Pulling its punches: Does the Commerce Commission’s draft report of the residential building industry address the key issues?
Significant changes to regulation of the residential building supply sector are proposed by the Commerce Commission in its current study of the sector, but they may not address key underlying issues.
What are the key findings in the Commerce Commission draft report?
The Commission’s preliminary view in its draft report is that competition for the supply and acquisition of key building materials is not working as well as it could, as it should be easier for building products to be introduced and for competing suppliers to expand their businesses.
This seems a slightly muted finding, and may come as a surprise to some people in the building industry, especially given the high market shares of some product suppliers, including the recent focus on the Fletcher group of companies regarding plasterboard.
The Commission did acknowledge that high structural barriers to entry and expansion appear to be protecting the market shares of incumbent product suppliers. It found that there are generally high sunk costs and scale economies associated with manufacturing key building supplies, and that importing can sometimes not be viable. It also said that New Zealand’s small size and demand uncertainties make it challenging for domestic manufacturers to reach efficient scale, and less attractive for new companies to import products.
The Commission also acknowledged that vertical integration (e.g. by the Fletcher’s group of companies which operate across the supply chain) exists.
The Commission’s draft report, however, does not contain any recommendations addressing these issues and the Commission instead said it did not consider that vertical integration was impacting merchants’ access to key building supplies beyond the current supply shortages.
This could be a missed opportunity, but rather than trying to address these structural issues, the Commission may have decided to focus on areas where it considers that change can be made to improve the competitive situation. On the other hand, as the Commission notes in its report, it may be balancing competition objectives with other objectives of the regulatory system.
Are there risks in the Commission’s recommendations?
As noted below, the Commission’s draft report recommends a number of changes to the building regulatory system to improve competition.
Greater competition is needed and very welcome. It should lead to lower prices, better products and choice, and better outcomes overall. As the Commission acknowledges, however, it cannot compromise the other objectives of the building regulatory system.
In making any changes, care will need to be taken to ensure compliance standards are met when implementing new supply chains and product substitution – government and industry stakeholders will need to be wary of encouraging substandard products to flood the market or product safety and assurance standards and certification to be circumvented.
We have seen the detrimental impact on New Zealand’s construction industry because of past efforts to meet demand in supply chain, for example substandard products and practices led to the leaky building crisis, and the influx of substandard imported steel and plumbing products has caused concern for infrastructure, commercial development, and amongst engineers over the past decade.
The detail: the market study into the residential building supply sector
Setting those issues aside, we summarise below the key points in the Commission’s draft report.
The Commission is conducting the study under the Commerce Act 1986. The study was initiated by the Minister of Commerce and Consumer Affairs, David Clark, after significant public and political concern over issues in the building material supply chain. The Commission is currently consulting on its draft findings and the proposals, after releasing its draft report on 4 August 2022.
Factors identified as reducing competition
As noted above, the Commerce Commission’s key finding is that it should be easier for new products to enter and expand in the market. It found that particular “tried and tested” products have become central to home-building practices within New Zealand, leaving little room for new, innovative products to enter. If new innovative products could enter there would be more competition and more choice for customers.
The draft report attributes this focus on tried and tested products as arising principally from the regulatory system combined with the way it is applied by designers, builders and building consent authorities. It criticised specification of building materials by brand in consent applications for making expansion of new products difficult.
The regulatory system was identified as hindering competition because any flexibility created by the system to use new products is negated by the timeframes, costs, and uncertainties in getting them accepted for general use.
The use of rebates paid by established suppliers to merchants for purchasing higher volumes of product was also identified as contributing to the dominance of “tried and tested” products. The Commission considered that the rebate system incentivises merchants to purchase heavily from a single supplier. This makes it more difficult for smaller suppliers to secure stockists and expand in the market.
Restrictive covenants and exclusive leases, which were key criticisms of the fuel and grocery sectors in the Commission’s studies into those industries, were also identified as having the effect of reducing competition in the residential building supply chain. The Commission said that two main types of restrictive covenants are potentially a problem, namely:
- Store covenants: These are covenants on land containing clauses or terms which prevent or restrict the site from being used for operating a business that sells key building supplies. They tend to reduce the availability of sites for merchant stores.
- Land development covenants: These are covenants on land zoned for residential buildings, which contain clauses or terms that give preferential rights to a merchant to supply key building supplies for any housing constrictions. They tend to limit other merchants’ ability to attract customers.
Exclusive leases are where merchants enter into commercial leases with landlords containing exclusivity clauses or terms which prevent or restrict the operation of businesses selling key building supplies nearby, on other land owned by the same landlord.
What are the Commission’s main recommendations?
The Commission’s draft recommendations centre on “three interdependent groups” of issues with the aim to: enhance the regulatory system, support sound decision making, and address strategic business conduct. Some of these will require new legislation through Parliament, but many can be implemented within the existing regulatory system, by Government and BCAs. There are also some actions for the Commission.
Enhance the regulatory system
The Commission provisionally recommends that the Government seek to incorporate competition as a “deliberate objective” into the building regulatory system and other measures to make it easier for market participants to use new or competing business supplies.
These other measures include creating additional ways for key building supplies to comply with the Building Code, introducing incentives for market participants to use and adopt new or competing building supplies, and removing the existing impediments on product substitution (for example, by removing brand specification in the consenting process).
The Commerce Commission also recommends that the Government and BCAs engage with Māori to better reflect their perspectives in the system and provide flexibility around traditional Māori methods of construction.
Support sound decision-making
The draft report sees the development of centralised information sharing about building supplies as a key measure to improve decision-making by BCAs. It is hoped that better information will lead to better regulatory decisions.
The Commission’s draft recommendations include establishing a national key building products register to provide a centralised repository for information about building products and consenting, as well as establishing a BCA centre of excellence to facilitate a better co-ordinated approach by BCAs to consenting and the product approval process.
The Commission also acknowledged other initiatives are being explored through MBIE’s review of the building consent system, which may lead to further policy development related to these draft recommendations.
Address strategic business conduct
In order to address strategic conduct by building suppliers (i.e. actions that are potentially anti-competitive), the Commission proposes to greater promote (and presumably enforce) compliance with the Commerce Act, particularly the new changes to section 36 of the Act which come into force in April 2023. It hopes that this will address the anti-competitive effects of the use by suppliers of quantity-based rebates.
The amended section 36 will prohibit firms with substantial market power from engaging in conduct that substantially lessens competition. This is a significant change to the current test under section 36 and will expand the situations to which the section applies.
As it currently stands, the Commission considers that legislative changes to prohibit rebate structures in the industry are not justified.
Further, the Commission has provisionally recommended that the Government review the use of restrictive covenants and exclusive leases across the economy. As noted above, this study was the Commission’s third consecutive study to identify issues with exclusive leases and restrictive covenants in restricting competition.
The Commission is receiving submissions on the draft report until 1 September 2022 and a week-long consultation conference will begin on 26 September 2022. The Commission will then re-consider its draft findings and recommendations with the Commission’s final report is due on 6 December 2022. It will be interesting to see whether the Commission expands its recommendations, especially to deal with any vertical integration issues.
Disclaimer: the content of this article is general in nature and not intended as a substitute for specific professional advice on any matter and should not be relied upon for that purpose.