a result, the AA battery standard – which is unwritten, but exists as a set of electrical engineering boundaries – continues to be the same. As a result, an AA battery bought today is no better (or only marginally better) than the AA batteries that could be bought in 1983 when the current standard evolved, led by Energizer (then a recent re-branding of the Eveready Battery Company of Missouri).

Gillette may have learned from its history in razor blades: In the 1960’s, stainless steel razor blades became popular across Europe. Much like the hypothetical improved AA batteries, they lasted much longer (Gillette famously advertised at the time that a stainless steel blade could be used for a week, where many men in Germany at the time were using a fresh steel blade every day). Gillette engaged in a huge marketing push to attempt to strengthen its brand and build a premium perception around stainless steel blades, since their adoption would inevitably mean selling 80% to 90% fewer blades. Eventually, Gillette won this battle, being profitable even in a world with far lower unit volume. Presumably, it hopes it could do the same in a world of long-lasting AA batteries.

The other case of interesting industry self-regulation – which was not international, unlike the AA battery agreement – was the limitation on horsepower produced by cars sold by Japanese manufacturers. In 1989, after the Japanese Grand Prix, the major manufacturers, led by Honda, met for two days in Tokyo and came to a series of engineering agreements. One of them, never formally signed but merely made as a gentleman’s pact among Japanese businessmen, was that no Japanese manufacturer would produce a car for road use that would produce more than 276 horsepower (which was, probably not coincidentally, the precise output of Honda’s 2760cc V6, under development at the time to produce 100 horsepower per litre or 276 horsepower).

Toyota agreed and eventually Nissan agreed to the pact as well (though it initially asked for an exception for its Skyline GT-R V-Spec sports coupe). The agreement lasted only five years (Honda produced a 300-horsepower version of its V6 in late 2004), in part due to German competition for Japan’s higher-end brands like Lexus and Acura. Though the 300-horsepower version of Honda’s V6 appeared only in the U.S.-market version of its Acura RL luxury sedan in 2004 and one year later in the Japanese-market Honda Legend S of 2005, this was hardly enough to keep pace. During the same time, the competing 2004 Mercedes E55 AMG produced 469 horsepower and 516 foot-pounds of torque.

Today, the horsepower deficit remains, something many attribute to Japan’s failure to research and design high-output road car engines during this period. Even the largest passenger car engine produced by a major manufacturer in Japan, the 303-cubic-inch (5 litre) V8 used in Lexus’s top model, produces only 438 horsepower. The equivalent Mercedes product, the S63 sedan, produces 577 horsepower. The equivalent Audi product, the Audi S8, produces 520 horsepower. Toyota argues that the hybrid technology of the LS600h creates outputs that roughly match the horsepower of the German competition, but the performance numbers say otherwise.

Overall, what was gained by retarding the progress of high-performance road car engines in Japan for five years? For one, government regulators were stopped from stepping in (high-profile street-racing deaths in Tokyo in 1987 and 1988 had led to concerns from regulators). But, secondly, Japan was forced to focus on lighter materials and new design principles that would allow car performance to continue to improve despite limited horsepower. Some cars (notably the Toyota Supra MkIV J-Spec and Nissan Skyline R34 GT-R NISMO) were rated at “274” horsepower, which became a “cue” to consumers that the cars actually generated more than the supposed 276 horsepower limit (some Skyline R34 GT-R NISMOs were tested at 350 horsepower, which would have required 380 horsepower at the crank). Today, the number 274 remains a Japanese slang shorthand for a car that’s faster than it looks.

Still, customers – especially in the increasingly-important American market – were not impressed. Toyota’s top sports car, the Supra, saw production fall from 14,549 units in 1989 (the year of the agreement) to 3,624 cars in 1991. During the same period, the Supra’s main European competitor, the Porsche 944S, 951, and, later, 968, outsold the Supra (despite only having produced 10,593 units in 1989 compared with the Toyota Supra’s 14,549). Of seven car reviews of Supras of this period I’ve examined, six of the seven note the Toyota’s “limited” horsepower compared to competitors.

These two frameworks are common ones policymakers often encounter: the intra-industry agreement that benefits the industry at the expense of consumers and the national industry agreement that is not adopted internationally. By studying cases of these types of intra-industry dealmaking, we can not only determine when policymakers should intervene, but what the likely outcomes of the deal as proposed might be (and how those outcomes can be steered positively).