Retail Trade Policy and the
Philippine Economy
Submitted to:
Trade and Investment Policy Analysis and Advocacy Support (TAPS) Philippine Exporters Confederation
A Project of:
Policy and Development Foundation, Inc.
1999
2
Part I
An Integrative Report
3
Retail Trade and Liberalization: Towards Retailing and
Distribution Services for the 21st Century
The project was commissioned by PHILEXPORT-TAPS to examine further the
policy issue of retail trade liberalization. The contributions of the project to the ongoing
discussion on the liberalization issue as well as to future discussions on the development
of the retail trade sector are as follows:
•
The project provides more detailed information about the state of the
Philippine retail and wholesale trade sector than earlier studies.
•
The project emphasizes the importance of addressing the entire
distribution sector rather than just the retail trade industry.
•
The project examines, and draws insights for the issue of retail trade
liberalization in the country from, the experiences on retail trade
regulation in OECD countries, retail trade deregulation in Japan, and the
liberalization of selected service industries in the OECD countries and the
Philippines.
The study team was headed by Dr. Ponciano S. Intal,Jr., Executive Director of the
DLSU Angelo King Institute for Economic and Business Studies, De La Salle University
and former President of the Philippine Institute for Development Studies (PIDS). The
members of the study team were: Dr. Myrna Austria, Research Fellow, PIDS; Dr. Cesar
Cororaton, Research Fellow, PIDS; Ms. Melanie Milo, Research Associate, PIDS; and
Ms. Rafaelita Aldaba, Research Associate, PIDS. Research support was provided by Mr.
Ronald Yacat (programmer) and Ms. Leilanie Basilio, Mr. Euben Paracuelles and Ms.
Janet Cuenca (research assistants). The study team benefited a lot from the support and
understanding of Ms. Pilipinas Quising of PHILEXPORT-TAPS as well as the
4
administrative support of Ms. Corazon Marquez and Mr. Oscar Laspunia of Policy and
Development Foundation, Inc. (PDFI).
The Project Report consists of three parts. Part One is the integrative report. It is
composed of three chapters; namely, Chapter One, on the structure and development of
the Philippine distribution industry and on the competitive pressure and efficiency of the
distribution sector and the retail trade industry; Chapter Two, on regulation and
regulatory changes in retail trade and selected service industries in OECD countries and
the Philippines; and Chapter Three, on retail trade nationalization and liberalization:
towards retailing and distribution services for the 21st century. Part Two consists of four
supporting and related studies on the liberalization of the banking, insurance and
telecommunications industries, the issue of franchising and technology transfer and the
simulations on the impact of foreign direct investment in retailing on the rest of the
economy. Part Three consists of Appendix tables.
5
Chapter I
Structure and Development of the Philippine Distribution
Industry
I.
Contribution of the distribution sector to the economy
Output and Employment. The distribution sector; i.e., wholesale and
retail trade, is an important and rising sector of the Philippine economy. The sector
accounted for 15.6 percent of GDP in 1998, up from 14.5 percent in 1985 (see Table 1).
The bulk of the value added in the sector is contributed by the retail trade sub-sector,
accounting for about four-fifths in 1985 and three-fourths in 1998. The decline in the
share of retail trade to the total value added in the distribution sector stems from the faster
growth of the wholesale sub-sector during the period. Indeed, the share of wholesale
trade to the national output increased significantly while that of retail trade actually
declined marginally during the past decade or so.
The contribution of the distribution sector to total output varies
considerably among the regions in the country. The top four regions in terms of the share
of the distribution sector to the regional gross domestic product are Central Visayas,
Western Visayas, Northern Mindanao and Southern Mindanao. Their trade shares are
much higher than the national average, with Central Visayas being the most trade
dependent at 29 percent of regional output (see Table 1). The four regions with the
lowest shares are CAR, ARMM, Eastern Visayas and Central Mindanao. These four
regions are among the poorer regions in the country. Metro Manila, which dominates
much of the country’s wholesale and retail trade, is actually less trade dependent than the
national average. Nevertheless, Metro Manila accounts for more than a quarter of the
national value added in retail and wholesale trade. Similarly, Southern Tagalog and
Central Visayas together account for another quarter. A trio of regions -Western Visayas,
Southern Mindanao and Central Luzon - contribute another quarter. Thus, trading activity
6
in the country is largely concentrated in 6 or 7 regions (including Northern Mindanao)
that tend to be the “richer” regions in the country.
The distribution sector is also a major and rising source of employment in
the country. The sector accounted for 13.8 and 15.1 percent of total employment in 1991
and 1997, respectively. The sector is even more important for female employment as it
accounts for a quarter of total female employment in the country. Indeed, the sector
depends overwhelmingly on female employment: females account for nearly two-thirds
of total employment in the sector. Finally, employment in the sector is primarily
concentrated in the informal sector, accounting for nearly three-fourths of total
employment in 1995. Nonetheless, the underemployment rate (i.e., the percentage of
underemployed to total employed) in the sector is less than the national average for all
the sectors. (See Table 2.)
The shares of the distribution sector to total output and employment,
respectively, in selected countries are shown in Table 3. The Philippine output share is
comparable to those of Italy and the United States, higher than those of Malaysia, Korea,
Japan, France and Germany but lower than those of Indonesia, Australia, Singapore and
Hong Kong. There is no discernible relationship between the output share and per capita
income. Nonetheless, in most of the countries, the distribution sector contributes a
substantial share to national output. The importance of the distribution sector is even
more pronounced with respect to employment. The figures for the OECD countries in
Table 3 show substantially higher employment shares compared with output shares.
Notice that the employment share of the distribution sector in the Philippines is lower
than many OECD countries. This suggests that, given the still low per capita income of
the Philippines vis-à-vis the OECD countries, the distribution sector in the Philippines
can be expected to be a major generator of employment in the country in the future.
Number of establishments and retail density. There were about 208,732
wholesale and retail establishments in the country in 1995, up by 15 percent from the
7
181,576 wholesale and retail establishments in 1991. Out of the 208,730 in 1995, 185,968
were retail establishments (6,628 large and 179,340 small) and 22,762 were wholesale
establishments (2,778 large and 19,984 small). These establishments are those included in
the annual surveys of wholesale and retail establishments for 1991 and 1995. The annual
surveys and census of establishments include only sari-sari stores with at least one
regular employee. They do not include “…pseudo-establishments found in stalls, booths,
or stands that could easily transfer or disappear, e.g., open market stalls, movable
magazine and book stands, etc.” (NSO). In short, the census and annual surveys cover
mainly the formal retail sub-sector and do not include the large informal retail segment in
the country. 1
As a comparison, there were about 96,703 manufacturing establishments
in 1995 in the country. Thus, wholesale and retail trade establishments are far more
numerous than manufacturing establishments. The big gap in the number of
establishments can be explained in part by the small size of a typical retail establishment
compared to a typical manufacturing concern. Nonetheless, what the numbers indicate is
that wholesaling and retailing contribute significantly to business activity in the country.
Pilat (1997) states that in a typical OECD country the wholesale and retail
trade sector accounts for between 25 percent to 30 percent of all enterprises, which is
substantially higher than the sector’s contribution to national output. The Philippine case
follows the OECD case; indeed, perhaps more so, similar to the poorer OECD countries
like Greece and Portugal where wholesale and retail establishments account for about 40
percent of all enterprises because of the comparatively small size of the retail
establishments.
Table 4 presents the retail density as well as the retail and wholesale
density in the Philippines by region in 1991 and 1995. Retail density in the Philippines
inched up from 25 establishments per 10,000 population in 1991 to 27 establishments in
1
For the issue of opening up the retail trade industry to foreign investment, it is the formal retail trade subsector which is most relevant.
8
1995. The national average of the combined retail and wholesale density hovered
between 29 to 30 establishments per 10,000 population during the period. The national
average for retail density masks a wide range of retail densities among the country’s
regions. The highest retail densities are in Metro Manila and, surprisingly, Western
Mindanao; the lowest retail densities are in the Autonomous Region of Muslim Mindanao
(ARMM) and Eastern Visayas. There is no clear cut relationship between the level of
economic development of a region and its retail density, although Table 4 indicates that
the poorest regions in the country (i.e., ARMM, Eastern Visayas and Bicol) have the
lowest retail densities.1 Nevertheless, Table 4 also indicates that the retail densities of
most of the regions inched up during the early 1990s.
The retail density in the OECD countries is shown in Table 5. What is
most striking from the table is that the retail density in the OECD countries is
substantially higher than the retail density in the Philippines; indeed, in a number of
OECD countries, it is several times higher than that of the Philippines. Table 5 also
shows that the retail density of the poorer OECD countries (e.g., Greece, Portugal, Spain)
increased significantly during the 1955-1990 period, while the retail density of the richer
and more densely populated OECD countries declined during the period (e.g., Japan,
Germany, France, United Kingdom, Belgium, Denmark, Netherlands).
The OECD experience suggests that there seems to be an “inverted U”
relationship between retail density and per capita income. That is, as a low middle
income country develops, its retail density increases; however, after reaching some
“turning point” per capita level (range), its retail density secularly declines. This
“inverted U” relationship is similar to the Kuznets curve relating the degree of income
inequality and per capita income. Drawing from Table 5, it appears that the level of per
capita income for the turning point in retail trade density appears to be significantly
1
As noted earlier, the census and annual survey data do not include the “pseudo-establishments” and sarisari stores without any regular employee. It is likely that the poorer the region is, the higher would be its
reliance on the informal retail trade sector. Thus, the very low retail density in the poorest regions of the
country may reflect in part the larger importance of the informal sector in these regions.
9
higher than the generally accepted turning point per capita level (range) in the
distribution of income.
The historical experience of the OECD countries is instructive for the
likely future path of Philippine retailing. Given the far lower retail density and per capita
income of the Philippines relative to the OECD countries, Table 5 suggests that there
remains a huge scope for the growth in the number of retail establishments in the
Philippines as the country grows over time. (Notice that Korea, one of the new members
of OECD, had a retail density of 166 establishments per 10,000 population in 1990.) It
must be noted that the retail density estimate for the Philippines does not include much of
the informal retail sector. It is likely that the OECD countries do not also include the
informal sector although it is probable that the share of the informal sector in the
Philippines is higher than in the OECD countries. Nevertheless, the vast gap in the retail
densities between the Philippines and the OECD countries indicates the vast scope for
growth of the country’s formal retail trade sector in consonance with the growth of the
economy and the rise in per capita income. The expansion of the formal retail trade sector
may arise either from the “graduation” of hitherto informal establishments into formal
retail establishments (as per the definition in the annual surveys and censuses) or from the
establishment of altogether new stores and shops.
Industry classification of the distribution sector. In the censuses and
annual surveys, the National Statistics Office (NSO) defines wholesale trade as the
“resale or sale without transformation of new and used goods to retailers, to industrial,
commercial, institution or professional users, to other wholesalers, and to government,
wholesale merchant, industrial distributors, exporters and importers”. Likewise, retail
trade is defined by NSO as the “resale or sale without transformation of new and used
goods for personal or household consumption” (NSO). The wholesale trade sub-sector
and the retail trade sub-sector are decomposed further according to the kinds of products
resold and the nature of outlets. Thus, the industry classification at the 3-digit PSIC is as
follows:
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Wholesale Trade:
•
Farm, forest and marine products
•
Processed food, beverages and tobacco products
•
Dry goods, textiles and wearing apparel
•
Construction materials and supplies
•
Office and household furniture, furnishings, and appliances and
wares
•
Machinery equipment, including transport equipment
•
Minerals, metals, and industrial chemicals
•
Petroleum and petroleum products
•
Wholesale trade, n.e.c.
Retail Trade:
•
Books, office, school supplies, including newspapers and
magazines
•
Food, beverages and tobacco
•
Dry goods, textiles and wearing apparel
•
Construction materials and supplies
•
Office and household furniture, furnishings, and appliances and
wares
•
Transportation, machinery and equipment, accessories and supplies
•
Medical supplies and equipment stores
•
Petroleum and other fuel products
•
Retail trade, n.e.c.
Notice the similarity in the industry disaggregation of wholesale and retail
trade at the 3-digit PSIC level. Table 6 presents the industry disaggregation at the 5-digit
level. For retail trade, the more familiar retailing institutions listed in Table 6 are
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groceries (PSIC no. 62211), supermarkets (62212), sari-sari stores (62213), department
stores and bazaars (62301), hardware stores (62401), drug stores (62701) and gasoline
stations (62801). What Table 6 brings out with respect to retail trade is the great diversity
of retail activities and retailing institutions. This reflects the market and institutional
responses to the varied consumer wants as well as the apparently growing specialization
and changes in retailing formats in the provision of retailing services.
Industry composition. There is a preponderance of retailers and
wholesalers in the food, beverages and tobacco classification, followed by retailers and
wholesalers in dry goods, textile and wearing apparel. The third most numerous retail and
wholesale establishments are in the wholesaling and retailing of construction materials
and supplies (see Table 7). The preponderance of retailers and wholesalers in food,
clothing and housing is not surprising because they constitute the bulk of expenditures of
a Filipino consumer. In 1991, 48.5 percent of total family expenditures was spent on
food, 13.5 percent on housing1, 3.7 percent on clothing, footwear and other wear, and 2.7
percent on beverages and tobacco. In 1997, 43.9 percent of total family expenditures was
on food, 15.4 percent on housing, 3.3 percent on clothing, footwear and other wear, and
2.1 percent on beverages and tobacco. Thus, expenditures on food, clothing, housing,
beverages and tobacco as a share of total family expenditures was 68.4 percent in 1991
and 64.7 percent in 1997, respectively (NSCB).
There is a significant difference in the industry composition of large
wholesalers and retailers from the small wholesalers and retailers. (A “ large” wholesaler
or retailer is an establishment with average total employment of 10 or more people; a “
small” wholesaler or retailer has less than 10 people average employment.) (See Table
7.) The biggest number of large wholesale establishments is in the dealership of
machinery and equipment (especially the dealership of commercial and industrial
1
Housing expenditures is composed primarily of rentals and house maintenance expenditures. Much of
construction expenditures is on house construction, which is an investment expenditure. Much of
wholesaling and retailing of construction materials and supplies cover both investment and consumption
expenditures of households, apart from investment expenditures of firms and the government.
12
machinery and equipment), followed closely by wholesale trade not elsewhere classified
(which is dominated by merchandise brokers, general merchants, importers and
exporters), followed by wholesalers of paper and paper products. Small wholesalers are
concentrated in the wholesaling of farm, forest and marine products (which are primarily
wholesalers of grains such as rice and corn and wholesalers of coconut and coconut
products), followed by the dealing of minerals, metals and industrial chemicals except
petroleum (the most numerous of which are in scrap metal).
In retailing, the top three
sub-industries in terms of number of establishments are the same for both the large and
small establishments, although there is a slight difference in ranking. The top three are
the retailing of food, beverages and tobacco, retailing of dry goods, textiles and wearing
apparel, and finally, retailing of construction materials and supplies. The most numerous
of the retail establishments in food, beverages and tobacco are sari-sari stores, groceries
and retailers of cereals (e.g., rice, corn) and pulses. Retailers of dry goods, textiles and
wearing apparel are concentrated in the retailing of wearing apparel and footwear.
Hardware stores, retailers of construction materials and lumber retailers account for the
bulk of retail establishments in construction materials and supplies.
There is no detailed information on wholesale and retail trade establishments
after 1995. Nevertheless, it is likely that the same general features of the early 1990s
remain. Drawing from the survey data, there may be a possible reduction in the share of
small retailers in food, beverage and tobacco as well as of small retailers in dry goods,
textiles and wearing apparel. The decline would probably be due to the graduation of
some of the establishments into the “large” category. Another possible reason is the
secular decline in the share of food expenditures to total family expenditures during the
period.
The industry composition of total sales, value added and employment for
small and large establishments in wholesale and retail trade are shown in Table 8, Table
9 and Table 10. Wholesale trade is largely the province of large establishments because
they account for the bulk of sales, value added and even employment. In contrast, retail
trade is largely small scale, with small establishments dominant in employment
13
generation and accounting for more than half of retail value added despite the much
larger gross sales of large retail establishments than the gross sales of small retail
establishments.
Large establishments accounted for 84 percent of total sales and 91
percent of gross value added in wholesale trade in 1991. The corresponding shares in
1995 were 74 percent and 79 percent, respectively. There is thus a significant shift in
composition towards the small establishments in wholesaling during the period. Notice
that the total value of gross value added of large establishments in wholesaling declined
in absolute terms during 1991-1995 while that of small wholesale establishments more
than doubled. In contrast, the composition of gross sales and value added shifted in favor
of large establishments in retailing during the period. The share of large establishments in
gross sales and gross value added in retail trade rose from 53 percent and 38 percent,
respectively, in 1991 to 55 percent and 46 percent respectively in 1995. In terms of
employment, the share of large establishments declined in wholesaling from 58.6 percent
in 1991 to 54.6 percent in 1995 but increased in retailing from 20.8 percent to 22.1
percent during the same period. The level of employment of large wholesalers declined in
absolute terms during the period, accounting for the significant drop in the share of large
wholesalers to the total employment in wholesaling during the early 1990s.
A more detailed disaggregation of gross sales, gross value added and
employment in wholesaling and retailing at the 5-digit PSIC level is shown for 1994 in
Appendix Table A.1.
Among the large wholesale establishments, wholesaling of
petroleum and petroleum products dominated in terms of gross sales and gross value
added, accounting for 24.1 percent and 20 percent respectively of total gross sales and
gross value added of large wholesale firms. The next five industries were wholesaling of
medicinal and pharmaceutical products, wholesaling of processed food, wholesaling of
beverages, dealing of land motor vehicles and parts, and merchandise brokers, general
merchants, importers and exporters. Notice that the top six industries are also the major
employers among the large wholesalers, with the sole exception of petroleum and
petroleum products wholesaling which is in fact one of the lowest employment
14
generators. Among the small wholesalers, wholesaling of petroleum and petroleum
products is also the most important in terms of gross sales and gross value added, while
contributing only a few to employment. The other major contributors to gross sales are
wholesaling of grains, wholesaling of cement and masonry products, beverage and
processed food wholesaling, and wholesaling of coconut and coconut by-products. The
most important employment generators among small wholesalers are the wholesalers of
grains and coconut and coconut by-products.
In retailing, department stores and bazaars contributed the largest to gross
sales, gross value added, and employment of large retailers accounting for 22.9 percent,
36 percent and 22 percent, respectively in 1994. The other major contributors to gross
sales, gross value added, and employment are retailing of motor vehicles, supermarkets,
groceries, gasoline stations, and retailing of household appliances. Retailing is dominated
by small establishments when it comes to employment and gross value added. The most
important employment generators are sari-sari stores, department stores and bazaars,
groceries, retailers of rice, corn and other grains and pulses, hardware stores, drug stores
and retailers of automotive parts. The major contributors to gross value added were food
and beverages retailing, department stores and bazaars, retailing of household appliances,
groceries and sari-sari stores. Department stores and bazaars accounted for the largest
share to total sales among small retailers, followed by gasoline stations, food and
beverage retailers, n.e.c., groceries, hardware stores, and retailers of household
appliances.
Regional Distribution.
The regional distribution of the number of
establishments in wholesaling and retailing for 1991 and 1995 is shown in Table 12. The
regional distribution of gross sales, gross value added and total employment in wholesale
and retail is presented in Table 13. Not surprisingly, Metro Manila houses the majority
of large wholesale firms, and even to some extent, retail firms. In 1991, Metro Manila
accounted for 60 percent of the country’s large wholesale firms and 47 percent of all the
large retail establishments. In 1995, Metro Manila accounted for 56.7 percent of the
15
country’s large wholesale establishments and 45.2 percent of the large retailers. The
dominance of Metro Manila in large wholesale and retail establishments is even more
evident in terms of gross sales and gross value added. Metro Manila’s large wholesale
and retail establishments accounted for 69 percent of gross sales and 75 percent of gross
value added of all large wholesale and retail establishments in 1991, although the shares
declined to 64 percent and 67 percent, respectively, in 1995. For the whole distribution
sector, Metro Manila accounted for 63 percent of total sales and 68 percent of gross value
added of both wholesale and retail trade in 1991, although the corresponding shares in
1995 declined significantly to 50 percent for both gross sales and gross value added.
The share of Metro Manila to gross sales, gross value added and
employment by industry in 1995 is shown in Table 14. The table shows that Metro
Manila virtually monopolizes the large establishment segment in a number of industries,
particularly wholesaling of office and household furniture, furnishings and appliances
(615), wholesale trade not elsewhere classified; i.e., merchandise brokering, import and
export (619), dealing of machinery and equipment (616), retailing of books, office and
school supplies (621) and retailing of dry goods, textiles and wearing apparel (623).
Notice in Table 14 that the share of Metro Manila in gross value added is generally
higher than its share in gross sales for large wholesale enterprises, suggesting that much
of the returns of wholesaling in the country accrues to the Metro Manila large
wholesalers. Metro Manila is not as dominant in retailing as in wholesaling, especially
for small retail establishments. Nevertheless, the region is still an important presence
especially in the retailing of office and household furniture, furnishings and appliances
(625), retailing of books and office and school supplies (621), retailing of transport
machinery and equipment, accessories and supplies (626), and retailing of construction
materials and supplies (624). The large presence of Metro Manila even in retailing stems
from the fact that the region is the premier retail market in the country given its large
population and higher per capita income.
In comparing the total sales by region by industry in 1991 and 1995, the
share of Metro Manila declined in a number of industries but increased in a few others
16
during the early 1990s. Specifically, Metro Manila’s share in gross sales declined in the
wholesaling of farm, forest and marine products (611), wholesaling of processed food,
beverages and tobacco (612), dealing of petroleum and petroleum products (618) and
retailing of food, beverages and tobacco (622). On the other hand, Metro Manila
increased its share to total gross sales in industries such as the wholesaling of office and
household furniture, furnishings and appliances and supplies (615), retailing of transport
machinery and equipment, accessories and supplies (626) and retailing of construction
materials and supplies (624). The changes in shares appear to indicate that Metro Manila
is losing share in favor of other regions in the wholesale and retail trade of “basic
commodities” (e.g., farm and processed food, dry goods, textiles and wearing apparel)
but it is gaining market shares in the commodities with higher income elasticity of
demand, e.g., office and household furniture and appliances, transport equipment.
In summary, the retail trade sub-sector consists primarily of small
establishments but the small number of large retail establishments (mainly Metro Manila
based) account for nearly one half of total retail sales in the country. Wholesale trade
sales is dominated by large establishments in most wholesale trade lines, and Metro
Manila’s large wholesalers dominate wholesaling in a number of wholesale lines. Metro
Manila’s large wholesalers also captured much of the returns from wholesaling among all
large establishments in the country. The dominance (and virtual monopoly in a few
wholesale lines) of Metro Manila, although not at all unexpected, has significant bearing
on the efficiency and cost of the country’s distribution system. It is likely that
transportation bottlenecks and the price margins between Metro Manila and the rest of
the country can be explained in part by the concentration of wholesaling in Metro Manila.
It may also suggest low competitive pressure (and possibly even cartel in certain lines)
which can have possible negative impact on the entire distribution sector in the country.
The findings on gross margins bring out the issue of competitive pressure in wholesale
trade as much as in retail trade.
17
II.
Efficiency and Competitive Pressure in the Distribution Sector
and the Retail Trade Industry
Gross Margins. In the public hearing of the Senate Committee on Trade and
Commerce on October 9, 1998, Mr. Roberto Claudio of the Philippine Retailers
Association stated that Philippine retailers are operating on a 20 to 25 percent gross
margin. This compares well with other Asian retailers which are operating on 40 to 50
percent gross margin and North American retailers at 60 to 80 percent gross margin.
Gross margins are widely used as indicators of the competitive pressure and/or
efficiency in the distribution sector. Specifically, the lower the margin is, the keener
price competition is likely to be (and firms would have to be more efficient to survive
the competition).
This section presents estimates of gross margins by industry based on the
results of the 1988 and 1994 Census of Establishments. The estimates are compared with
some estimates for a few OECD countries in the 1970s and 1980s, industry–level
estimates for the UK in the 1950s and Japan in the 1980s, and estimates for a few retail
chains in the UK and France in the 1990s. The estimates and comparisons help clarify
Mr. Claudio’s statement and point to the need to widen the policy concern towards the
whole distribution sector and not just the retailing sub-sector.
Estimates of the gross margin (as a ratio of gross sales) in both the
wholesale and retail trade sub-sectors by industries for large and small establishments in
1988 and 1994 are presented in Table 15. The average gross margin for all wholesale
establishments was 20 percent in 1988 and 29 percent in 1994; the average gross margin
for all retail establishments was 19 percent for both 1988 and 1994. The average gross
margin of large retail establishments was 16 percent in 1988 and 15 percent in 1994; the
corresponding gross margin for small retail establishments was 24 percent in 1988 and 25
percent in 1994. The average gross margin of large wholesale establishments was 19
percent in 1988 and 22 percent in 1994; the average gross margin of small wholesale
establishments was 30 percent in 1988 and 21 percent in 1994. Thus, on the average,
18
wholesale trade posted higher gross margin compared to retail trade in 1988 and
especially in 1994. The gap is particularly evident among large establishments.
There is a wide variation in gross margins among industries and by
establishment size around the mean values in both wholesale and retail trade. Drawing
from the 1994 Census data, industries that registered low gross margin (i.e., 12 percent or
below) include the following:
All establishments:
•
Gasoline stations
•
Groceries
•
Supermarkets
•
Land motor vehicles and parts, dealing
•
Lumber and planing mill products, wholesaling
•
Tobacco products, wholesaling
Large establishments:
•
Gasoline stations;
•
Liquefied petroleum gas retailing
•
Drug stores
•
Supermarkets
•
Fish and other seafoods retailing
•
Rice, corn and other grains and pulses retailing
•
Motor vehicles, including used vehicles, dealing
•
Textile fabrics, retailing
•
Cement and masonry materials wholesaling
•
Lumber and planing mill products, retailing
•
Tobacco products wholesaling
19
Small establishments:
•
Gasoline stations
•
Petroleum and petroleum products, wholesaling
•
Fish and other seafoods, wholesaling
•
Tobacco leaf, wholesaling
•
Cement and masonry materials, wholesaling
Industries which had very high gross margin (i.e., 36 percent and up) include the
following:
All establishments:
•
Electrical materials wholesaling
•
Footwear, all kinds of materials, wholesaling
•
Nonmetallic minerals wholesaling
•
Handicraft products wholesaling
•
Scraps, except metal, wholesaling
•
Art goods, marble products, paintings, and artists supplies,
retailing
•
Optical goods and supplies, retailing
•
Toys and gifts retailing
Large establishments:
•
Wearing apparel, wholesaling
•
Electrical materials, wholesaling
•
Agricultural machinery, equipment and accessories, dealing
•
Flowers and plants, wholesaling and retailing
•
Handicraft products, wholesaling and retailing
•
Musical instruments, amusement goods and toys, wholesaling
•
Radio and TV parts and accessories, retailing
•
Art goods, marble products, paintings and artists supplies
20
•
Medical, surgical and dental equipment and supplies, retailing
•
Optical goods and supplies, retailing
•
Toys and gifts retailing
Small establishments:
•
Beverage wholesaling
•
Footwear wholesaling
•
Cordage, rope and twine
•
Electrical materials, wholesaling
•
Agricultural machinery, equipment and accessories, dealing
•
Nonmetallic minerals, wholesaling
•
Industrial chemicals, dealing
•
Medical and pharmaceutical products, wholesaling
•
Handicraft products, wholesaling
•
Scraps, except metal, wholesaling
•
Paper and paper products, wholesaling
•
Books, office and school supplies, retailing
•
Bakery products, retailing
•
Leather goods, retailing
•
Nipa, bamboo and rattan, retailing
•
Art goods, marble products, paintings and artists supplies
•
Office machines and equipment, retailing
•
Optical goods and supplies, retailing
•
Fresh and artificial flowers, retailing
•
Photographic equipment and supplies, retailing
The wide variation of gross margins among sub-industries is not surprising
given the wide variety of products and shop types. It appears that stores that rely on
volume tend to have low gross margins (e.g., drug stores, gasoline stations,
supermarkets), although administered pricing and government-mandated price guidelines
21
may have also contributed to the low margins for automobile dealers and gasoline
stations, respectively. It also appears that gross margins tend to be higher for
commodities that are more perishable or breakable (e.g., fruits and vegetables) and for
commodities with high unit value but low traffic and therefore with high inventory costs.
Nevertheless, only detailed industry or commodity analyses can unravel the reasons
behind the high gross margins; this is beyond the scope of the paper and the study report.
Gross margin by establishment size. The discussion above highlights that
on the average small establishments tend to have higher gross margins. Table 11
elaborates on this by decomposing further the gross margin by establishment size at the
3-digit PSIC level and in a few cases at the 5-digit level. The table indicates that for the
most part, the pattern of the gross margin follows somewhat a U-curve, in that sense that
the gross margin starts relatively high for very small establishments, declines as the
establishment size increases and then turns up at a higher level of employment.
Industries that tend to follow the U-curve pattern include the following:
•
department stores and bazaars (62301),
•
groceries (62211),
•
farm, forest and marine products wholesaling (611),
•
office and household furniture, furnishings and appliances
wholesaling (615),
•
construction materials and supplies retailing (624),
•
office and household furniture and furnishings, fixtures, and
appliances and wares retailing (625).
•
supermarkets
Another discernible pattern of the gross margin by establishment size is
the initial high gross margin at the very low establishment sizes followed by reduction to
a low level as the establishment size increases; the gross margins tend to hover near the
22
low level as the establishment size increases further. This pattern is akin to an L-shape.
Industries that tend to follow this pattern include:
•
transport machinery and equipment, accessories and supplies
retailing
•
petroleum and other fuel products retailing, and
•
medical supplies and equipment stores
The “L-shape” pattern merits attention because it suggests that there are
constant returns to scale beyond the small scale of operations. The petroleum and other
fuel products retailing industry appears to exemplify the L-shape pattern. This implies
that petroleum distribution can accommodate an appreciable number of large distributors.
However, it is the “U-shape” pattern that seems to be dominant in the Philippine
distribution sector, especially the retailing industry.
The U-shaped pattern of the gross margin is not unique to the Philippines.
Hughes and Pollard (1957) found that the U-shaped pattern characterized the majority of
the retail industries in Great Britain in the 1950s. Hughes and Pollard explained the Ushaped pattern as arising from the large establishments not passing all the benefits of bulk
purchase to their consumers while the small stores, buying at unfavorable rates, had to
charge higher prices to recoup their investments or had to limit their stocks to highmargin goods. It was the middle-sized stores, the bulk with working proprietors which
had the lowest margins (Hughes and Pollard, 1957). The explanation of Hughes and
Pollard for the case of Great Britain in the 1950s seems to be relevant also for the
Philippines in the 1990s. That is, it is likely that the high gross margin of small
establishments has much to do with unfavorable purchase rates. It may also reflect the
willingness of customers to pay for the convenience and small lots that neighborhood
stores provide. Similarly, the gross margin of large establishments may reflect the
decision not to pass to consumers the benefits of bulk purchases. It may also reflect the
possible turning up of the average cost of operations arising from diseconomies of scale.
23
The U-shaped pattern of gross margin implies that there are limits to the expansion of an
organization.
Gross margins by location. Gross margins differ widely among provinces
just as there is a wide variation in gross margins among industries. Gross margin ratios
at the provincial level at the three digit level are shown in Table 17. The gross margin
ratios in selected wholesale and retail industries (at the 5-digit level) in Metro Manila,
Cebu and Zamboanga del Sur are shown in Table 18. The gross margin results seem to
be idiosyncratic; that is, the gross margin in each industry of each province is
determined uniquely by the circumstances affecting such industry in the given province.
Nonetheless, the tables seem to bring out the following:
•
Gross margins tend to be higher in the provinces than in Metro Manila,
except especially in the wholesaling of farm, forest and marine products.
There is an even number of higher and lower gross margin ratios (than
Metro Manila’s) in the retailing of construction materials and supplies as
well as of petroleum products. It appears that gross margins in the
provinces tend to be lower or as low as Metro Manila in industries where
the source of supply is largely outside of Metro Manila (e.g., farm, forest
and marine products; construction materials) or where there may be an
industry practice of low margin (e.g., petroleum retailing industry).
•
In a number of difficult-to-reach provinces such as the mountainous
provinces of Mt. Province, Lanao del Sur and Bukidnon, gross margins
tend to be high, especially for goods that are mainly sourced from the
Metro Manila area and environs (e.g., processed foods, dry goods). In
addition, retailing in these provinces is largely undertaken by small
establishments which tend to have higher margins.
24
•
Cebu and (to a lesser extent) Iloilo tend to have comparatively lower gross
margins than Metro Manila in a number of industries; this may be due to
their being at the cross-roads of inter-island shipping in the country.
•
In many instances, the high gross margins in the provinces is linked to the
preponderance of small retail establishments which, on the average for the
country, have higher gross margins than large establishments.
Gross margins of other countries. Gross margins in a few developed
countries are presented in Table 19 and Table 20 as points of comparison for the
Philippines. Table 19 presents the average gross margin for wholesale trade, retail trade
and the entire distribution sector. The table highlights two major differences between the
Philippines and the developed countries. The first one is that whereas in the Philippines
the gross margin in wholesale trade is higher than the gross margin in retail trade, in
developed countries the gross margin in wholesale trade is lower than the gross margin in
retail trade.
The second major difference is that the gross margin of the entire
distribution sector in the Philippines is lower than the gross margins of the developed
countries. The lower gross margin of the entire distribution sector in the Philippines
stems primarily from a much lower retail trade margin despite a much higher wholesale
trade margin. Notice also that in comparing the 1988 and 1994 estimates for the
Philippines, the gross margin of the entire distribution sector declined despite a sharply
higher wholesale trade margin because of the decline in the retail trade margin. In effect,
it has been the squeeze in the retail trade margin that contributed to the comparatively
low and declining gross margin in the entire distribution network.
The comparatively higher wholesale trade gross margin in the face of the
comparatively low retail trade margin suggests that the overriding policy concern for the
further reduction in the gross margin of the distribution sector is not so much the retail
trade sector but the high margin in the wholesaling sector and further improvements in
25
the distribution network including such ancillary services as transportation and handling
services. In the ongoing debate on the liberalization of the retail trade subsector, what
the above finding indicates is that an important but overlooked issue is whether or not
retail trade liberalization can be used as an indirect means of inducing greater
competitive pressure in the wholesale trade sector. In this regard, an important
development in retailing in the developed countries during the past two decades has
been the integration of wholesaling and retailing operations by major retail chains.
Retail chains have shifted toward central distribution systems as merchandise goes
through consolidation warehouses and distribution services. As a result, retail chains
have provided competitive pressure on wholesale trade and indeed have led toward the
demise of traditional merchant wholesalers (Sternquist and Kacker, 1994, p.36). Thus, in
the ongoing debate in the country on the liberalization of the retail trade industry, it is
important to take into account the possible impact of foreign retailers on the structure of
gross margins in the entire distribution sector. Larger foreign retailers which have used
the integration of wholesale and retail operations as a source of their competitive
advantage have the greater potentials for instituting innovative processes and
mechanisms into the country’s distribution sector. This points to a policy bias in favor of
a more liberal policy stance toward large foreign retailers.
Table 20 compares the Philippine gross margins in a few retailing
industries with those of Japan and the United Kingdom. The table shows that retail gross
margins in the Philippines are lower than in Japan. The comparison with the UK
estimates in 1950, when perhaps there is greater similarity between the Philippines now
and the UK then, also indicates that Philippine retail margins are either comparable or
lower. Thus, the comparisons echo the earlier finding based on Table 19; that is, gross
margin in retailing in the Philippines is comparatively lower than in developed countries.
26
Corstjens, Cortsjens and Lal (1995) present the following estimates of
gross margins of selected major French and UK (grocery) retail chains in the early 1990s:
•
Carrefour (Fr.):
12 %
Sainsbury (UK)
21 %
•
Promodes (Fr.)
11
Tesco (UK)
21
•
Casino (Fr.)
16
Argyll (UK)
20
The UK chains have higher gross margins than the French chains because the
former generate a much higher share of private label sales to total sales than the French
chains (Corstjens, Corstjens and Lal, 1995). The gross margin of large establishment
groceries in the Philippines in 1994 (see Table 15) is lower than the gross margins of the
French chains and especially of the UK chains
In summary, retail margins in the Philippines are generally lower than those
in a number of OECD countries which are the likely sources of retail investments into the
country. The gross margins of the more popular retail types are in general very low
except for department stores. However, the wholesale gross margins in the Philippines
are substantially higher than the wholesale margins in OECD countries. This brings to the
fore that the important policy concern for the government is how to improve the
efficiency of, and reduce margins in, the entire distribution sector (and especially the
wholesale trade industry) and not just the retail industry.
Concentration ratio and competition. The financial profile of the Top 2,000
corporations in the Philippines was used to estimate concentration ratios in selected
wholesale and retail trade industries for 1991-1995. The data for the gross sales for all
establishments were taken from the annual survey of wholesale and retail establishments,
except for 1994 which used the 1994 Census results. The concentration ratios at the 3digit PSIC level for 1991, 1992, 1993 and 1995 are shown in Table 21 while the
concentration ratios at the 5-digit level for 1994 are shown in Table 22. Table 21
indicates that there has been an increase in the average concentration ratio for wholesale
27
trade and retail trade during the first half of the 1990s. Moreover, it appears that retail
trade is increasingly more concentrated than wholesale trade. However, aggregate data
hide a wide variation in concentration ratios. More importantly, it is likely that it is at the
more disaggregated level where monopoly power and contestability are more relevant
because of greater commonality of markets. Thus, the concentration ratios at the 5-digit
PSIC level are likely to be more insightful (see Table 22). Two observations stand out
from Table 21; namely,
(a) A few wholesale and retail industries are highly concentrated,
e.g.,dealing of livestock and poultry and unprocessed animal products
(61107), wholesaling of wearing apparel, except footwear (61302),
wholesaling of
construction materials and supplies (61409),
wholesaling of commercial machinery and equipment (61602),
wholesaling of musical instruments, amusement goods and toys
(61905), retailing of passenger motor vehicles (62601), retailing of
drugs
and
pharmaceutical
goods
(62701)
and
retailing
of
photographic equipment and supplies (62907).
(b) There are more wholesale trade industries that are relatively more
concentrated than retail trade industries. From the table, there are 11
wholesale trade industries with concentration ratios of at least 0.40
as compared to 5 retail trade industries. This is not very surprising
because wholesalers consolidate supplies from various producers
(both foreign and local) and distribute them to a large number of
retailers, thereby allowing wholesalers to reap the benefits of possible
economies of scale or scope.
Nonetheless, the high concentration ratios in wholesale trade bring out the
issue of monopoly power of a few large wholesalers vis-à-vis thousands of retailers. It is
likely that one reason behind the comparatively high gross margin in wholesaling in the
Philippines is the high concentration ratio in a number of wholesale trade industries.
28
Thus, an important policy issue concerning the overall efficiency of the entire distribution
network is the encouragement of greater competition in wholesale trade. As noted earlier,
the greater competitive pressure in wholesale trade in developed countries arose from the
expansion and integration of wholesaling functions by large retail chains. For the
Philippines, a number of options are in principle available, including entry of new firms
(either locally owned or foreign owned) in wholesaling, integration of large retail stores
into wholesaling operations (i.e., bypassing wholesalers), and amalgamation of small
retail establishments into large buying groups. The experience in other countries with
respect to buying groups is a mixed one except where it is an endogenous response to
tightening labor markets and growing competition from large retail chains. Thus, it is
primarily through investments either directly into wholesaling or indirectly through
integrated wholesale-retail operations that greater contestability and competition in
wholesale trade can be effected in the country.
29
Chapter II
Regulation and Regulatory Changes in Retail Trade and Other
Selected Service Industries
Retail trade regulation in OECD countries.1
Retail trade is regulated in a number of OECD countries. The regulations
center on restrictions on the establishment of large scale retail enterprises, regulations of
shop opening hours, zoning regulations, restrictions on vertical restraints, pricing and
promotion, and restrictions or public monopoly in the sale of pharmaceutical products,
liquor and tobacco products.
The most important regulation in retail trade in OECD countries is the
restriction on the establishment of large-scale retail establishments. A number of OECD
countries have enacted laws for this purpose; for example, Japan’s Large Scale Retail
Store law (enacted in 1974), France’s Loi Royer (1973), Begium’s Second Padlock Law
(1975) and Italy’s No. 426/71 (1971). Large scale retail establishments have been
restricted in order to protect the small scale, “mom and pop” stores, to protect the
downtown (or city center) stores (from competition from suburban retail centers), and to
manage land use at the local level. The regulations on large-scale retail stores have
become more restrictive in recent years in these countries, with the major exception of
Japan, which has embarked on a path of liberalization.
Studies have shown that the restrictions on large-scale retail stores have
had significant impact on the retail landscape. In Japan, the high retail density and the
preponderance of small neighborhood “mom and pop” stores have been attributed in part
to the Large Scale Retail Store law. In addition, fundamental and structural factors like
the lack of storage space in most Japanese homes, limited car ownership and high
1
This section draws heavily on Pilat (1997).
30
population density (which encourage frequent purchases from stores within short walking
distance) are also important determinants of Japan’s retail landscape (Flath 1996). In
Belgium, the enactment of the Second Padlock Law drastically curtailed the growth of
hypermarts but encouraged the growth of large supermarkets (but smaller than
hypermarts) and franchising (which was used by the large retailers to circumvent the law
to increase their sales). Also, it contributed to the significantly lower average size of retail
outlets in Belgium relative to those in neighboring countries. Finally, it contributed to the
international expansion of major retailers in Belgium because their domestic expansions
were constrained by the Padlock Law. In Italy, Law 426/71 slowed the diffusion of large
stores especially in Southern Italy, favored co-operative chains based on local stores over
retailers with multiple outlets and led to large retailers forced to live with stores of suboptimal size. In France, the Loi Royer limited the growth of supermarkets in the 1970s.
However, the growth of hypermarts was not as much affected because the law was
circumvented through
(1) the filing of a larger number of applications for new
hypermarts than really planned to take into account the percentage of rejection, (2) the
splitting up of adjoining retail units to be consistent with the size limitations, and (3)
expansion in the size of existing hypermarts when the implementation of the law became
more stringent in the later years. Ironically, the Loi Royer, which was enacted partly
because of pressures from municipalities worried about the adverse impact of large outof-town retailers on local shopping centers, also slowed down the growth of city center
shopping areas, which require large stores as anchors for a large number of small retail
establishments. (See Pilat 1997.)
The policy stance on large-scale retail establishments has seesawed over
the years in a number of OECD countries. Belgium abolished the First Padlock Law in
1961. The ensuing growth of large stores put increasing pressure on small stores, so much
so that the latter succeeded in the enactment of the Second Padlock Law in 1975 which
restricts the establishment and expansion of large stores. Similarly, Italy tightened the
implementation of its 426/71 law during the 1970s when there was high level of
unemployment and social unrest and relaxed its implementation in the 1980s when the
country’s economic growth improved. Spain, after a period of liberal stance on the
31
establishment of large stores, introduced a law in 1996 restricting large retail
establishments. Likewise, France has increasingly tightened the implementation of its
legal restrictions on large stores in the 1990s with the introduction of new laws
strengthening Loi Royer.
Large stores have been adversely affected not only by the laws that
explicitly restrict their growth but also by other regulations in retail trade. In particular,
zoning regulations have been used to discourage the growth of large retail stores in the
suburbs in order to protect the stores in the city center in addition to the objective of
rationalizing land use consistent with local infrastructure constraints and environmental
considerations.
Similarly, restrictions on shopping hours (which have been most
stringent in Germany) are biased against large stores which, in contrast to small
neighborhood stores, have the flexibility and economies of scale to hire appropriate
numbers of personnel to accommodate more flexible and longer shopping hours.
In OECD countries, there is a tendency for the average size of retail
establishments to increase as per capita income increases. Nevertheless, Hoj et.al. (1995)
find in their regression analyses that zoning laws and restrictions on large scale
establishments slowed down the growth of the average size of establishments in OECD
countries. Similarly, an OECD study cited in Hoj et.al. (1995) indicates that the density
of food outlets in Japan and Italy would have been lower were it not for the laws in Italy
and Japan explicitly restricting the growth of large establishments.
The restrictions on large retailers have meant that large retailers have a
much smaller share of total retail sales, and correspondingly, a higher share by small
establishments,
in the more restrictive countries compared to countries with more
liberalized retail environments. For example, small stores with employment of less than
10 accounted for 48.9 percent of Japan’s retail sales and 36 percent of France’s retail
sales in the late 1980s, in sharp contrast to the 13.7 percent share of small stores in the
United States. Correspondingly, large retail establishments with employment of more
than 100 accounted for 15 percent of Japan’s retail sales while large establishments with
32
employees numbering more than 200 accounted for 34 percent in France. In sharp
contrast, 65.2 percent of US retail sales and 63.6 percent of UK retail sales come from
large retail establishments with employment of more than 200 (Baily 1993, p.124).
The preponderance of small retailers in countries with more restrictive
policies on large retail enterprises appears to have also contributed to lower labor
productivity in retailing in these countries compared to that of the United States. Baily
(1993) estimates that labor productivity in general merchandise retailing in Japan and
France was only 44 percent and 69 percent respectively of the US level in 1987. Pilat
(1997) finds that the productivity growth appears to have slowed down in Japan, France,
Italy and Belgium following the introduction of legislation restricting the establishment
of large retail establishments. Large retailers tend to be more efficient; they have also
been the source of innovation and new technologies in the sector. Hoj, et.al. (1995) find
that higher average size of retail establishments is associated with lower average price
levels, suggesting that large enterprises increase the efficiency of the distribution system.
Large retailers like Wal-mart have been in the vanguard in the use of information
technology in retailing and distribution activities which have contributed to lower-thanaverage share of distribution costs to total sales (Pilat 1997). Other potential gains from
the rise in the average size of retail outlets include the reduction in consumer prices and
increased output of distribution services (Hoj, et.al. 1995).
In summary, large stores have been a politically sensitive issue in a
number of OECD countries.
Concerns about employment and the management of
structural changes in the sector are at the heart of the issue as liberalization can be
expected to generate structural changes in the sector. In a number of European countries
(e.g., France, Spain, Belgium, Italy), this has led to the tightening of their regulations on
the establishment of large retail establishments in recent years. Japan stands as a notable
exception among the OECD countries with restrictive policies in retailing because it has
embarked on a path of deregulation in the 1990s. The impact of the retail trade
liberalization in Japan is discussed in the succeeding section.
33
An important concern is whether or not the liberalization of the retailing
industry leads to significant losses in overall employment. The experience in Japan after
the liberalization of the Large Scale Retail Stores Law did not result in significant losses
in employment. The United States, which arguably has the most modern retailing
industry among OECD countries, has seen growing employment in retailing over the past
two decades. Moreover, the US experience indicates that small shops still play an
important part in the whole retailing system in developed countries despite their much
reduced share to total retail sales. Small shops have become more specialized and
customer-oriented. In addition, small shops have been finding ways to improve efficiency
in operations, reduce costs and gain economies of scale through, for example,
franchising. Thus, in the end, addressing the issue of whether or not, or at what phase, to
liberalize restrictions on large stores involves judgements on the trade-off, at least in the
short run, between social stability and efficiency. And the efficiency “opportunity cost”
of social stability is the lower labor productivity in retailing in the countries with more
restrictive policy environments in retail trade.
Retail trade liberalization in Japan
Japan successively liberalized the Large-Scale Retail Store Law during
the 1990s. The more recent revisions include the streamlining of procedures for opening
up large retail establishments, abolition of regulations on store space for stores with less
than 1,000 square meters, and allowing longer and more frequent opening hours of large
stores. As a result, there was a significant rise in the number of applications to open large
stores (up to 6,000 square meters in the largest cities). The rise in the number of large
stores coincided with the decline in the number of “mom and pop” neighborhood stores,
increased integration of neighborhood stores into larger convenience store chains such as
7-Eleven, decline in unincorporated enterprises and rise in incorporated businesses. In
spite of these developments, however, the losses in employment arising from the easing
of restrictions on large retailers in Japan have not been significant. (See Pilat 1997.).
34
The liberalization of the implementation of the Large-Scale Retail Store
Law occurred at the same that there were significant changes in the retail industry, arising
in part from the increased motorisation of Japan and more importantly
from the
appreciation of the Japanese yen in the late 1980s and early 1990s. The changes were not
only in terms of the structure of the industry but also in terms of the business
relationships and practices in the distribution sector.
Up until the 1970s, the degree of motorisation in Japan was only about
half that of Germany, United Kingdom and France (and was still lower than had been in
the United States in 1930). This meant that shopping was on foot or by public
transportation (near railway stations), with limited choice as to the size and location of
stores. With very high land costs in such store locations, stores were mainly small stores
as they had to have high space efficiency in order to survive. The sharp rise in cars
encouraged the growth of suburban type-large scale retail chain stores; nevertheless, poor
roads for suburban shopping, traffic jams and high land cost slowed down the growth of
large suburban stores. (See Itoh 1996.)
But the more important factor behind the changes in structure and business
relationships in the Japanese distribution industry was the appreciation of the Japanese
yen which led to the growth of the large retail chains and discount stores. The
appreciation of the yen led to the surge of imports of such products as Asian-made
apparel products, foreign processed foods and home electronic appliances supported
primarily by the importation of large retail stores and chains. This meant a significant
change in the traditional keiretsu-type relationships between manufacturers and retailers
(and wholesalers). For example, apparel is traditionally distributed by the large
manufacturing firms through the large department stores on a consignment basis wherein
the firms send their sales clerks to the stores, set their retail prices and all unsold products
are returned to them. Department stores merely provided space and did not take risk on
the products. Thus, apparel firms engaged heavily in retail activities while department
stores depended heavily on apparel firms. The appreciation of the Japanese yen changed
the importance of this relationship significantly. Specifically, it encouraged the sharp
35
growth in the so-called "roadside chain stores” where the stores sell same types of
apparel (usually their own brand) allowing for economies of scale and do not rely on
consignment arrangements. Because they take risks on the products they sell, the roadside
store chains (which can have more than 300 outlets) relied a lot on low wage countries
like China for sewing. The sharp growth of roadside store chains can be surmised from
the fact that they accounted for about one half of the volume of men’s suit sold in Japan
by the mid 1990s compared to almost nothing in the mid-1970s. (See Itoh 1996.)
The impact of the growth of large stores on the vertical relationships
between manufacturers and retailers (and wholesalers) is also exemplified by the retailing
of home medicine ( Itoh 1996). Because of government regulations, retail drug stores in
Japan were traditionally dominated by mom and pop shops heavily dependent on
wholesalers for such services as store display arrangement, transportation of products,
choice of products sold and setting of retail prices. Manufacturers used rebate system
with wholesalers and retailers in order to promote their products. Because manufacturers
were allowed to control the prices of most medicines, manufacturers (especially those
selling directly to retailers) kept high retail margins in order to give the retailers strong
incentives to sell their products. Such high retail margins were largely maintained
because discounts were discouraged and the stores were small and spread apart resulting
in low price elasticity of demand. The rapid expansion of retail chain drugstores in recent
years has led to more common use of discounting and has made it more difficult for
manufacturers to maintain high retail margins. (See Itoh 1996.)
There were economy-wide gains from the liberalization of the Large Scale
Retail Stores law. The price of the distribution sector relative to the overall price level
(i.e., GDP deflator) declined by about 2 percent per year during 1992 and 1993. Estimates
of consumer welfare gains and increased demand arising from the retail trade
liberalization in Japan ranged between ¾ to 1 percent of GDP (Pilat 1997).
36
Deregulation and liberalization in other service industries in the OECD
countries1.
There has been a marked shift towards deregulation and liberalization of
service industries in many countries including OECD countries. The experiences indicate
that the regulatory changes have been on the whole welfare- and efficiency- enhancing.
Where the performance is mixed, complementary competition policy measures were
needed but not implemented. To wit:
•
Road transport. Road freight and passenger transport was once one of the
most regulated in the OECD countries. However, it has been increasingly liberalized
during the past three decades. Freight transport was deregulated in the 1960s in
Australia, Sweden and the United Kingdom and in the 1980s in France, New Zealand,
Norway and the United States. The deregulation of the passenger transport industry
occurred in the 1980s in the OECD countries. The impact of the deregulation has
been largely positive. In all of the OECD countries that deregulated, the entry of new
firms into the road transport industry increased. For example, the number of carriers
and intermediaries in road freight doubled between 1979 and 1985, although most of
the new entrants were small firms such that the overall industry concentration
increased only slightly during the period. Similarly, the number of transport
authorisations in France doubled during 1974 and 1987. In addition, the quality of
service (in terms of routes served, safety, and facilities and equipment) improved. In
most cases, rates and fares dropped arising from the liberalization. For example,
transport fares fell by 6.4 percent for short-zone traffic and by 3.4 percent for longzone traffic in France after the 1986 deregulation. Other effects worth noting were the
following:
(a) increased concentration in freight transport in Australia and the United
States,
(b) reduction in industry profits in Canada
1
This section draws heavily on Hoj, et. al., 1995.
37
(c) increase in employment in New Zealand
(d) the use of market niching in terms of routes and quality of service as a
survival and/or growth strategy, especially in the United Kingdom
(e) reduction in the procurement costs for scheduled bus services in
Sweden.
•
Telecommunications. There has been a significant change in the
state of competition and policy regime in the telecommunications industry in
many OECD countries. Where once the industry was viewed a natural monopoly
requiring government ownership or at least substantial government equity
participation as well as strict government regulation, technological developments
have created new avenues for contestability and allowed new participants in the
industry.
As a result, there has been a shift towards privatization and
liberalization of the telecommunications industry. Nevertheless, only the United
States,
Canada
and
the
United
telecommunication services industries.
Kingdom
have
completely
private
As of 1994, the rest of the OECD
countries are either still publicly owned (e.g., France, Germany, Norway,
Belgium, Austria, Greece, Switzerland, Ireland and Turkey) or have a mix of
public and private ownership (e.g., Japan, Australia, New Zealand, Italy, the
Netherlands, Spain, Portugal, Sweden and Finland).
Similarly the degree of
competition differs among the various telecommunication services and countries.
Voice telephony (local, trunk and international) is still a monopoly in most OECD
countries, except for Japan, New Zealand, United Kingdom, Sweden, Finland, the
United States (for trunk and international) and Canada (for international). Where
there has been a greater degree of competition is in mobile communications
(especially paging and to a lesser extent digital) and data transmission services.
The greatest degree of competition is in the market for telecommunication
equipment and the provision of value added services.
38
The differences in the ownership structure and degree of competition in
the various telecommunication services among the OECD countries allow for
comparative analysis on the impact of regulation and liberalization in the industry. Baily
(1993) compared the productivity in telecommunications in the United States, France,
Germany, Japan and the United Kingdom. He found that productivity in
telecommunications in Germany and France was about half that of the United States, that
of Japan was between two-thirds to three-fourths of the United States and that of the
United Kingdom about two-fifths to one-half of the United States. Although there may be
many reasons for the significant gap in productivity among the sample countries, it is
likely that a significant reason is the competition environment. In both Germany and
France, up until the early 1990s, telecommunications was largely a government
monopoly with the German industry stuck with mechanical switching devices and the
French telecommunications firms overstaffed at the same time that the French
government subsidized an aggressive and expensive technology upgrading program. The
United Kingdom privatized its telecommunications; however, British Telecom (BT) was
a virtual monopoly in local phone service and did not reduce employment substantially.
The comparatively higher productivity in Japan relative to the European countries
stemmed in part from the streamlining and restructuring of NKK with the significant rise
in the number of players in the various telecommunications fields.
Privatization and regulatory reform in telecommunications in OECD
countries has led to more efficient pricing. There has been a shift towards fixed charges
in line with the high fixed cost and very low marginal costs in the industry. Cross
subsidization of local calls by long distance calls has been reduced. This has resulted in
lower long distance rates and higher local call rates. The decline in long distance rates
and the corresponding rise in local call rates has been particularly pronounced in the
countries with the more competitive telecommunications industry as compared to those
with
more
restrictive
policy regimes.
Thus,
in
countries
with
competitive
telecommunications industries, long distance call rates dropped by between 18 and 35
percent, business charges by about 9 percent and total residential charges by 3 percent
while local calls increased by 15 percent during 1990-1994. In countries with non-
39
competitive industries, long distance call rates declined by between 12 and 16 percent
and business charges by 3 percent while local calls increased by 20 percent and total
residential charges by about 9 percent during the same period (Hoj, et.al., 1995).
Output and productivity in the telecommunications industry improved
because of the developments in technology and increased outsourcing. New products and
services were developed as the demand for telecommunication services increased.
Drawing from the privatization experiences of Japan and Finland, employment did not
suffer despite the trimming down of personnel of the privatized former public utilities
because the reduction in personnel of privatized firms was at least offset (or even more
than offset) by increased employment from new entrants into the liberalized industry.
Privatization was more welfare enhancing when complementary competition policy rules
were enacted that ensured entry of new entrants and “… level playing field in terms of
competition, technical standards and fair access between different operators’ networks.”
Privatization that does not lead to competition and improvements in efficiency is best
exemplified by the privatization experience in the United Kingdom in the 1980s when
British Telecom virtually dominated the industry; it was only in the 1990s that there has
been greater competitive pressures because of the influx of many new investors ( Hoj,
et.al., 1995).
•
Airline industry. The airline industry is largely a regulated industry in the
OECD countries with the principal exceptions of the United States and Canada.
Domestic services tend to be monopolies or duopolies; international services are
regulated through bilateral agreements.
A comparison of the deregulated airline
industry in the U.S. and the more regulated airline industries in Europe provides some
insights on the effects of competition and deregulation of the industry. The
comparison indicates that the U.S. airlines have been able to optimize operations and
maximize economies of scope from their hub-and-spoke operations that allow for
easy interconnection. (Airline operations offer little economies of scale except in offflight services like ground handling but more of economies of scope through hub and
spoke operations, code sharing and the operation of computer reservation systems.)
40
With greater reliance on international flight operations, European airlines have also
been hampered by bilateral agreements that control international flight frequencies as
well as more ponderous immigration arrangements compared to domestic operations
in continent-wide U.S.A.. European airlines are also hampered by less efficient aircontrol systems, higher fuel prices and less competition in ground handling in Europe
than in the United States. As a result, the productivity of European airlines lag
behind the U.S. airlines in virtually all aspects of European operations (Baily 1993.)
Estimates of the productivity gap of European airlines relative to US airlines range
from 20 percent to 40 percent. Not surprisingly, the unit price and cost of European
airlines increased faster than those of U.S. airlines. There is a wide variation in costs
among European airlines reflecting the fact that some airlines find it difficult to
restructure and be cost efficient. In addition, airline pricing in the U.S. has become
more uniform in contrast to the wide variation in pricing among European airlines.
(Hoj, et.al., 1995).
The sectoral liberalization initiatives do not only have sectoral effects;
there are also economy wide effects. Although the quantification of the economy wide
effects is more difficult to do and has been much more limited, the prevailing view is that
the economy wide effects can exceed the sectoral effects. There are three reasons for this;
namely,(a) increased efficiency in one sector frees up resources to other sectors and
thereby improves overall resource allocation (the “static” effect), (b) increased capacity
for product innovation and growth by expanding the range of goods and services
provided as exemplified in the cases of the distribution and telecommunication industries
(the “dynamic” effect), and (c) improved flexibility and competitiveness of the whole
economy because the higher productivity or lower prices in the liberalized sectors
reverberate into the industries that use the outputs of the liberalized industries. Estimates
of the effects of the regulatory reforms in the United States in airlines, trucking,
telecommunications, among others, suggest increased social welfare amounting to
between 0.65 and 0.85 percent of GNP. Moreover, such gains were shared by both the
consumers and the workers and producers, who generally also benefited from the
liberalization programs. Estimates on the effects of the deregulation arising from the
41
European internal market suggest that the gains from the economies of scale, lower profit
margins, and the dismantling of technical and customs barriers range from 1.5 percent to
as high as 7 percent of GDP. Similar analysis for Australia on the “Hilmer” reform
package of enhancing competition in the whole Australian economy including the utility
sector, road transport and ports show large welfare gains that is widely distributed among
the various sectors of the economy. Country studies in the United Kingdom, the
Netherlands and Germany also point to contributions to international competitiveness,
rise in employment and GDP, and reduction in the inflation rate. Even in the case of New
Zealand, the wide ranging reforms in the country which had initial negative effects
eventually resulted in the rebound of productivity and improvement in the international
orientation and competitiveness of the country. (See Hoj, et.al. 1995.)
Deregulation and liberalization in selected service industries in the
Philippines
The Philippines has been liberalizing much of the Philippine economy. In the
service sector, the country has allowed more foreign banks to enter the banking industry,
liberalized the insurance industry allowing 100 percent foreign ownership, and
significantly deregulated the telecommunications industry. The impact of the
liberalization and deregulation initiatives in these industries on the country has largely
been positive. To wit:
•
Telecommunications industry.
Up until the 1980s, the Philippine
telecommunications industry was characterized by a virtual private monopoly in the
most important segment, the telephone sub-sector. Teledensity was low, the queue for
a telephone line was inordinately long measured in years, the quality of service left
much to be desired. Starting in the late 1980s but more importantly beginning in
1993, the Philippine government implemented a series of policy reforms that
deregulated and encouraged greater competition in the various segments of the
telecommunication industry. Among these policy reforms were the mandating of
42
compulsory interconnection among authorized public telecommunications carriers,
mandating the provision of more telephone exchanges and developed the service area
scheme requiring international gateway facility operators and other service providers
to subsidize the provision of local exchange carrier service in unserved or
underserved areas of the country, promoted an open and competitive environment for
services such as cellular mobile telephone system, and reduced barriers to entry into
the telecommunication industry.
The impact of the reforms on the industry and the economy has been
significant. The number of operators in the various segments of the industry increased
tremendously during the 1990s, with the attendant increase of competition in the industry.
Thus, for example, there are now 74 private and 4 government telephone operators in the
country (as compared to 45 companies in 1992), with PLDT accounting for 32 percent of
the total number of installed lines in 1998 as compared to 94 percent before the
liberalization. Similarly, from being the sole operator of the country’s international
switching center, PLDT is now only one of the 11 such IGF operators. By 1997, there
were 15 paging companies, 5 cellular mobile telephone system companies, and 130
internet service providers as compared to 6 paging companies, 2 cellular mobile
telephone system companies and no internet service provider in 1992. The expansion in
the number of operators gave rise to the expansion in services offered. Thus, for example,
the 1990s has seen the sharp expansion in the subscriber base of cellular mobile phones
and pagers. To a large extent, the expansion of the industry has been propelled by the
inflow of foreign investments in the sector as a number of major American, European and
Asian companies formed joint ventures with local firms. The total foreign direct
investment in telecommunications for the period 1990-1998 was 25 times higher than the
total for the period 1973-1989. As a result of the increased investments, the country’s
teledensity has increased, from 1.2 in 1992 to 8.1 in 1997, although the regional
distribution remains highly uneven from 0.9 in Cagayan Valley to 28.6 in Metro Manila.
43
The consumers benefited from the liberalization and deregulation in the
telecommunications industry. The waiting time for a telephone line has dropped
tremendously. The prices for international calls, cellular mobile phone and paging
services have declined. There has been an expansion in the services provided by
telephone firms and other telecommunications companies to their customers, as perhaps
best exemplified by the “texting” phenomenon.
The expansion of the industry in the face of increased competition and foreign
as well as local investment has led to the increase in the share of the industry to the
country’s national output (GDP) from 1.4 percent in 1990 to 2.0 percent in 1997. The
impact on the economy is likely much more. The emerging reputation of the Philippines
as a good site for backroom operations of large multinational firms abroad is partly
attributable to the improvement of the country’s telecommunications facilities. Similarly,
for the rising professional service exports of the country, best exemplified by computer
software but also include such services as film animation and magazine and book
editorial services.
Study One of the Report provides a detailed discussion on the opening up of
the Philippine telecommunications industry to competition and foreign investment.
•
Banking and Insurance industries. In both the banking and insurance
industries, foreign companies had a major presence in the Philippines during the
colonial period beginning in the 1870s. However, the post World War II period
has been restrictions on the establishment of foreign institutions, either
specifically stated as in the 1948 General Banking Act or as part of an overall ban
on the entry of new insurance companies under the 1966 Insurance Act. In recent
decades, there was a stop-go nature to the further opening up of the banking
industry to foreign participation until the passage of RA 7721which allowed the
entry of up to 10 new fully-owned foreign banks (up to 6 branches for each bank)
into the country. Other foreign banks have since come in by buying into existing
banks. In the case of the insurance industry, foreign participation in non-life
44
insurance companies was allowed up to 40 percent under the Omnibus Investment
Code; foreign equity in life insurance companies apart from those operating
already before the passage of the Code was not allowed because the sector was
deemed by the Insurance Commission to be adequately capitalized. It was in 1994
that the entry of new insurance companies was allowed, including 100 percent
foreign ownership, in both the life and non-life segments of the industry.
The liberalization of entry of foreign investments into the banking and
insurance industries had the expected impact of foreign direct investment into the
industries and the attendant increase in the share of foreign-owned banks or insurance
companies to total assets in the industry. The share of foreign banks to the industry’s
total assets rose from 11.4 percent in 1990 to 16.5 percent in 1997. The share of foreign
banks to the industry’s total loans increased slightly from 10.4 percent in 1990 to 11.7
percent in 1997. The share of foreign banks to the industry’s total deposits declined
however from 7.5 percent in 1990 to only 7.2 percent in 1997. In the case of the
insurance industry, the number of foreign insurance companies rose from 18 in 1993 to
24 in 1997 with the new entrants concentrated mainly in the life insurance business. The
share of foreign companies to the industry’s total assets increased marginally from 41
percent in 1993 to 43 percent in 1997.
There are no thorough analyses yet of the impact of the liberalization of the
banking and insurance industries on the Philippine economy. In contrast to the
telecommunications industry, the impact on the consumer is not as clear cut. There is no
perceptible narrowing of the interest rate spread between the average lending rate and the
average deposit rate following the bank entry liberalization. The non-life insurance
industry, which is generally viewed to be undercapitalized, has not yet generated much
foreign investment. Nevertheless, there are indications that the entry of foreign banks and
insurance companies has raised the competitive pressure in the banking and insurance
industries. Mergers, bank niching and branching, and increases in bank capitalization of
the larger domestic banks sharpened up in recent years, most likely partly in response to
the entry of the new banks. Similarly, there appears to be increased competition in terms
45
of insurance products being offered to consumers. To some extent, the liberalization
initiatives are still very recent and the changes are likely to be slow and more subtle in
the two industries (including possible changes in operational strategies and streamlining
of operations), in contrast to the telecommunications industry which responded to a huge
unmet demand. Nevertheless, it can be expected that over time the larger capitalization of
the banks and insurance firms as well as the more transparent corporate governance
environments of the foreign firms would contribute to the strengthening of the
foundations of the country’s financial system as long as the overall macroeconomic
policy regime remains prudent.
Study Two of the Report presents a more detailed discussion of the
liberalization of the banking and insurance industries in the country.
The experiences presented above bring out that on the whole the increased
competitive environment arising from deregulation, privatization and regulatory reform
has been beneficial. Productivity is higher and costs have been contained. Behind this has
been the ability of firms to enter and exit freely, lay off workers and restructure industries
(Baily 1993). In the Philippines, the inflow of foreign investments has been important
and allowed to help address an important unmet demand at least with respect to
telecommunications services. Nonetheless, while in the aggregate there are net positive
results, there are also individual disruptions at the micro-level as firms may die or
restructure and workers are laid off at least temporarily. Or, as in the US experience,
stores in downtown business districts closed shop with the rise of retail centers in the
suburbs. It is clear that part of the challenge is how to manage the reform process in order
to minimize such disruptions and maximize the opportunities brought about by the
liberalization and regulatory reform initiatives.
46
Chapter III
Retail Trade Nationalization and Liberalization: Towards
Retailing and Distribution Services for the 21st Century
I.
Retail trade nationalization, retail trade liberalization
The Philippines nationalized retail trade in 1954 with the enactment of
R.A. 1180, popularly known as the “Retail Trade Nationalization Law.” It was, as
Agpalo (1962) put it, “..the culmination of a social movement” (p.20). The law was the
result of decades of agitation since the start of the century by many of the country’s
prominent leaders to Filipinize retailing and put Filipino faces behind a ubiquitous social
institution. In fact the earliest attempt to exclude the Chinese from retail trade was
initiated by the Spaniards in the 1580s because the latter felt they could not compete with
the Chinese and deserved to be given the opportunity to profit from the trade themselves.
The royal decree in 1589 forbidding the Chinese to engage in retail trade was not
implemented though. 1
The impulse for the movement to Filipinize retail trade in the country
during the 20th century started with the William Taft’s “The Philippines for the Filipinos”
slogan that inspired the agitation for the nationalization of the country’s retail trade by
1905. The administrative route to the Filipinization of retail trade was given impetus with
the establishment of the Bureau of Commerce in 1918. The legislative route started with
the adoption by the Philippine Legislature of a Bookkeeping Act in 1921, requiring
merchants to keep their accounts in English, Spanish or a local dialect and thus was
aimed primarily against the Chinese shopkeepers. However, the Chinese succeeded in
convincing the United States Supreme Court to render the Act null and void. It was
beginning 1930, with the establishment of the Ang Bagong Katipunan organized by the
1
The paragreph and the succeeding two paragraphs draw very heavily on Agpalo (1962).
47
then Speaker Manuel Roxas, that the movement for the nationalization of retail trade
gathered momentum. Ang Bagong Katipunan espoused economic protectionism, which
became fully developed in the National Economic Protectionism Association (NEPA)
organized in 1934. One of the founders of NEPA, Salvador Araneta, was instrumental in
pushing the nationalization of the retail trade (i.e., ownership of at least 75 percent by
citizens of the Philippine Islands and the United States) in the 1934-1935 Constitutional
Convention.
Although the Convention eventually defeated the Araneta proposal
primarily out of fear of adverse foreign repercussions, the Convention delegates
nevertheless passed the “Cuenco Resolution.” The Cuenco Resolution indicated that the
Convention delegates were in favor of the nationalization of retail trade but that it did not
approve the Araneta proposal because the National Assembly (the Legislature during the
Commonwealth period) was empowered to enact such law. Thus, the Constitutional
Convention through the Cuenco Resolution set the stage for the legislative route in
wresting the control of the retail trade industry from the Chinese in the succeeding years
into the early 1950s.
There were proposals for retail trade nationalization brought to the
National 4th Assembly during the Commonwealth period but they did not prosper because
the government was worried about possible intervention by Japan (which was a rising
military power then) in Philippine affairs ostensibly to protect Japanese nationals in the
country. A bill nationalizing the retail trade industry was passed by Congress in 1945 but
was vetoed by President Osmena because of concerns about international repercussions.
The political salience of retail trade nationalization at that time could be discerned by the
fact that three bills nationalizing retail trade were introduced on the first session in 1946
of the First Congress (1946-1949). Several more bills of similar nature were introduced
during 1947-1953. The series of bills nationalizing the retail trade industry had one
important constant: the movement to nationalize the retail trade was the wellspring of
ideas and eventually the utilization of the techniques of lobbying and organizing in
support of the bills. Indeed, the leaders of the movement would become critical in
monitoring and keeping vigil of the legislative process until the eventual passage of
Republic Act 1180, otherwise known as the Retail Trade Nationalization Law, in 1954.
48
The nationalization of retail trade was an embodiment of the economic
nationalism at that time born during the colonial period when much of the nation’s
business and most of the corporations were foreign owned. It was consistent with the
industrial protection policy at that time, where protection of domestic enterprises against
competition from imports was viewed as a mechanism not only to build the country’s
manufacturing sector but also to nurture Filipino industrialists and businessmen. The
1950s culminated with President Garcia’s Filipino First Policy. Agpalo’s (1962) account
of the movement for, and the legislative debate on, the nationalization of retail trade
amply shows that the process was not an easy one, punctuated by pressures from foreign
countries (especially China) as well as fears by Filipino top political leaders during the
late 1930s that retail trade nationalization could become a pretext for Japan to intervene
in the Philippines to protect Japanese nationals in the country. The drive to have more
Filipino participation in the nation’s retail trade even spawned nongovernment initiatives
like the Pera-Pera Movement organized in 1938 (Agpalo 1962, p.32). In short, the
nationalization of the retail trade industry was a product of its times; it was principally a
social policy-cum-political measure rather than an economic policy measure.
Overall, the law succeeded in putting the retail trade industry into the
hands of the Filipinos. There is no longer any need for what one of the earliest agitators
for the nationalization of the retail trade did in 1905, when Dr. Bonifacio Arevalo urged
Filipinos to establish retail stores and appealed to the consumers to patronize Filipino
stores (Agpalo 1962, p.23).
Times have changed drastically since the 1950s, however. The economic
policy of protectionism and Filipino First has given way to competition, liberalization
and outwardness. The Philippine government has progressively liberalized and opened
the Philippine economy through a series of reforms for about a decade and a half now.
Foreign investors can now have 100 percent ownership of enterprises in many economic
sectors in the economy. Thus, the Retail Trade Nationalization Law has become an
anachronism, especially when foreigners can invest in sectors that can be considered
49
more “sensitive” and “strategic” (e.g., banking) than retailing. Moreover, the social
context under which the nationalization law was enacted (i.e., foreign control of retailing)
is no longer as politically salient today as during the colonial period. Not surprisingly, it
is the government that has been spearheading the move to amend the Retail Trade
Nationalization Law. (Government officials during the Commonwealth period did not
support the retail trade nationalization bills at that time not because they did not support
the economic ideology behind the nationalization bills but because they were afraid that
foreign governments could use the retail trade nationalization as a pretext to intervene in
Philippine afffairs.)
At the same time, however, it is important to take into account the social
context of retail trade. Especially during the colonial period and in the early post WWII
period, the retail store is a social institution that every Filipino interacts with from birth to
adulthood. Thus, the alien control of the retail industry during the colonial period and
well into the Philippine republic rankled the Filipino nationalist such that nationalism was
equated with Filipinization at that time. The Filipino-Chinese crisis of 1923, when a
quarrel between a Filipino customer and a Chinese shopkeeper led to a near riot among
Filipinos and Chinese aiding their fellow countrymen as well as the momentary closure
of Chinese shops in Manila (Agpalo 1962, p.26), exemplifies a social stress arising from
the perceived inequitable alien control of the retail trade sector. Moreover, retail trade
remains an important training ground for new entrepreneurs especially in the light of the
substantial unemployment and underemployment in the country. As Agpalo (1962, p.
56) puts it: “…a retailer someday can become a wholesaler and later as importer and
exporter. The retailer, too, may become a chain-store owner…” This perspective, that
retailing is a breeding ground for new Filipino entrepreneurs, remains a key rallying point
of the Filipino retailers today in their objection to the opening of the retail trade industry
to foreign investment.
Given that the Retail Trade Nationalization Law is already inconsistent
with the economic policy and realities at present, the issue therefore is no longer
whether or not to liberalize the industry but rather the degree and pace of the
50
liberalization process. In the light of the lingering concerns about the fate of Filipino
retailers in case the industry is opened up to foreign investment, it is important to
address perhaps the most important concern, which is whether or not Filipino retailers
would be swamped by foreign retailers when the industry is opened up to them. Related
to this is the fear that the entry of big foreign retailers would hasten the demise of small
retailers in the country.
Retail trade liberalization: the demise of the Filipino retailer?
The estimates of gross margins in Table 15 are instructive in this regard.
The estimates indicate that on the average the margins among large establishments are
low in many of the more popular retail formats. This is especially the case in Metro
Manila and Cebu, the two major retail markets in the country.
The margins are
significantly lower than the retail margins in the OECD countries which are the likely
sources of foreign investments in retailing in the country. This means that domestic stores
can compete with foreign stores, in terms of price competition. Given the low margins
and likely higher set up costs, foreign firms would have to have unique advantages, either
in terms of more efficient systems, product niches or service quality, to be able to
compete effectively vis-à-vis domestic retailers. If the gross margin data in the Annual
Surveys and Census of Establishments are a fair representation of the true industry
situation; i.e., firms give correct data to the National Statistical Office, then it is highly
unlikely that domestic retailers would be swamped by foreign retailers after the
liberalization of the industry. Moreover, the retail density in the country is still low and
offers a huge scope for the expansion of the number of establishments in the retail trade
industry as the economy grows over time.
The retail margins among small establishments are higher than among large
establishments. This may suggest that there are opportunities to exploit in small scale
retailing. There are two probable sources of foreign competition here. The first one would
be direct competition from potential immigrants from low- income Asian countries (e.g.,
51
India, Pakistan) with strong trading tradition. However, it is unlikely that Philippine
immigration laws would be relaxed to allow such flow of immigrants. The second one is
where large foreign retailers use their market power and economies of scale to kill off
local small retailers. While there is some likelihood of this, there are economic conditions
in the country that would minimize such occurrence. The more likely impact is greater
competitive pressure on medium and large retailers especially in the supermarket and
grocery segment as well as, importantly, on wholesaling operations. This is discussed
further below. On the whole, it is likely that the opening up of the retail trade industry to
foreign investment would not appreciably hurt the small retailers in the country.
Moreover, the experience in other countries indicates that there are no
guarantees for success for foreign retailers. For example, US retailers like Federated,
Sears and Woolworth failed in their attempts to gain market share in Spain and left
(Sternquist and Kacker 1994, p.117). Walmart apears to have failed in Indonesia. A Hong
Kong retail institution failed in Singapore. Foreign retailers seem to have been on the
retreat in East Asia during the past two years in view of the East Asian crisis.
Nevertheless, foreign retailers can be expected to become aggressive in
their expansion into Asia as East Asia recovers from the crisis and resumes growth. There
are already a number of big retailers making their presence felt in Asia. Thus, Carrefour
(France) is already in Taiwan, China, Thailand, Korea, Malaysia, Hong Kong, Singapore
and Indonesia. Ahold (the Netherlands) is in Malaysia, Shanghai, Thailand, Singapore
and Indonesia. Dairy Farm, a regional food and drugstore operator, is in Hong Kong (its
home base), Singapore, Australia, Taiwan, Indonesia, New Zealand, Malaysia and China.
Makro (Netherlands), focusing on wholesaling, is in Thailand, Indonesia, Taiwan,
Malaysia, China and the Philippines. AS Watson is in Hong Kong, Singapore, China,
Taiwan, Thailand and Malaysia. Other multinational retailers with so far more limited
country coverage in Asia include: Walmart (US; in China, Korea), Promodes (France; in
Taiwan, Indonesia and Korea), Delhaize (Belgium; in Thailand, Indonesia, Singapore),
Tesco (UK; in Thailand, Korea), Metro (Germany; in China), Auchan (France; in
Thailand), Casino (France; in Taiwan and Thailand), Boots (UK; in Thailand) and Jusco
52
(Japan; in Hong Kong, Malaysia and Thailand). (See Banzon 1999). It is interesting to
note that despite its vaunted financial resources and technological prowess, Walmart is
not yet a major presence in Asia; indeed, it retreated from Indonesia.
It may noted that the above mentioned retailers are mainly into
supermarkets, drugstores, grocery and convenience stores, where there are economies of
scale and therefore are likely focus of concerns of domestic retailers. Foreign retailers
that are more into non-food items like Marks and Spencer may not be a major concern to
domestic retailers because there is greater avenue for product differentiation and market
niching as well as less scope for economies of scale in non-food retailing.
The experience in developed countries is that there are economies of scale
in food retailing, such that a small number of big chains control much of the food
retailing industry. Thus, for example, the UK grocery giants (Tesco, Sainsbury and
Safeway) control 40 percent of UK’s food market and, together with Asda, Kwik Save
and Isoceles, dominate UK’s grocery retailing business. Similarly, the top ten leading
companies control 52 percent of France’s food retail sector, with Intermarche, Leclerc
and Carrefour controlling 25 percent of the total. Food distribution in Germany is also
highly concentrated, with 0.3 percent of all distributors headed by giants like Aldi and
Tengleman controlling 64 percent of total sales by the late 1980s. Behind the economies
of scale in food distribution is the highly integrated nature of operations of the large
players that allow them to coordinate their purchases without the need for wholesalers,
use specialized skills and new technology in purchasing and inventory management, and
gain negotiations leverage with manufacturers. (See Sternquist and Kacker 1994.) Some
store chains also adapt their store formats depending on the market and location, ranging
from a superstore which offers the widest range of products down to an express or
convenience store stocking a much more limited range of products.
There is also
potential for bringing economies of scale to small establishments located in residential
neighborhoods by operating them around a centrally located large anchor store (Banzon
1999). Large food distributors, especially in the United Kingdom, have also developed
53
private labels manufactured to their specifications that allow them higher margins and
rate of profit (Sternquist and Kacker 1994).
The economies of scale in food distribution suggest that small independent
grocery stores and supermarkets are the ones most vulnerable to foreign competition. The
1994 Census results indicate that smaller grocery stores and supermarkets (i.e., those
establishments with employees less than 10) have higher gross margin than the bigger
grocery stores and supermarkets. Thus, there may be potentials for well-coordinated
chains of food stores to gain market share. Nonetheless, the success of large food
distributors in developed countries stems in part from the developed infrastructure
facilities and systems in these countries that allow food distributors the opportunities to
coordinate purchases, warehousing and distribution efficiently and reduce costs. The poor
infrastructure facilities and the archipelagic nature of the Philippines are likely important
constraints for foreign retailers in being able to replicate their systems effortlessly into
the country. In short, it is unlikely that big foreign retailers would be able to dominate
food distribution and shut out domestic retailers in the country in the same way that big
domestic retailers have so far failed to do so.
Big foreign retailers could gain significant market presence domestically if
they succeed in reducing wholesale margins which, as indicated in Table 19, are
comparatively higher in the Philippines than in the developed countries. Indeed, this is
likely an important source of competitiveness of the big foreign retailers because of their
systems, processes and technology that integrate wholesaling and retailing functions. Part
of the success of the big chains is precisely the ability to negotiate directly with
manufacturers and manage the distribution process to meet the demands of consumers in
a more timely and efficient manner than competitor establishments. Foreign firms relying
on economies of scale as their source of competitiveness in the Philippines would have to
be big in order to generate the needed scale of operations where the investments in
backward integration and logistics (e.g., distribution centers) become profitable. This
means that the foreign firms would have to have multiple stores domestically. Thus, for
example, Ahold has 47 stores in Malaysia, 44 stores in Shanghai and 38 stores in
54
Thailand. Similarly, Dairy Farm has 261 supermarkets in Australia, 220 supermarkets in
Hong Kong, 86 supermarkets in Indonesia and 77 supermarkets in New Zealand (Banzon
1999). This suggests that if foreign retailers were to come in a big way, they would locate
their chain of stores in very few urban markets in the country in order that the logistics
economies are maximized.
There are economic factors in the Philippines at present that will prevent
the demise of small retailers despite the entry of big foreign retailers. The first are the
high unemployment and underemployment rates in the country compared to developed
countries. The second is the low entry cost into retailing. The two together explain the
huge informal retail sector in the country. The reason for the decline in the small
independent retailers, especially in food retailing, in the developed countries is because of
the comparatively tight labor market and much higher wage rates in these countries
which make labor-saving but capital intensive large integrated purchasing, distribution
and retailing operations cost-effective. It may be noted that the enactment of laws
imposing restrictions on large scale retail enterprises in Europe occurred only in the
1970s and not much earlier (except in Belgium which had such a law passed before the
Second World War) because the tightening labor market and rising labor cost have made
small scale retailing increasingly vulnerable to competition from new and bigger retail
formats like hypermarts in Europe.
Another important consideration for the success of large stores like
Walmart in the United States is the availability of private transportation. The Walmart
strategy in the U.S. is to set up a store at a site within driving distance of several small
communities and to use lower prices (from its lower land costs and efficiencies in
integrating its distribution system by bypassing wholesalers) to undercut the small local
stores and drive them out of business (Baily 1993, p.87). In the Philippines, however, the
low level of private car ownership, the lack of appropriate storage space at home and the
low purchasing power of an average Filipino would likely prevent the optimal use of
economies of scale a-la Walmart and would likely mean the continued growth of small
neighborhood stores at least in the near future.
55
Nonetheless, the entry of foreign retailers into the country may likely
influence the way retailing is done in the country. For example, Walmart is known not
just for its technological prowess (it has one of the best information systems in the world)
but also for its heavy investment in consumer research and large investments in the
training of its employees (Banzon 1999), two areas that Philippine retailers appear to be
negligent of. Similarly, the increased competitive pressure from the entry of big foreign
supermarket and grocery chains into the country could encourage domestic operators to
integrate, cooperate and/or streamline operations. The introduction of distribution
systems by big foreign retailers will increase competitive pressure in wholesaling that
could lead to improvements in the services of wholesalers to the small retailers, and/or to
the reduction of wholesale margins and/or to changes in the channels of distribution in
the country away from wholesalers and towards self-distributing retailers (i.e, where
distribution and retailing are under the same firm). It may be recalled that there are more
wholesale industries than retail industries that are highly concentrated in the Philippines.
Finally, the entry of big foreign retailers that rely on technology-based systems and
processes could accelerate the domestic retailers’ investment into efficient consumer
response (ECR) initiatives that ultimately benefit consumers. The ECR initiative is
discussed further in the next section.
In summary, while it will not result in the demise of the Filipino retailer,
the entry of foreign retailers in the country would accelerate changes in the Philippine
retailing industry that most likely would prepare the industry better for the challenges of
the 21st century.
II.
Towards Retailing and Distribution Services for the 21st Century
The changing shape of retailing. Retailing is changing significantly, especially
in developed countries. First, there is a growing internationalization of retailing. Where
once retailing is viewed as an essential service in a community around a specific location,
retail services and retailing concepts have become increasingly globalized. Innovative
56
retail ideas have spread around the world in varying degrees despite the vast difference in
per capita incomes. Retail ideas get exported to the rest of the world through various
channels such as foreign branches, foreign acquisitions, joint ventures, management
contracts, licensing and franchising. A successful retailer with a unique business and
product innovation or merchandise mix or cost advantage from vertically integrated
facilities of food processing and packaging may be motivated to expand operations
internationally (Sternquist and Kacker 1994, pp.1-3). Thus, retail service is increasingly
becoming exportable.
There is a growing globalization of retailing. A number of major retailers
in the developed countries have been expanding internationally, primarily into the rest of
Europe and the United States but increasingly into Asia and Latin America. The
motivations for expansion beyond the home market were both “pull” and “push” factors.
Among the “push” factors were the market saturation of the home market and the policy
constraint to the expansion of large establishments. For example, French hypermarket
chains expanded into southern Europe, Germany, United Kingdom, Brazil and Argentina
after the enactment and implementation of the 1973 Loi Royer Act (Sternquist and
Kacker 1994, pp. 152-153). Among the “pull” factors, especially with respect to the
European investments in the United States included compatibility in culture, language,
level of economic growth and climate, a much more business-friendly policy
environment in the US compared to Europe, the opportunity to understand the US
market, and the exchange of retailing knowhow with partner US retailers (Sternquist and
Kacker 1994, pp.154-161). The results of foreign investments in US retailing or of US
retailers investments have been very uneven: many foreign investments in major US
retailers (e.g., Sach’s Fifth, Marshall Field, Bonwit Teller) did not prove sustainable just
as major US retailers (e.g., J.C. Penney, Sears Roebuck, Safeway, Woolworth and
Federated Department Stores) sold off some or all of their foreign investments by the
1980s (Hollander and Keep 1992). The expansion of the big retailers into the rest of the
world, especially Asia and Latin America, appears linked not only to the growth
potentials in selected countries in the two emerging regions but also to the perception that
there would only be extremely few retailers with dominant global presence, Thus, there
57
is to some extent a race for global expansion among the major retailers in the developed
countries (Banzon 1999).
Second, retail operation is increasingly becoming an automated system of
managing consumer needs (Sternquist and Kacker 1994, pp.1). Food distribution is
increasingly consumer-driven, rather than producer-driven, as the system is being
designed increasingly to respond to consumer demand as quickly and as cheaply as
possible. Scanners are not only being used to speed up checkout and verify prices but also
to facilitate a variety of consumer loyalty programs and the targetting of products to
consumers based on their consumer patterns and demographic characteristics (Kinsey,
et.al., 1996, pp.13-14). This leads, for example, away from market segmentation into
relationship marketing by treating customers individually (Achabal and McIntyre 1992).
Indeed, technology is reshaping retailing. The most recent example is the explosion of ecommerce especially in the developed countries. The effect is increasingly retailing
without borders.
And third, processes, systems and relationships in the entire distribution
sector are changing in order to gear the whole supply chain better to consumer needs.
This is best exemplified by the ECR (Efficient Consumer Response) initiative of the US
grocery industry. This is an industry-wide collaborative effort among food manufacturers,
distributors, brokers and retailers in order to improve intra- and inter-firm efficiencies
through new forms of collaboration primarily based on the more effective use of
information technology. By redesigning their own value chain and their linkages with the
value chain of their trading partners, firms can improve their competitive advantage. The
ECR initiative supports such reengineering efforts by facilitating improvements in
category management towards efficient product assortment, reengineering of warehouse
and logistics operations and redesign of processes that link separate firms. The
improvements in physical distribution and faster and a more accurate transmission of
orders, billing and product information allow faster and less costly movement of products
through the supply chain and reduce product inventories throughout the system. (See
King and Phumpiu 1996.)
58
There are significant benefits to manufacturers, retailers and consumers
from the adoption of ECR technologies. For the manufacturer, ECR strategies reduce outof-stock problems, improve relationship with trading partner and better image of the
manufacturer’s brand. For the retailer, ECR strategies improves customer loyalty and
allows more efficient store assortment and efficient replenishment of goods. For the
consumer, ECR strategies increase choice, fresher products, reduced out-of-stock and
increased shopping convenience. (See Banzon 1999.)
It may be noted that there are three major channels of distribution in the
grocery industry; namely, wholesaler supplied (where manufacturing, distribution and
retailing are performed by separate firms), self-distributing retailer (where distribution
and retailing are under the control of the same firm) and manufacturer direct store
delivery (where manufacturing and distribution are under the control of the same firm).
New competitors in the industry emerged as new technologies, business practices and
market conditions offered new opportunities for profit. For instance, large selfdistributing general merchandisers such as Wal-mart entered the grocery retail business
armed with new information technologies, sophisticated retail information and logistics
systems designed to maximize the use of such technologies. Similarly, “category killers”
specialize in a single line of products sold in supermarkets, replicate standardized formats
and business practices in a large number of stores and exercise volume buying power
with a narrow set of manufacturers or vendors. (See King and Phumpiu 1996.) Thus,
innovation and competition in retailing has emerged in part through the deft use of new
technologies, business practices, product mix and linkages within the supply chain.
The Philippine retail industry has been influenced to some extent by the
changes in the world retailing market. New retail formats such as warehouse or discount
stores have been established. Specialty stores, primarily boutiques and under franchise
arrangements, have taken root. Nonetheless, it is likely that the Philippine retail industry
and the Philippine economy can benefit from the systems and business practices of
59
foreign retailers that have succeeded in taking advantage of potentials for efficiencies in
effectively managing the firms’ supply and value added chains.
In addition, there remains the challenge of improving the systems and
procedures facing the country’s retail industry. Banzon (1999) enumerates many issues
that face the retail industry, including high costs of processing invoices in the country
that is at least twice the world average, high rate of out-of-stock that can go up to 20
percent of the time, long retail inventory time and unpaid balances that can go up to 6
months. Thus, Banzon brings out the importance of ECR for a more efficient retail trade
sector in the country.
Franchising, FDI and technology transfer. Franchising is growing fast
in the country. The number of franchises in the country nearly tripled during 1995-1998.
The share of foreign franchises increased from 42 percent in 1995 to 57 percent in 1998.
Most of the franchises were in the food business until the mid-1990s but by 1998, 57
percent of the total franchises were in the non-food business, especially for the local
franchises. Franchising started in the US with product franchising in the 1840s but there
is an increasing trend towards the business format franchise. In the US, among the more
important product franchises are automobile and gasoline retailing and softdrink bottling;
among the more important business format franchises are restaurants, hotels and motels,
and convenience stores.
Franchising is acknowledged as an important means to small business
growth. Indeed, around 40 percent of the total retail sales in the United States is
accounted by franchise establishments. Franchising is still new in Asia. For example,
franchise sales accounted for only 5 percent of Singapore of GNP in the early 1990s
(Robinson 1994) Franchising combines “…the advantages of entrepreneurial small
business with the large-scale marketing and buying power of a great corporation” (Katz
1996, p.1).
60
The franchise route is one means toward increasing productivity and
meeting the challenges of a changing retail and service sector. For a up-front fee and a
royalty (usually between 3 to 8 percent of gross sales), franchisees capitalize on the
franchisor’s brand name, well-developed concept and business system as well as
supporting business expertise such as management expertise, training, economies of scale
and advertising and promotions support. On the other hand, franchising allows
franchisors the opportunity to expand, albeit with less management control, without much
capital as compared to a chain.
In interviews with a small group of Filipino franchisees, franchising
allowed the franchisees to gain access to the technology they need to run the business.
Most of them felt that the technology could not be acquired from other sources. The
major areas of technology transfer are in operations (primarily in processing, physical
lay-outing and quality control), human resource development or training for both the
management and operations personnel, and marketing support (pricing, raw material
sourcing). Nevertheless, the most important for the franchisees is the brand name. To the
franchisees, the brand name and the proven system of running the business are enough
assurance that a franchise is more likely to succeed than starting an independent business.
Study Three discusses franchising and technology transfer in the
Philippines.
Franchising is one means of technology transfer from abroad. It is a
possible alternative to opening up the retail trade sector to foreign investment. However,
at the macroeconomic level, franchising involves capital outflows from the country while
opening the retail trade industry to foreign direct investment results in capital inflow in
addition to technology transfer. This is an important consideration at the macroeconomic
level for a country like the Philippines that is perennially short of capital for investments.
Nonetheless, franchising and opening up retail trade to foreign investment are not likely
to be substitutes. Some foreign retailers would prefer the franchising route; others the
foreign direct investment route. Even in Hong Kong, with a more welcoming
61
environment to foreign direct investment in retailing than the Philippines, franchising
remains profitable to foreign franchisors.
FDI in retail trade and the macroeconomy. Foreign investments in retail
trade have impacts not only on the retail trade industry but also on other sectors of the
economy. A simple simulation of the impact of foreign investments in retail trade by
Cororaton and Cuenca (1999) using an input-output framework indicates that the sectors
that will be significantly benefited from the foreign investments, apart from the retail
trade industry, are the finance, utilities and transportation industries. Foreign investments
in retail trade also contribute to macroeconomic stability and improved balance of
payments position as well as, directly or indirectly, increased employment.
Study Four presents Cororaton and Cuenca’s simulations.
Cororaton and Cuenca’s simulations are a simple one; they do not capture
the efficiency effects of technology transfer nor the benefits from greater competition in
the entire distribution sector arising from the inflow of foreign direct investment in
retailing. Another macroeconomic impact of foreign direct investment in retailing that is
not captured in Cororaton and Cuenca is that foreign direct investment eases the
constraint on capital for investment in retailing. Given the limited capital in the country,
domestic investments and loans (both local and foreign) for the retail sector are
opportunities lost in the other sectors of the economy. The recent East Asian crisis shows
that too much capital spent on the nontradable sector of the economy such as retail and
real estate property can lead to a deterioration in the international competitiveness of the
economy and a likely balance of payments crisis. Given that there will be a growing
demand for retail trade services as the economy grows and in the light of the limited
capital resources of the country, it would be better to open up the retail trade industry to
foreign investment.
62
As a final note, it is sometimes argued that the opening up of retail trade to
foreign retailers would encourage the latter to dump their goods in the country thereby
hurting the Filipino retailers and unnecessarily raising imports. While the risk of dumping
remains, the country has anti-dumping regulations that can be imposed. In addition,
foreign retailers need to pay tariffs on their imports while at present Filipino
viajeros/viajeras buy goods during sale seasons abroad and bring them over to the
country with likely nary a duty. Thus, the dumping issue may not likely be an important
concern with respect to the opening up of the retail trade industry to foreign investment.
III.
Policy Implications
The discussion in the paper leads to a number of policy implications, to wit:
•
Allow foreign investments in the retail trade industry. On the whole, the
returns to the country of opening up the industry to foreign investments are higher than
possible costs. The benefits stem from the increased competitive pressure in the entire
distribution network especially in wholesale trade, technology transfer including human
resource development, and the macroeconomic benefits of foreign direct investment. The
possible adjustment costs appear to be manageable considering that the retail margins in
the country are on the average lower than in the OECD countries. Thus, Filipino retailers
on the whole can compete with foreign retailers price-wise. Moreover, the retail density
of the country is still low; thus, there is a large scope for the expansion of the number of
retail establishments over time. It may be noted that virtually all the major East Asian
countries except the Philippines now host foreign retailers, either fully-owned or in joint
ventures, in their countries.
•
Favor large- scale foreign retailers over small- scale retailers. It is the
large-scale retailers that have developed the systems and processes that improve the
efficiency of distribution services. They are also the ones that can provide the competitive
pressure in wholesale trade. The bias for large-scale foreign retailers can be implemented
63
through a higher allowable foreign equity participation for large-scale investments or, a
higher cut-off investment level if a uniform foreign equity participation for both largeand small-scale foreign retailers is preferred. (The extent of the foreign equity
participation beyond a simple majority of 51 percent is fundamentally a political
question.)
•
Controlled opening up to large-scale foreign retailers may be preferable
While Filipino retailers can on the whole compete price-wise vis-à-vis foreign retailers,
there are some vulnerable sectors especially medium-sized supermarkets and grocery
stores. A policy bias for joint ventures may be called for in order to maximize the
benefits of technology transfer. Similarly, a policy bias for a mix of chain stores and
franchise stores is preferable to a sole emphasis on chain stores in order to encourage the
growth, rather than displacement, of small Filipino retailers.
•
Encourage domestic franchising. Franchising is one means of instituting
greater efficiencies in retailing through streamlined business systems, human resource
development, continuous quality control and product development, and market
development. Franchising is one means by which Filipino retailers can adjust to an open
retail trade industry. In Singapore, the government has launched several initiatives to
encourage franchising in Singapore. The initiatives include the setting up of a Franchise
Development Centre tasked to help in upgrading the local retail sector by fostering
economic groupings among retailers and assist them establish franchises and
cooperatives, the Management of Economic Group Assistance (MEGA) Scheme which
provides grants to the more established local firms for study missions, consultancy work
and training to encourage them to initiate franchises, and the Franchise Development
Assistance Scheme (FRANDAS) which absorbs part of the cost of developing the
franchise programs of local firms planning to expand abroad through franchising (e.g.,
feasibility studies, hiring of consultants and lawyers) (Robinson 1994). Like in
Singapore, it is important for the Philippines to provide government support to the
development of local franchises and possibly even the expansion of local franchises
abroad.
64
•
Strengthen the Domestic Trade Development Council. It is clear from
the discussion above that beyond the liberalization of the retail trade industry, the policy
challenge for the Philippine government is the improvement of the entire distribution
sector. The liberalization of the retail trade industry can be a catalyst for possible
innovations and changes in the distribution sector. Nevertheless, it is important for the
government to give more attention to the sector. The Domestic Trade Development
Council can be tasked to develop a Distribution Sector Development Plan for both the
wholesale and retail trade sector. The Council can also be a policy advocate for the
improvements in the policy regime and infrastructure in shipping, transportation, credit
and storage.
65
References:
Achabal, D. and S. McIntyre (1992), “Emerging Technology in Retailing:
Challenges and Opportunities for the 1990s” in R. Peterson (ed.) The
Future of U.S. Retailing: An Agenda for the 21st Century. New York:
Quorum Books.
Agpalo, R. (1962). The Political Process and the Nationalization of the Retail
Industry. Quezon City: University of the Philippines.
Arceo-Dumlao, T (1999). “Franchising may not immediately turn your firm into
a Jollibee, but it could the first step” Philippine Daily Inquirer, April 23
issue.
Baily, M.N. (1993), “Competition, Regulation and Efficiency in Service
Industries” Brookings Papers on Economic Activity: Microeconomics,
Vol 2.
Banzon, G. (1999)’ “Emerging Global Retailing Trends” Paper presented at the
1st Cebu Retail Expo and Convention, SM Conference Hall, Cebu City,
October.
Cortsjens, J,, M. Cortsjens, and R. Lal (1995). Retail Competition in the FastMoving Consumer Goods Industry: The Case of France and the U.K..
INSEAD Working Paper, INSEAD (France), March.
Flath, D. (1996), “Is Japan’s Retail Sector Truly Distinctive?” Journal of
Comparative Economics, Vol. 23, pp.181-191.
Hall, M. and J. Knapp (1955), “Gross Margins and Efficiency Measurement in
Retail Trade” Oxford Economic Papers, Vol 7. Reprinted in K. Tucker
and B. Yamey (eds.) Economics of Retailing. Penguin Education, 1973.
66
Hoj, J., T. Kato and D. Pilat (1995), “Deregulation and Privatization in the
Service Sector” OECD Economic Studies, No. 5.
Hughes, J.D. and S. Pollard (1957), “Gross Margins in Retail Distribution”
Oxford Economic Papers, Vol. 9. Reprinted in K. Tucker and B. Yamey
(eds.) Economics of Retailing. Penguin Education, 1973.
Itoh, M. (1996), “Regulatory Reform: An Experience of the Japanese Distribution
System” in OECD, Regulatory Reform and International Market
Openness. Paris: OECD.
Jefferys, J. and D. Knee (1962). Retailing in Europe: Present Structure and
FutureTrends. London: MacMillan and Co.
Katz, J. (1996), “Franchise Nation” Regional Review, Federal Reserve Bank of
Boston.
Maruyama, M. (1993). A Study of the Distribution System of Japan. OECD
Working Paper No. 12. Paris: OECD.
Pilat, D. (1997) Regulation and Performance in the Distribution Sector. OECD
Economic Department Working Paper No. 180. Paris: OECD.
Robinson. J. (1994), The Franchising Business in Singapore DBS BankSingapore Briefing, Economic Research Department, DBS Bank,
Singapore.
Sternquist, B. and M. Kacker (1994). European Retailing’s Vanishing Borders.
Westport, Conn. U.S.A.: Quorum Books.
Yoshino, M. Y.(1971). The Japanese Marketing System: Adaptations and
Innovations. Massachusetts Institute of Technology.
67
Part II
Supporting Studies
68
Study I
Opening Up the Philippine
Telecommunications
Industry To Competition
and Foreign Investment
By: Rafaelita A. Mercado- Aldaba
69
Opening Up The Philippine Telecommunications Industry To Competition and
Foreign Investment
Rafaelita A. Mercado-Aldaba
I.
Introduction
Historically, the provision of telecommunications services has been a prime
example of natural monopoly owing to the high cost of fixed investment in building a
telecommunications network. The traditional assumption was that the market could not
efficiently support more than one firm and allowing firms to pursue profit-maximizing
strategies in a market that was not structurally competitive would not maximize consumer
welfare. Economic regulation was seen as the best policy to correct this market failure
and serve public interest. State-run telecommunications organizations (which maintained
monopoly control of access to the network) have, thus, become the norm.
Technological change, however, has challenged the traditional notions of natural
monopolies. This has been especially evident in telecommunications where rapid
technological change in the sector has considerably reduced costs and expanded the range
of networks and the types of services offered. As the traditional market structure that was
suitable for voice telephony was no longer appropriate for new network services known
as “value added services or value added network services (VANS)”1, many countries
decided to liberalize. The 1980s witnessed the introduction of competition, deregulation
on long distance services, and privatization in the UK, USA, and Japan. And soon, many
countries followed suit by privatizing their state-owned telecommunications providers.
Apparently, the natural monopoly model and economies of scale arguments were no
longer true for the telecommunications sector. Technological change with some growth
in market size has increased the technical feasibility of competition (Janow, 1998).
In the Philippines, the government allowed a private monopoly to provide
telecommunications services. For more than half a century, the telecommunications
1
These include data banks, electronic mail, and electronic data interchange.
70
industry was a regulated monopoly which was subject to significant regulatory barriers to
entry. Congressional franchises, which were difficult to acquire, were required prior to
entry into telecommunications services and facilities. For almost 65 years, the Philippine
Long Distance and Telephone Company (PLDT) dominated the industry and controlled
both domestic and overseas toll services.
Amidst the wave of deregulation and liberalization that swept the world economy,
the Philippines implemented a series of substantial policy reforms in 1993 aimed towards
universal access to basic telephone services. The policy changes were also meant to
address the dismal state of the telecommunications sector as indicated by the long waiting
time to own a telephone and the huge telephone backlog. Service was generally not
available and where it was, quality of service was unreliable (World Bank, 1993). These
problems were attributed to the failure of a private monopoly to develop the
telecommunications industry and by the weak policy and regulatory framework of the
government resulting in its inability to discipline PLDT effectively (Gavino, 1992 as cited
in Serafica, 1998).
Opportunities for foreign investment in the past had been limited by the fact that
many countries had state- or private-owned monopoly carriers. Telecommunications had,
traditionally, been an industry requiring large-scale and lumpy investments. Domestic
investors could not provide that level of investment in contrast to foreign firms which had
the capital, managerial expertise and technology. Market liberalization has offered the
potential benefits of additional investment, new and improved products as well as lower
prices. Nevertheless, many developing countries fear that by opening up their market to
competition and foreign investment, they will lose control of a strategic industry.
The Philippines restricts foreign equity participation up to 40 percent. The
liberalization and deregulation of the telecommunications sector saw the entry of nine new
firms, all of which were joint ventures, in a market which was previously controlled by a
monopoly. The main objective of this paper is to determine the impact of foreign
71
investment on the Philippine telecommunications industry. An attempt is also made to
draw lessons from the experience of the sector as these may be useful to the on-going
debate on the retail trade liberalization bill.
The next section discusses recent government policy on telecommunications and
the existing regulatory framework, after which, the current structure of the industry is
presented. The paper then looks at the effects of foreign investment on the performance
of the industry. The final section provides some insights and lessons based on the
experience of the telecommunications sector and contribute to the ongoing discussions on
the retail trade liberalization law.
I.
Regulatory Framework and Government Policy Towards the
Liberalization of Telecommunications
Regulatory and Administrative Framework
The telecommunications industry operates under close government regulation.
The Philippine Constitution allows foreign equity participation in the industry up to a
maximum ownership of forty percent. Entry into the industry requires a congressional
franchise which is issued for a maximum period of fifty years. After the franchise is
acquired, another authorization requirement is the Certificate of Public Convenience and
Necessity (CPCN) which is issued by the National Telecommunications Office (NTC).
The operations of telecommunications operators including operating facilities, services
provided, and rates charged are regulated by the NTC. In procuring telecommunications
equipment, buyers are required to secure a permit to purchase and permit to import from
the NTC. The enactment of RA in 1995 introduced some regulatory changes in the
industry. For instance, radio paging is no longer regulated by the NTC, except only with
respect to the norms on radio frequency use while value added service is no longer
required to secure a franchise and is allowed to competitively offer its services, provided
that it does not put up its own network.
72
The Department of Transportation and Communications (DOTC) is the primary
government office responsible for formulating telecommunications policy in the
country. Its functions include the following:
•
Formulate and recommend national policies and guidelines for the
preparation and implementation of integrated and comprehensive
communications systems at the national, regional, and local levels;
•
Establish and administer comprehensive and integrated programs for
communications;
•
Assess, review and provide direction to communications research and
development programs of the government; Administer and enforce all
laws, rules and regulations in the telecommunications sector.
The National Telecommunications Office (NTC) is a quasi-judicial body acting as
the regulatory arm of the telecommunications industry. The DOTC provides the overall
policy guidance to the NTC. It issues Certificate of Public Convenience and Necessity
(CPCN) to telecommunications carriers and regulates the operations of
telecommunications carriers and radio and television broadcasters. Its functions include
the following:
•
Establish, prescribe and regulate areas of operation of particular operators
of public service communications;
•
Determine and prescribe charges or rates pertinent to the operation of such
public utility and services with some exception;
•
Grant permits for the use of radio frequencies and sub-allocate frequencies
allocated
at
the
international
Telecommunications Union;
level
by
the
International
73
•
Register radio transmitters and receivers.
The Telecommunications Office (TELOF) and the Municipal Telephone Project
Office (MTPO) are operating arms of the government providing limited telephone and
telegraph services in rural areas. The TELOF provides the following services to the
general public particularly in areas where the private sector has not ventured:
telegraphic transfer, telegraph messages, and telephone lines/units. The MTPO
implements the government’s municipal telephone program which was established
under the Municipal Telephone Act (RA 6849) to implement a nationwide plan and
install telephones in every unserved municipality. RA 6849 gave qualified private
telecommunications operators the first option to provide, install, and operate public
calling stations in all unserved municipalities.
Recent Policy Changes
After the change of administration in 1986, telecommunications was identified as
one of the most serious constraints to a strategy of private-sector-led growth. In 1987,
following discussions with various stakeholders, the DOTC announced a broad package
of policy statements including the deregulation of the telecommunications sector and
the definition of the government’s role as creating a business environment in which the
private sector could compete profitably. Shortly thereafter, the NTC granted
Certificates of Convenience and Necessity to two international record carriers, Eastern
Telecommunications Philippines, Inc (ETPI) and Philippine Global Communications
(Philcom). The two firms were expected to provide competition to PLDT in the
provision of international telephone traffic. This was, however, delayed as PLDT
reacted by waging legal battles to protect its market share against new entrants.
The reform process was accelerated only in recent years with the issuance of
substantial policy changes in 1993 which were aimed at increasing private sector
investment in the telecommunications sector and fostering competition between the
74
heavily protected monopoly, PLDT, and companies that were willing to invest in the
sector. These policy reforms which were intended to deregulate and liberalize the
industry are briefly described below:
Executive Order 59 (February 1993): mandated the compulsory interconnection
of authorized public telecommunications carriers in order to create a universally
accessible and fully integrated nationwide telecommunications networks.
Executive Order 109 (July 1993): mandated the provision of more local telephone
exchanges and required international gateway facility (IGF) operators and providers of
services which were possible sources of subsidy to provide local exchange carrier service
in unserved or underserved areas. To facilitate the implementation of EO 109, the NTC
developed the service area scheme (SAS) under which the country was divided into
eleven equally viable local exchange carrier (LEC) areas which were assigned to IGF and
CMTS licensees. Each area has a mix of urban and less profitable rural markets to
prevent concentrating telephone services in lucrative areas.
In return for the authorizations granted them to operate the highly profitable
cellular phone and international gateway operations, IGF and CMTS franchise holders
were each required to provide at least 300,000 and 400,000 local exchange lines,
respectively, within five years. A telecommunications operator with both CMTS and
IGF franchises must install 700,000 land lines within its designated area. There are
three carriers with both IGF and CMTS permits: Globe Telecom, Isla Communications,
and Smart Communications.
Republic Act 7925 (1995): reduced barriers to entry in the telecommunications
industry.
•
The use of radio frequency shall be subject to reasonable spectrum
user fees. Where the demand for specific frequencies exceeds availability, the
NTC shall hold open tenders for the same.
75
•
Protection of the local exchange operator from uncompensated
bypass or overlapping of operations of other telecommunications entities in
need of physical links or connection to its customers in the areas.
•
Rates shall no longer be governed by the 12 percent ceiling.
•
Radio paging is no longer regulated by the NTC, except only with
respect to the norms on radio frequency use.
•
Value added service is no longer required to secure a franchise and
is allowed to competitively offer its services, provided that it does not put up
its own network.
•
The required period for international gateway facility (IGF) and
CMTS operators to provide local exchange service is reduced from five years
(under EO 109) to three years.
Department Circular Number 91-260: minimize or eliminate situations where
multiple operators are providing local exchange service in a given area.
Department Circular Number 92-269: promote an open and competitive
environment for services such as cellular mobile telephone system (CMTS) subject to
availability of radio spectrum.
Department Circular Number 93-273: promote and develop a robust domestic
satellite services industry through a dynamic, healthy, and competitive environment.
Department Circular Number 94-277: broaden access to international satellite
systems in order to permit the public to experience the benefits to be derived from greater
competition and new technologies.
76
I.
Structure of the Industry
Based on the 1994 Census of Establishments, the telecommunications industry
generated a total value added of P 26.4 billion which represented a contribution of about
1.6 percent of the country’s gross domestic product (see Table 1). The telephone subsector contributed the bulk of the total with its share of about 81 percent of total
telecommunications value added. The industry employed about 393,360 workers. The
sector was heavily dominated by large firms. Although small firms represented 51
percent of total telecommunications establishments, they accounted for a very small
percentage, almost negligible, of total value added and roughly one percent of total
average employment.
In 1995 (based on the Annual Survey of Establishments), the telecommunications
industry registered an increase of about 17 percent in its total value added. Its
contribution to the economy as measured by its ratio to GDP remained unchanged at 1.6
percent.
The provision of telephone services still dominated the industry as its share to
total value added rose to 86 percent. The total number of telecommunications companies
increased by 38 percent between 1994 and 1995, with small firms posting the highest
increase. The total number of workers increased by about 17 percent, or 461,688 workers
(refer to Table 1).
77
Table 1: Economic Contribution of the Telecommunications Industry, 1994 and
1995
Telecommunications
Sub-sector
Value Added
In P million
As % of GDP
1994
Telephone Service
With 10 or more 21438.5
employees
With less than 10
16.1
employees
Sub total
21454.6
Telegraph Services
With 10 or more 3025.0
employees
With less than 10
0.4
employees
Sub total
3025.4
Communications
Services, nec
With 10 or more 1931.6
employees
With less than 10
1.7
employees
Sub total
1933.3
With 10 or more 26395.1
employees
With less than 10
18.2
employees
Total
26413.3
1995
1994
1995
Average Total Number of
Employment
Establishments
1994
1995 1994 1995
26440.1
22933
27989
39
60
37.8
193
377
56
86
23126
28366
95
146
2424.4
7569
8067
14
12
1.4
15
21
5
6
7584
8088
19
18
1847.8
2011
1914
21
23
49.7
59
106
15
20
2070
32513
2020
37970
36
74
43
95
267
504
76
112
32780
38474
150
207
26477.9
2425.8
1897.5
30712.0
1.3
0.2
0.1
1.4
0.1
0.1
88.9
30800.9
1.6
1.6
Source: 1994 Census of Establishments and 1995 Annual Survey of
Establishments
In terms of profitability, the telecommunications sector posted a total net
income of P 8.1 billion in 1995, more than half of which (about 71 percent) was
accounted for by the telecommunications giant, PLDT (see Table 2). Total net income
increased by about 22 percent in 1996 as the share of PLDT dropped to 64 percent. In
1995, a total of fourteen telecommunications companies landed in the top 1000
corporations in terms of gross revenues. In 1996, this went up to sixteen companies. As
78
expected, telephone service was the most profitable segment of the industry with a share
of 83 percent of the total in 1995, although this dropped to 74 percent in 1996. Aside
from PLDT, the other top earners were Piltel (a PLDT subsidiary) and Smart. The
telegraph service sub-sector posted losses of about P183 million in 1995 and P879
million in 1996. Other communication services registered net income of P1.6 billion with
the
top
earners
composed
of
Philippine
Telecom
Investment,
Eastern
Telecommunications Philippines, Philippine Communications Satellite, and Philippine
Overseas Telecom. The net income of this sub-sector more than doubled in 1996 as
gateway operators Digital and Islacom increased their shares to 25 and 20 percent,
respectively. The other companies’ share of the sub-sector’s total net income declined
substantially from their 1995 levels. The share of Philippine Telecom dropped from 62 to
36 percent while ETPI’s share decreased from 34 to 13 percent. Philcomsat experienced
the same as its share slid from 20 to only five percent in the years under review.
79
Table 2: Net Income Of Major Telecommunications Operators, 1995 and 1996
(in million pesos)
Subsector
Telephone
Service
Telegraph
Service
Commu
nication
Service,
nec
Total
Net
InCom
6724
-183
1626
1995
Top Earners %
Rank
Share
PLDT
Piltel
Smart
GMCR
Phil.
Wireless
PT&T
86
12
2
-85
41
Phil.Telecom
ETPI
Philcomsat
Phil.
Overseas
Digital
Extelcom
Phil. Global
EasyCall
62
34
26
26
340
236
348
691
11
0.5
-35
-1
461
402
288
592
8167
8
76
371
453
583
757
Net
Income
7365
-879
-15
3505
1996
Top Earners
PLDT
Piltel
Smart
GMCR
Phil. Wireless
PT&T
Radio
Commns
Phil.Telecom
ETPI
Philcomsat
Digital
Extelcom
Phil. Global
EasyCall
Interl Commns
Islacom
%
Rank
Share
87
10
3
-85
10
-4
-29
36
13
5
20
-12
-0.2
2
-4
25
8
72
182
228
560
754
919
339
294
538
246
384
465
525
365
555
9991
Source: Business Profiles 1997-98: Top 7000 Corporations
The telecommunications industry is composed of the following operations:
1. Voice Carrier Service
The country has a total of 74 private and four government telephone operators
including the TELOF, the government’s nationwide telecommunications carrier. There
are currently 6,548,114 installed lines in the country (as of October 1998).
PLDT is the dominant carrier with a total percentage share of about 32 percent of
the total number of installed lines in 1998. Far second are Islacom with a share of 11
80
percent and Smart and Globe with equal shares of 10.8 percent. Bayantel follows with a
share of 7 percent (see Table 3).
Table 3: Number of Installed Lines by Carrier
Carrier
Number of Installed
Lines
2114780
374816
705288
462509
727407
71334
379413
172314
704073
71357
764823
6548114
PLDT
Digitel
Globe
Bayantel
Islacom
Philcom
Piltel
PT&T
Smart
ETPI/TTPI
Other Operators
Total
% Share
32.3
5.7
10.8
7.1
11.0
1.1
5.8
2.6
10.8
1.1
11.7
100.0
Source: NTC
Table 4: Telephone Distribution By Region, 1997
Region
CAR
I
II
III
IV
V
VI
VII
VIII
IX
X
XI
XII
ARMM
NCR
Total
Installed
Lines
64814
242742
23630
427199
734047
133363
258204
380290
89182
44457
115943
339941
67468
45319
2808957
5775556
Source: NTC
Population
1309811
3931261
2640554
7218913
10463047
4488068
5983675
5214527
3511714
2930263
4139703
5331644
2473078
2087362
9814977
71538597
Telephone
Density
4.95
6.17
0.89
5.92
7.02
2.97
4.32
7.29
2.54
1.52
2.80
6.38
2.73
2.17
28.62
8.07
81
Telephone density is about 9.6 for every 100 persons, an improvement from the
1997 figure of 8.07. The distribution of telephones across regions as shown in Table 4
reveals a highly uneven distribution. Most telephone lines are concentrated in Metro
Manila, the center of economic and political power in the country. Metro Manila had a
high telephone density of 28.62 in 1997 while the rest of the country had a telephone
density ranging from 0.89 (Region II) to 7.29 (Region VII). The table also shows that
coming far second after Metro Manila is Region VII followed by Regions IV, XI and I.
Telephone services are classified into two: local exchange services and long
distance telephone services. The latter is further divided into domestic or national long
distance and international long distance. Local exchange service in the country is
provided under the service area scheme wherein a single carrier (operator) is allowed
to serve only in its assigned area (refer to Table 5). The scheme requires each IGF
operator and CMTS operator to install 300,000 and 400,000 telephone lines,
respectively within three years. A telecommunications operator with both CMTS and
IGF franchises must install 700,000 telephone lines. PLDT is excluded from the
scheme as it is not obligated to fulfil the same requirement.
82
Table 5: Service Area Scheme
Assigned
Carrier
Smartcom
Eastern
PT&T/Ca
pwire
Globe
GMCR
ICC
Islacom
SA
Number
1
I
Abra, Ilocos Norte, Ilocos Sur, La Union, Pangasinan, Mt.
Province, Benguet
Pasay City, Las Pinas, Paranaque, Pateros, Taguig,
Muntinlupa
Tarlac, Pampanga, Zambales, Bataan, Bulacan, Nueva
Ecija
Batanes, Cagayan Valley, Isabela, Quirino, Nueva Viscaya,
Ifugao, Kalinga-Apayao
Manila, Navotas, Caloocan City
3
2
II
4
NCR
A
IVA
5
11
IVB
XII
6
NCR
C
V
7
9
10
Philcom
Province
NCR
D
III
8
Piltel
Region
9
10
Source: NTC
NCR
B
VI
VII A
VII B
VIII
IX A
X
XI A
IX B
X
XI B
XI A
IXB
Aurora, Laguna, Quezon, Marinduque, Rizal, Romblon
Cavite, Batangas, Occ. Mindoro, Or. Mindoro, Palawan
Lanao del Norte, Lanao del Sur, Maguindanao, North
Cotabato, Sultan Kudarat
Makati, San Juan, Mandaluyong, Marikina, Pasig
Albay, Camarines Norte, Camarines Sur, Catanduanes,
Masbate, Sorsogon
Quezon City, Valenzuela, Malabon
Aklan, Antique, Capiz, Iloilo, Negros Occidental,
Guimaras
Negros Oriental, Siquijor
Bohol, Cebu
Eastern Samar, Leyte, Northern Samar, Southern Leyte,
Samar, Biliran
Zamboanga del Norte, Zamboanga del Sur
Misamis Occidental
Davao del Sur, South Cotabato, Sarangani
Sulu, Tawi-Tawi
Agusan del Norte, Agusan del Sur, Bukidnon, Camiguin
Misamis Oriental, Surigao del Norte
Surigao del Sur, Davao Oriental
Davao del Norte
Basilan
83
There are nine telephone firms currently operating under this scheme: Globe
Telecom, Islacom, Smart, Digitel, International Communications Corporation-Bayantel,
Philippine Global Communications/ Major Telecoms (Philcom), Piltel, PT&T/Capitol
Wireless, and ETPI (see Table 6). Under EO 109, the SAS participants are required to
install a total of four million telephone lines within three years. As these carriers began
their rollout programs in 1996, PLDT launched its Zero Backlog Program under which
it continued to install lines. Based on the revised rollout plans of the SAS participants,
main telephone lines are expected to reach 4,110,248 lines in 1998 while PLDT
committed to install an additional 1,254,372 lines.
The SAS carriers have been lagging in fulfilling the three-year deadline set by
Congress. According to the DOTC, these carriers have concentrated their installations
in profitable urban areas while the provision of telephone lines in rural areas has
remained sluggish. Based on the 1998 second quarter accomplishment ratings1 reported
by the NTC, five firms failed to comply with their EO 109 commitments: Islacom –
49.5%, Major/Philcom - 23.8%, Piltel – 94.9%, PT&T/Capwire - 57.4%, and ETPI 23.8% (refer to Table 6). ETPI obtained its provisional authority to provide local
exchange carrier service only in September 1996 and extended its total rollout program
up to 1999. The NTC warned that penalties would be imposed on those telephone firms
that would not measure up by September 1999. It also plans to open up the areas where
assigned operators failed to supply the required lines to other carriers.
1
Ratio of a firm’s installed telephone lines to its total required lines under EO 109.
84
Table 6: Status of Service Area Scheme
Telecommunications Carrier
Total Lines
Required
Under SAS
Cumulative
Lines Installed
300000
700000
300000
Total Lines
Committed
Under Revised
Rollout Plans
337932
705205
341410
Digitel
Globe Telecom
ICC/Bayantel
Islacom
Major/Philcom
Piltel
PT&T/Capwire
Smart
ETPI
Sub-total
PLDT
Total
Performance
Rating
374816
705288
462509
124.9
100.8
154.2
700000
300000
400000
300000
700000
300000
4000000
4000000
701330
305706
417858
300000
700310
300497
4110248
1254372
5364620
346457
71334
379413
172314
704073
71357
3287561
1274282
4561843
49.5
23.8
94.9
57.4
100.6
23.8
-
Source: NTC
Newcomers in the industry, however, are lobbying for the abolition of the service
area scheme as it tends to limit the smaller carriers’ growth capacity and ability to
compete with the dominant PLDT. Lamberte (1996) called for a review of the scheme
as it seemed to run counter to the policy of competition. What the scheme did was to
level the playing field for PLDT as new entrants were obligated to practice crosssubsidization between the less lucrative areas with the very profitable ones. Lamberte
hinted that it may not be too late to abandon the scheme especially since many of the
participants were way behind their schedule.
Alonzo and San Pedro (1996) commented that there may be too many players
competing in a capital intensive sector where operating a network of 300,000 or
400,000 lines may not be profitable. Out of the eleven service areas designated by the
NTC, only four included parts of the profitable Metro Manila area where PLDT’s main
lines were already concentrated. Thus, the less populated areas would not be as
attractive to operators.
85
Serafica (1998) argued that in opening up previously monopolized markets,
competition may be hampered due to the presence of asymmetry (e.g. control of
essential facility by incumbent) between an established firm and new players. There is,
thus, a need to provide assistance to new players by limiting further entry, ensuring
favorable terms of interconnection or relieving entrants from obligations placed on the
incumbent. This is exactly the opposite of what the service area scheme seeks to
achieve. Serafica added that the experience of telecommunications worldwide showed
that effective competition took place only with some form of assistance to new players.
PLDT provides not only local telephone service but domestic and international
long distance services as well. It is the principal supplier of long distance telephone
service in the country as it owns and operates an extensive nationwide backbone
transmission network which is necessary for the processing of long distance telephone
calls. Smaller telecommunications companies must go through PLDT’s network to allow
them to process these calls. They have long complained that PLDT has been charging
them unreasonably higher fees. An alternative backbone facility is currently being
developed by the government, the National Telephone Digital Network, which was
initially pushed by Philippine Global Communications and Bayan Communications.
The issuance of EO 59 in February 1993 mandated compulsory interconnections
of all public telecommunications carriers. Many considered the pace of interconnection
to be very slow. As PLDT controls the public switch network, it has dictated the pace
of interconnection. New industry players and smaller firms complained that it was
difficult for them to negotiate favorable interconnection deals with PLDT as, being the
incumbent operator, it had a stronger bargaining position. After more than five years
since the issuance of EO 59, it was only recently that interconnections have been
almost fully completed. Early this year, PLDT reported that it is now fully connected
with other carriers including its international gateway facility for long distance calls,
except for ETPI, with which it is set to conclude an interconnection agreement within
the year (Manila Times, January 12, 1999).
86
PLDT used to be the only operator of an international switching center in the
Philippines. With the liberalization of the sector, there are now a total of eleven IGF
operators (including PLDT).
2. Record/Data Carrier Services
Record/data carrier services are classified into domestic and international record
carrier services. The services provided are telegraph, telex, facsimile, electronic mail
and data communications services. There are currently six domestic record carriers
consisting of GMCR (Globe Telecom), Oceanic Wireless Network (OWNI), Philippine
Telegraph and Telephone (PT&T), Radio Communications of the Philippines (RCPI),
Universal Telecommunications, and TELOF. There are five international record
carriers composed of Capwire, ETPI, Globe Telecom, Philcom, and PLDT.
The domestic record carrier services is dominated by telegraph with the
government’s TELOF providing the major telegraph service in the country. Telex is the
second largest domestic record service which is provided mainly by private domestic
record carriers.
3. Carrier’ s Carrier Service
Prior to the liberalization of the sub-sector, there used to be only two satellite
carriers, PHILCOMSAT and DOMSAT providing leased circuits to the international
and domestic record carriers. With the issuance of DOTC Circular Number 93-273, any
qualified applicant may apply for a CPCN/Provisonal Authority (PA) to install, operate
and maintain any satellite related services. There are three companies which were
granted authority to provide various transmission services for other communications
carriers. These are: DOMSAT PHILCOMSAT, and CAPWIRE.
87
4. Other Services
Radio Paging Services
Prior to the liberalization of the radio paging services sub-sector, there was only
one provider of such services. As of December 1998, there were fifteen companies that
provided radio paging services in the country. The number of radio paging subscribers
has rapidly grown over the years. Given the limited supply of fixed telephone lines and
increasing demand, radio paging services provided an alternative. Between 1990 and
1995, the number of radio paging subscribers increased by 62 percent annually. As of
December 1998, the NTC reported that there were 704,138 radio paging subscribers
dominated by Easycall with its share of 39 percent of the market. Pocketbell closely
followed with a share of 28 percent of the market (see Table 7).
Trunked Repeater Radio System
Trunk radio services served as another alternative to address the deficiencies in
telephone services. There are, currently, ten trunk repeater radio system providers. The
number of trunk radio system subscribers increased substantially from 1,938 in 1991 to
45,859 in 1997.
88
Table 7: Radio Paging System by Company, 1998
Operator
Easycall Communications Philippines
Philippine Wireless (Pocketbell)
Infocom Communication (Infopage)
Pilipino Telephone Corporation (Beeper)
Radio Marine (Power Page)
Island Country (Jaspage)
Isla Communications (Icon)
Multi-Media Telephone (Index)
Ermita Electronics (Star Pager 2000)
Message System (Recall 138)
Teodoro Romasanta (Digipage)
Worldwide Communications
AZ Communications
Smart Communications (Smartpage)
Corona International
Total
Number of
Subscribers
275560
195275
77750
40828
30200
26000
22197
17397
11168
4243
3320
200
704138
% Share
39.1
27.7
11.0
5.8
4.3
3.7
3.2
2.5
1.6
0.6
0.5
0.0
100.0
Source: NTC
Cellular Mobile Telephone System
There are, currently, five CMTS companies in the country Express
Telecommunications (Digital), Piltel (Mobiline), Smart, Isla Communications, and
GMCR (Handyphone). In 1989, the government granted Piltel and Extelcom franchises
to operate cellular mobile telephone systems. Smartcom, Islacom, and Globe entered the
market in 1993.
Owing to the shortage of fixed telephone lines, the demand for cellular telephones
swelled as a result of a growing population and economic growth. In 1991, there were
only 34,600 cellular mobile telephone subscribers. This increased to 493,862 subscribers
in 1995. In 1997, there were 1,343,620 subscribers.
89
The cellular mobile telephone market is dominated by Smart with its share of 49
percent of the market (see Table 8). This is followed by Piltel with a share of 19
percent and by Extelcom and Globe with equal shares of about 13 percent each.
Table 8: Cellular Mobile Telephone System Subscribers by Company
Operator
Smart
Piltel
Globe
Extelcom
Islacom
Total
Number of Subscribers
762262
293340
203819
200000
100000
1559421
% Share
48.9
18.8
13.1
12.8
6.4
100.0
Source: NTC
I.
Impact of Foreign Investment in the Telecommunications Sector
Telecommunications play a paramount role in determining the competitiveness of
an economy in a modern society. Countries know full well that a modern
telecommunications network is strategic to their survival in a competitive global
economy.
Access to an advanced telecommunications services at reasonable prices is
essential to their economic and industrial development.
To fast track the development of telecommunications infrastructure, there are two
courses of action open to governments. One way is to commit more public funds to the
sector and the other is to open the sector to private capital through privatization,
liberalization, and deregulation. The latter, which has been pursued in the Philippines,
is the favored policy direction as governments find it hard to provide much better
infrastructure with the latest technology given their limited funds and inadequacies in
managing a technology-driven industry like the telecommunications sector (Ure and
Vivorakij, 1998).
90
The telecommunications industry is a high technology industry requiring largescale investment. The entry of foreign companies is crucial to the sector as local investors
would not be able to provide the required scale of investment whereas foreign companies
have the capital, managerial expertise, and technology. Historically, opportunities for
foreign investment flows in the telecommunications industry have been hampered
because most countries had either state-owned or privated-owned monopoly carriers.
With the recent liberalization, privatization, and deregulation of the sector, this era is
about to come to an end.
However, as the sector is viewed as a security issue and a national asset that must
not be controlled by foreigners, many developing countries still impose restrictions on
foreign equity participation. The Philippine Constitution limits foreign ownership in the
sector to 40 percent. Other Asian countries that impose foreign ownership limitation
include Indonesia - 35% (except PCS), Malaysia - 30% in existing licensed PTOs, and
Thailand - 20% while Australia, New Zealand, Pakistan, and Hongkong have none (Basic
Telecoms Agreement, GATS).
Foreign Direct Investment (FDI) in Telecommunications
The increasingly liberalized environment together with political stability in the
country spurred confidence for both domestic and foreign investors. With the opening
up of the sector, foreign carriers entered the country in alliance with local companies.
Nine telephone companies entered the market immediately after liberalization and
currently, there are two more firms, Belltel and Philcomsat, which have been given
approval to operate by the NTC.
91
Table 9: Foreign Direct Equity Investment in Telecommunications
In million US$
Year
1990
1991
1992
1993
1994
1995
1996
1997
1998
FDI
0.89
0.58
3.13
34.29
35.31
16.9
57.7
292.26
1.85
Total Foreign Direct Investment
1990-98
Total Foreign Direct Investment
1973-98
442.9
460.5
Source: Bangko Sentral ng Pilipinas
As shown in Table 9, FDI flows to the sector increased dramatically from
US$0.89 million in 1990 to US$292.3 million in 1997. The bulk ( 96 percent) of the
stock of foreign direct investment in the sector was accumulated starting in 1992
following the liberalization of the sector to competition and foreign investment. Note
that Asian companies like Thailand’s Telecom Asia and Shinawatra, Hongkong’s First
Pacific, Australia’s Telia, Singapore Telecom, Japan’s NTT and South Korea’s
Retelcom have been making their presence felt in the Philippines alongside European
and American companies like Cable and Wireless, Deutsche Telekom, Millicom, AIG
and Comsat (see Table 10).
Late in November 1998, First Pacific acquired a 17.2 percent stake at PLDT in a
US$749 million deal. The stake could be a controlling block in the company which has a
widely dispersed ownership structure. To increase PLDT’s income, First Pacific
announced its plan to reduce the staff from 15,000 to 12,000 and to merge Smart
Communications, the country’s largest cellular phone operator, with PLDT’s Piltel
(Manila Times, 14 November 1998). Industry players believe that First Pacific’s buy-in
to the country’s biggest telecommunications company would reinforce PLDT’s hold in
the industry and set the stage for the merger of their cellular phone companies. The
combined share of Smart and Piltel accounts for 68 percent of the total number of CMTS
subscribers. The merger could create an industry giant with combined telephone and
cellular phone subscribers of 3,874,455 which accounts for about 48 percent of the
92
country’s total subscribers in a country of 73 million people where the telephone market
is far from saturated.
Table 10: Foreign Investors in the Telecommunications Sector
Wireline and
Wireless Voice
Company
PLDT
Bayantel/ICC
Digital
Eastern
Extelcom
Globe GMCR
Islacom
PT&T/Capwire
Piltel
Smart
Philcom
Foreign Partner
Equity
First Pacific (Hongkong)
Nynex(US), Telecom Asia (Thailand)
Telia (Australia)
Cable & Wireless (UK)
Millicom (US)
Singapore Telecom
Deutsche Telekom, Shinawatra (Thailand)
Retelcom (South Korea)
AIG (US)
First Pacific (Hongkong), NTT (Japan)
Comsat (US)
17.20
32.24
15.00
40.00
40.00
37.00
30.00
20.00
40.00
16.80
Sources: Ure and Vivorakij,1998 and Lamberte, 1996
Gains from Opening Up The Telecommunications Sector To
Competition and Foreign Investment
Prior to the introduction of regulatory reforms in the 1990s, there was no
competition in the telecommunications industry. There was very little foreign direct
investment in the sector as
93
Table 11: Number of Telecommunications Services Companies by Sub-sector, 1992-97
Telecommunications
Sub-sector
Local
Exchange
Carrier Service
Cellular
Mobile
Telephone Service
Paging Service
Public
Trunk
Repeater Service
International
Gateway Facility
Satellite Service
International Record
Carrier
Domestic
Record
Carrier
Internet Service
1992
1993
1994
1995
1996
1997
45
49
60
67
74
76
2
5
5
5
5
5
6
7
6
8
10
8
11
10
14
10
15
10
3
5
9
9
9
11
3
4
3
4
3
5
3
5
3
5
3
5
6
6
6
6
6
6
0
-
1
-
113
130
Source: 1997 NTC Annual Report
shown in Table 9. After 1993, nine new firms entered the market. The range of
telecommunications services became diversified (see Table 11). Cellular phones and
pagers became a common sight and internet access became more widespread. Currently,
there are eleven IGF operators, five CMTS providers, 15 paging service companies, and
130 internet service providers.
Customers also benefited from the introduction of digital switching as well as the
availability of services such as call forwarding, call barring, call hold, and call waiting.
Customers have also experienced price reductions in international calls as well as CMTS
and paging services. With the operation of more international gateways, international toll
rates declined. Outgoing international calls increased from 136 million minutes in 1992
to 172 million minutes in 1995 while incoming traffic to the Philippines rose from 462
million minutes to 540 million minutes in 1995 (APEC, 1994 and ITU, 1997). In 1995,
94
this meant a net gain for the country which amounted to US$ 235 million in estimated net
settlement payments (ITU, 1997)1.
Table 12: Number of Main Lines and Subscribers in the
Telecommunications Industry
Year
Number
of Telephone
Main Lines
Density
1990
1991
1992
1993
1994
1995
1996
1997
740033
784719
1109652
1409639
3352842
5775556
1.17
1.21
1.67
2.01
4.66
8.07
Number
of Number
of
CMTS
Paging
Subscribers
Subscribers
14652
56044
71758
102400
171903
228547
493862
324816
959024
491025
1343620
704138
Number of
Trunk Radio
Subscribers
1938
5982
18799
32998
45859
Source: 1997 NTC Annual Report
Moreover, following the opening of the market, teledensity (telephone mainlines
per 100 inhabitants) increased from 0.95 in 1984 to 1.68 in 1994 (see Table 12). In 1997,
the country had a teledensity of 8.07 and this was projected to reach 9.8 by 1998. With
competition and the entry of foreign investment, the number of CMTS subscribers and
paging services subscribers more than doubled between the years 1995 and 1997. The
same goes for trunk radio service subscribers.
In terms of the absolute growth in mainlines, the country posted an impressive
cumulative annual growth rate (CAGR), especially when one compares this with other
ASEAN countries. Table 13 shows that the Philippines’ CAGR rose from 3.2 percent
prior to liberalization (calculated for the period 1984 to 1990) to 18.2 percent after
liberalization (i.e, for the period 1990-1995). As a result of greater telephone penetration,
the long waiting time to own a telephone which took over a decade prior to liberalization,
has ceased.
1
By international agreement, the telephone company in the country where the call is billed should pay the
95
Table 13: Comparison of Selected ASEAN Countries’ Cumulative Annual Growth
Rates
Country
Philippines
Thailand
Malaysia
Indonesia
Mainlines
1984
(in 000s)
505
519
849
536
Mainlines
1990
(in 000s)
610
1325
1588
1066
Mainlines
1995
(in 000s)
1410
3482
3332
3290
CAGR (%)
1984-90
CAGR (%)
1990-95
3.2
16.9
11.0
12.1
18.2
21.3
16.0
25.3
Source: Ure and Vivorakij, 1998
It is evident from Table 14 that opening the sector to competition and foreign
investment has boosted the contribution of the telecommunications industry to the
economy. Value added and revenues from the telecommunications sector improved
substantially. Value added as percentage of GDP increased from 1 percent in 1988 to 1.6
percent in 1994 while revenues as percentage of GDP rose from 1.4 percent in 1988 to
2.1 percent in 1994. These increases could be attributed mainly to the growth in the
telephone sub-sector as well as in other telecommunications services which include
cellular mobile telephone and paging services. The contribution of the telegraph subsector remained unchanged.
telephone company at the other end for terminating the call (ITU, 1997).
96
Table 14: Economic Contribution of the Telecommunications Sector Before and
After Liberalization
Telecommu Prior to Liberalization, 1988
nications
Number of Value
Revenue/
Subsector
EstablishSales
Added
(in
billion
p)
(in billion p)
ments
Telephone
30
6.1
8.1
As % of GDP
0.8
1.0
Telegraph
14
1.8
2.6
As % of GDP
0.2
0.3
Others
6
0.4
0.7
As % of GDP
0.05
0.08
Total
50
8.3
11.4
As % of GDP
1.0
1.4
After Liberalization, 1994
Number of
Establishments
95
19
36
150
Value
Added
(in billion p)
21.5
1.3
3.0
0.2
1.9
0.1
26.4
1.6
Revenue/
Sales
(in billion p)
27.0
1.6
5.0
0.3
3.0
0.2
35.0
2.1
Census of Establishments, 1988 and 1994
I.
Conclusions and Lessons from the Liberalization of Telecommunications
Amidst the continuing worldwide trend in economic deregulation and regulatory
reform, the Philippines introduced substantial policy changes in the telecommunications
sector in 1993. Five years have elapsed since these policy reforms opened up the sector to
competition and foreign investment and, as shown in the preceding section, the results
produced have been positive. The telecommunications sector has indeed benefited from
increased foreign investment in a liberalized environment (see Table 15). At the same
time, however, there are still policy issues that remains to be settled to sustain these
regulatory reforms and create and maintain a competitive marketplace that would ensure
significant benefits in terms of new market opportunities, more level playing field,
greater choice and lower prices in the telecommunications sector. Competition is what
drives businesses to improve their efficiency, develop new products and assists economic
growth and create employment. While liberalization may be a precondition for the
growth of a free market, it does not, by itself, guarantee effective
97
Table 15: Opening Up The Telecommunications Industry To Competition
and Foreign Investment : Summary Of Benefits
Foreign Direct Investment
Total Value Added
As % of GDP
Revenue/Sales
As % of GDP
Telephone Density
Fixed Telephones Lines
Mobile Telephone Subscribers
Paging Subscribers
Number of Establishments
Local Exchange Service
Cellular Mobile Telephone
Paging
Public Trunk Repeater
International Gateway Facility
Satellite Service
International Record Carrier
Domestic Record Carrier
Internet Service
Before
1973-89: US$ 17.6 million
1988: P8.3 billion
1.0
1988: P11.3 billion
1.4
1984: 0.95
1984:505000
After
1973-98: US$460.5million
1994: P26.4 billion
1.6
1994: P34.9 billion
2.1
1997: 8.07
1998: 6548114
1997: 1559421
1997: 704138
1997
76
5
15
10
11
3
5
6
130
competition. It is only by creating a policy environment that encourages competition that
we can maximize the benefits from foreign direct investment. Thus, it is essential to
remove the remaining impediments to competition and enforce a competition policy that
would foster competitive market outcomes and competition in the sector. It must be noted
that the regulatory reform process becomes more complex as the telecommunications
industry is subject to significant technological and market-based changes (Janow, 1998).
Uncertainties increase as new and advance technologies emerge such that policies that
may work today may no longer be appropriate in the future. It is necessary that the
regulatory system is continually adjusted to take into consideration domestic or
international policy changes. Liberalization, deregulation, and the whole regulatory
reform process requires an institutional structure that is technically competent in handling
the complex issues that emerge in the telecommunications industry.
98
Policy Issues and Remaining Barriers to Competition
1. Need for Domestic Competition Policy in the Telecommunications
Industry
With the opening up of the market to competition and foreign investment, the
dominant position of the incumbent firm, PLDT, declined from 94 percent prior to 1993
to 87 percent in 1995. In 1998, while still holding the largest share, this was further
reduced to only 32.3 percent (see Table 16). As this developed, First Pacific bought
control of PLDT. The PLDT-First Pacific deal is expected to bolster PLDT’s control of
the industry. The PLDT takeover was described by Finance Asia as a strategic acquisition
made for commercial rather than political reasons that would allow First Pacific to
consolidate its position in the Philippine telecommunications industry by synthesizing the
operations of PLDT and Smart. Smart and Piltel have a combined share of 68 percent of
the total number of CMTS subscribers while PLDT and Smart together account for 43%
of the total number of installed lines. The merger would, thus, reinforce PLDT’s position
with its combined telephone and cellular phone subscribers of 3,874,455 which currently
accounts for about 48 percent of the total number of telephone and cellular phone
subscribers in the country.
99
Table 16: Distribution of Working Lines by Carrier
Major Carrier
PLDT
Digitel
Globe
Bayantel
Islacom
Philcom
Piltel
PT&T
Smart
ETPI/TTPI
Other Operators
Prior to Liberalization
94.0
6.0
After Liberalization
1995
86.7
3.6
3.0
6.7
1998
32.3
5.7
10.8
7.1
11.0
1.1
5.8
2.6
10.8
1.1
11.7
It is important to distinguish between welfare enhancing mergers and welfare
diminishing mergers. In the former, mergers between firms can be an effective way of
developing competitive advantage, optimizing the benefits of complementary strengths
and taking advantage of economies of scale and scope. Mergers can also work as an
important discipline upon poorly performing management. Merger activity can thus
improve efficiency to the benefit of consumers and the community in general. On the
other hand, mergers can result in a decline in the number of players in an industry, at
least in the short run. In some cases, particularly where there are significant barriers to
entry, mergers can lead to increased industry concentration and increased market power
which may run counter to community interest .
To ensure that mergers and acquisitions do not create or enhance market power
which can damage emerging competition, it is necessary to design safeguards that would
ensure market contestability and regulate anti-competitive business conduct or practices.
For instance, in the US and Japan, mergers and acquisitions are controlled when they tend
to stifle competition substantially or to create a monopoly using important criteria which
include, among others, the threshold beyond which a merger or acquisition is subject to
scrutiny (in Japan, the market share of 25%), efficiency which will be created through the
100
merger or acquisition, competition from abroad, and acquisition of a failing company or
division ( Matsushita, 1996).
While liberalization is expected to provide increased foreign investment, access to
technology and opportunities for companies to improve efficiency, it may not be
sufficient to foster effective competition in a sector previously dominated by a monopoly.
If effective competition has to emerge, regulatory reforms have to be accompanied by the
creation of competitive market and industry structures. As competition laws were absent,
PLDT which owns the domestic backbone system, was able to influence not only the
speed but also the terms and conditions for interconnection as well as terms and
conditions for revenue-sharing arrangements. Industry experience has shown the slow
progress of interconnection, the difficulties of new entrants in getting interconnection
with PLDT’s domestic backbone and in drawing up satisfactory revenue sharing
arrangements. In contrast, in Australia, for instance, competition policy provides that the
new entrant be given access to the interconnection network at what is regarded as a
relatively inexpensive price to help offset the competitive advantages of the incumbent
(Hilmer Report, 1993).
The opening up of the telecommunications sector to foreign investment has
provided the economy with benefits, however, in the absence of competition laws, there
is a risk that liberalization may not be sufficient to foster effective competition in the
sector which used to be dominated by a private monopoly. Promoting competition is also
the single most effective way of maximizing the benefits that foreign investment offers.
Turning now to the liberalization of retail trade, the most important lesson that
can be drawn from this paper is the importance of well-designed and effectively
implemented competition law and policy to accompany regulatory reforms. Competition
rules play a very important role in ensuring the effectiveness of liberalization. As
liberalization progresses, private enterprises may engage in restrictive business practices
to offset the effect of liberalization. It becomes increasingly important to counteract these
practices through vigorous enforcement of competition laws. These would enable us to
101
control possible abuses of dominant positions by large scale firms including
multinationals. In small developing country markets, multinational companies are likely
to be dominant firms. Mergers and acquisitions would also be under the supervision of
competition laws, especially those between large scale firms which may result in an
increase in market concentration and a reduction in competition.
2. Reexamine the SAS
The SAS was drafted with the best of intentions. Unfortunately, good intentions
do not necessarily make good policy. The SAS has long been criticized as it seemed to
discourage the expansion of infrastructure and competition. The scheme ran counter to
competition policy and what it did was to level the playing field for PLDT as new
entrants were obligated to practice cross-subsidization between the less lucrative areas
with the very profitable ones (Lamberte, 1996).
To date, five out of the nine SAS carriers have been lagging in fulfilling their rollout targets. The NTC has given them up to September 1999 to install the required lines,
otherwise NTC warned that penalties would be imposed and their assigned areas would
be opened up to other carriers. Considering that most of the carriers failed to meet their
commitments, it is important for policy makers to review the merits of continuing the
scheme.
3. Bringing Telecom Services to Rural Areas
While increasingly open markets and competition in the telecommunications
industry can lead to economic gains, there is no assurance that outlying rural regions
can be linked to the network. The current policy of cross-subsidization in which the
cost of providing telephone lines in rural areas is subsidized by profits on heavy routes
and on long-distance calls may no longer be suitable in the light of declining cost of
long distance traffic. There is a need for the government together with the private sector
to design programs to help less-favored regions in order to achieve universal access.
102
4. Towards a Cost-based Tariff Structure
In order for competition to work efficiently, there is a need to bring the tariff
structure closer to costs. The introduction of more rational tariff-based policy (costbased) would cause users to make more efficient decisions and would also reduce the
likelihood of cream skimming of the most profitable traffic by new entrants.
103
References:
Abrenica, Ma. Joy V., Technological Convergence and Competition: The
Telecommunications Industry, paper presented at the IDE-UPSE SymposiumWorkshop on Studies in Governance and Regulation, 16 December 1998.
Alonzo, Ruperto P. and W. San Pedro, The Philippine Telecommunications
Industry PIDS Development Research News, Vol. XIV No. 4, July-Aug 1996.
Barriers To Entry Study Volume I, paper prepared by SGV Consulting for US
Agency for International Development, April 1992.
Business Profiles 1997-98: Top 7000 Corporations
Janow, Merit E., Policy Approaches to Economic Deregulation and Regulatory
Reform in Business, Markets and Government in the Asia Pacific, edited
by Rong-I Wu and Yun-Peng Chu, 1998, New York and London
Lamberte, Mario L. Trade in Services, 1996.
Serafica, Ramonette B., Was PLDT a Natural Monopoly? Telecommunications
Policy, Vol. 22, No. 4/5, pp. 359-370, 1998.
_________________, Beyond 2000: An Assessment of Infrastructure Policies,
PIDS Discussion Paper No. 98-07, May 1998.
Matsushita, Mitsuo, The System of Competition, paper prepared for APEC
Partners For Progress-Seminar on Competition Policy,
Bangkok, Thailand,
March 19, 1997.
National Competition Policy, Report by the Independent Committee of Inquiry for the
104
Heads of Australian Governments (Hilmer Report), Australia, August 1993 .
The Philippines: An Opening for Sustained Growth, World Bank document,
April 1, 1993.
Ure, John and Araya Vivorakij, Telecommunications and Privatization in Asia in
Business, Markets and Government in the Asia Pacific, edited by Rong-I
Wu and Yun-Peng Chu, 1998, New York and London
1997 NTC Annual Report
105
Study II
Retail Trade Policy and the
Philippine Economy: Some
Insights from Liberalization of
the Banking and Insurance
Sectors
By: Ma. Melanie R.S. Milo
106
Retail Trade Policy and the Philippine Economy: Some Insights from the
Liberalization of the Banking and Insurance Sectors1
Ma. Melanie R.S. Milo2
I.
Policy changes in the banking and insurance industries, especially with
respect to foreign ownership
A. Banking sector3
Foreign banks in the Philippines have a long history. The first commercial bank
established in the Philippines was the Banco Español Filipino, later known as the Bank of
the Philippine Islands, which began operations in 1851. Two British banks, the Chartered
Bank of India, Australia and China (now the Standard Chartered Bank) and the
Hongkong and Shanghai Banking Corporation opened branches in the Philippines in the
1870s, and an American bank (First National City Bank of New York) in 1902. Other
foreign bank branches were established over the period 1900-45, but they were shortlived or did not resume operations after the war. Only four foreign banks resumed
operations in 1945 – the First National City Bank, the Chartered Bank of India, Australia
and China, the Hongkong and Shanghai Banking Corporation, and the Nederlandsch
Indische Handlesbank. The latter was later absorbed by Bank of America, which was the
last foreign bank to establish a branch in the Philippines in 1947.
In 1948, the General Banking Act was enacted, which specifically restricted
foreigners from establishing full-fledged bank branches or locally incorporated
subsidiaries, although they were allowed a maximum equity participation of 30 (in some
cases 40) percent in newly established commercial banks. However, this provision was
significantly tightened in 1957 when the Monetary Board required all new banks to have
1
Draft report submitted to the Policy and Development Foundation, Inc. (PDFI) for the research project
“Retail Trade Policy and the Philippine Economy”.
2
Research Associate, Philippine Institute for Development Studies. The usual caveat applies.
3
This section draws on Milo (1998).
107
100 percent Filipino ownership. Furthermore, ownership of banks was limited to naturalborn Filipino citizens. This regulation was eased in 1965, with naturalized Filipinos
allowed 20-30 percent ownership of new banks. Thus, no new foreign banks were
established in the Philippines since 1947 (Emery 1976). Foreign banks were also
prohibited to open new branches, barred from accepting government deposits, and rarely
able to rediscount with the CB. The bias against foreign banks was due to the perception
that foreign banks were not using their resources, derived in large measure from local
deposits, to promote the growth of the Philippine economy, but rather to serve the needs
of multinational firms. Thus, there was a shift in policy towards the development of
private domestic banks.
Following the change in regulation of foreign banks, there was a significant shift
in the composition of commercial banks. The share of foreign banks in the total assets of
the commercial banking system significantly fell from 70 percent in 1900 to 25 percent in
1925 (with the establishment of the largest and government-owned Philippine National
Bank in 1916), 30 percent in 1950, 15 percent in 1960, and just 9 percent in 1970 (Table
1), as the number of domestic banks rapidly increased. When the Central Bank of the
Philippines commenced operations in 1949, only one of the eleven commercial banks
was a privately-owned Filipino bank – the rest were either government-owned (one),
controlled by the Catholic church (two), branches of foreign banks (four), or Philippinechartered banks controlled by American or Chinese interests (three). By the end of the
1960s, there were 38 commercial banks, consisting of the largest and government-owned
PNB, 33 domestic banks, and the 4 foreign bank branches.
108
Table 1. Total assets of the Philippine commercial banking system, 1900-95
Year
Total (mil pesos)
Total domestic
1900
1925
1950
1955
1960
1965
1970
1975
1980
1985
1990
1995
40
264
1,079
1,413
2,337
6,786
13,541
49,980
146,026
285,578
497,488
1,885,560
29.4
74.6
69.7
85.8
85.1
92.8
91.1
89.7
87.2
84.6
87.1
87.0
Percent Distribution
Domestic
Government
Private
n.a.
n.a.
n.a.
48.9
36.0
36.3
34.0
36.8
28.4
26.7
13.6
21.0
n.a.
n.a.
n.a.
36.9
49.1
56.5
57.1
52.9
58.8
57.9
73.5
66.0
Foreign
70.6
25.4
30.3
14.1
14.9
7.2
8.9
10.3
12.8
15.4
12.9
13.0
Source: Hutchcroft (1993); Bangko Sentral ng Pilipinas.
The mushrooming of banks led to a high degree of bank instability, with several
banks experiencing financial difficulties. In particular, there arose a two-pronged problem
in the banking sector: insider abuse by bank officers/owners and lack of prudential
supervision and regulation. Bank difficulties were primarily attributed to the rapid growth
of banks, which left most banks undercapitalized, lacking in managerial skills, and low
on deposits. Thus, the CB informally imposed a moratorium on the licensing of new
commercial banks in 1966. However, general malversation of funds was typically cited
as the underlying cause of bank difficulty and failure, in particular, fraud or insider abuse
by bank owners or officers (Emery 1976). Another problem that became evident during
this period was the lack of prudential supervision and regulation of banks, which in turn
worsened the problem of insider abuse.
In November 1971, the government authorized a review of the banking and
overall financial system of the country. The review was conducted by the Joint
International Monetary Fund-Central Bank of the Philippines Banking Survey
Commission to assess the performance and capacity of the country's financial sector. The
recommendations of the Commission were implemented in a package of financial
109
reforms that began in November 1972. The reforms covered four areas - the CB itself, the
money market, the banking system, and interest rate determination.
Reforms in the banking sector specifically sought to address the twin issues of
weak, family-based private banks, and the CB’s inability to supervise them. To
encourage banks to improve their condition, the Commission proposed mergers among
banks and the diffusion of equity within each bank, while retaining the CB policy from
1957 of 100 percent Filipino equity in any new commercial bank. The actual banking
reforms embodied in Presidential Decree No. 72 went further than the Commission’s
recommendations. The minimum paid-in capital of commercial banks was raised from
P20 million to P100 million. To enable commercial banks to meet the new capital
requirement, mergers and consolidations were encouraged. In addition, foreign equity
participation of up to 40 percent was allowed, thus overturning the prohibition imposed in
1957. It was believed that foreign participation would be a stabilizing influence, and
“professionalize” the management of banks. To deal with the problem of insider abuse,
the CB reduced the maximum ownership share of an individual to 20 percent, and of a
corporation to 30 percent to disperse bank ownership. Finally, no new bank licenses were
to be issued, making the informal cap on new banks imposed in 1966 official (Lamberte
1989; Hutchcroft 1993).
The mandated increase in paid-in capital of commercial banks achieved its stated
objective of encouraging mergers. From 1974-76, thirteen banks consolidated into 6
banks, reducing the number of domestic commercial banks from 34 to 27. Also, ten local
banks received substantial capital infusion from 13 foreign banks. However, the ultimate
objective of strengthening the weak banks to stabilize the banking system proved to be
elusive. Mergers typically occurred among the weak banks, since the sounder banks had
no incentive to merge with those banks saddled with bad, often DOSRI-related, loans.
Five of the six banks suffered major difficulties in later years. Foreign participation was
generally workable in banks that were already more broadly held and professionally
managed. On the other hand, major disputes between the foreign investors and local
families/owners over the composition of loan portfolio typically arose with the “errant”
110
banks. This resulted in five of the foreign banks divesting themselves of their stakes in
the local banks within the same period. Simply put, foreign equity participation was not a
successful deterrent to insider abuse of banks. With regards to the restriction on
ownership share of banks, while there was compliance on paper, this was easily
circumvented through the use of dummy stockholders, and was not strictly enforced. In
some cases, it was simply ignored, given the weakened position of bank supervisors
within the CB. The impetus of the reforms began to wane when it became obvious that
problems of bank instability had not been mitigated, but had even grown worse
(Lamberte 1989; Hutchcroft 1993).
Another financial sector review was conducted in 1979, this time by a joint IMFWorld Bank mission. The mission found the Philippine financial system to be relatively
well developed. However, the specialized nature of the various institutions had also led to
fragmentation and reduced competition, hampering the system’s ability to adjust to
changing needs and demands. Thus, measures that would foster active competition in the
system were deemed as central to any reform in the financial structure. Another major
concern raised by the mission was the underdeveloped state of the long term capital
market.
Following the financial sector review in 1979, the Philippines formally embarked
on a financial liberalization program in the early 1980s, after more than 30 years of
repressionist financial policies from the time the CB began operations in 1949. This was
part of an overall structural adjustment program of economic liberalization. The aims
were to: (i) promote competitive conditions to foster greater efficiency in the financial
system; and (ii) increase the availability of and access to longer term funds, which were
the major concerns raised by the 1979 mission (Remolona and Lamberte 1986).
The first objective of increased competition and efficiency was to be achieved by
lessening the enforced specialization of financial institutions, and broadening the range of
their services. These included: the introduction of extended commercial banks or
universal banks authorized to offer a wider range of services including those previously
111
reserved to investment houses, such as underwriting and securities dealing; the
elimination of all functional distinctions among thrift banks; reduction in differentiation
among categories of banks and non-bank financial intermediaries authorized to perform
quasi-banking functions (NBQBs); and increase in the powers and functions of NBQBs.
Minimum capital requirements for banks and NBQBs were also raised. However, entry
barriers were not relaxed. The second objective of increasing the availability of longer
term funds through term transformation was to be achieved through interest rate
deregulation.
Soon after the start of financial liberalization, the financial system went through a
crisis of confidence (Laya 1982). It was triggered by the defaults of a prominent
businessman, and compounded by a series of investment frauds and stockbroker failures
that exacerbated the fragility of the system. Before the financial system could fully
recover, it was hit by another, more severe crisis as a result of the unstable political
climate and the BOP crisis in 1983. The period from 1983-85 was marked by
considerable financial turbulence. Simply put, the timing of financial liberalization in the
Philippines was inauspicious, with the reforms overtaken by one crisis after another.
Whatever benefits were derived from the reforms were largely undermined by the
successive weakening of the financial system as a result of the crises. Overall, the
country’s initial attempt at financial liberalization was not deemed a success, and this was
attributed to the chaotic macroeconomic environment. However, there was also the
inadequate functioning of the market mechanism. What the crises also magnified were
the long standing structural weaknesses in the financial system, particularly its weak
structural base that consisted of too many weak, small banks, and a few strong, big banks.
And in contrast to the 1972 financial sector review, the 1979 review did not address the
issue of instability in the system and its inherent causes.
Policy changes to strengthen the CB’s supervision and regulation of the banking
system were implemented only in 1986. They covered the following areas: (a) policies on
prudential banking restrictions; (b) imposition of penalties and sanctions; (c) supervisory
procedures; and (d) policies on the establishment of new banks and branches. Policies
112
effecting prudential bank management included, among others, minimum capitalization
requirements; compliance with the minimum risk asset ratio; the single borrower’s limit;
limit on loans to directors, stockholders and related interests (DOSRI); allowable
interlocking directorships and officerships; provisions for loan loss or doubtful accounts;
audit and reporting requirements; and a major policy shift away from the policy of
sustaining weak banks except in times of general financial emergency or when specific
banks face problems of liquidity rather than solvency (Bautista 1992).
While stronger prudential supervision would help to alleviate moral hazard
problems in the banking sector, there was still the issue of corporate governance. As Park
(1991) pointed out, in relation to the financial liberalization experience of the Southern
Cone countries in the late 1970s and early 1980s, '… it is debatable whether better
regulation of bank activities would have mitigated the problem (of moral hazard) as long
as the banks were controlled by a few industrial groups and conglomerates, in particular
when these groups believed that the government could not afford to let them go bankrupt'
(p. 351).
The primary objective of removing interest rate ceilings and legislated functional
specialization among the different financial institutions was to improve the efficiency of
intermediation by promoting competition. In fact inter-institutional competition remained
limited. A review of the Philippine financial sector by the World Bank in 1988 still
identified the lack of competitive behavior among the banks as an important feature
needing reform. Efforts to widen the ownership base of commercial banks were again
largely unsuccessful. While interest rate deregulation is a necessary condition for
fostering competition, there were other barriers to competition. In particular, the impact
of removing interest rate ceilings depend on the degree of competitive pressure.
Competition would not improve if there is no serious threat of entry into the banking
system, or if other regulations, such as those concerning branching, become binding
constraints. The moratorium on granting new bank licenses in the Philippines, which was
imposed in the 1970s, was lifted in 1989. However, the CB’s policy on bank entry
continued to be restrictive. In particular, although the CB issued guidelines for the
113
establishment of banks, it retained a strictly discretionary policy on branching by locally
owned banks, and strict branching restrictions on the four foreign banks already in
operation. No commercial bank application was considered because the number of
commercial banks in the system was deemed too many already. And the limit on foreign
equity participation in domestic banks discouraged foreign banks from entering the
domestic market. The unfavorable outcome of joint ventures in the past made foreign
investors more aware of the need to have greater control over bank operations in order to
protect their investments (Lamberte and Llanto 1993).
In May 1992, President Ramos was elected into office, and he initiated a program
of policy reforms and deregulation in critical areas of the economy. The economic
reforms were aimed at leveling the playing field, and democratizing and liberalizing the
economy to make it more competitive. These included further tariff reforms aimed at a
more neutral tariff policy; a tax reform program, and reforms of the government’s
privatization and infrastructure programs; further liberalization of foreign investments;
liberalization of foreign exchange transactions; and liberalization of key industries such
as telecommunications, transport, banking, and other key commodities.
In the financial sector, regulations on the entry of new domestic banks and bank
branching were significantly relaxed in 1993, and further simplified and made uniform
across banks in 1995. And the moratorium on the entry of foreign banks, which had been
in place since 1948, was lifted in May 1994 with the passing of RA 7721. This law
allowed the entry of up to 10 foreign banks through the establishment of a branch within
the next 5 years, although they were not allowed to open more than six branches in the
country. As an alternative mode of entry, foreign banks can buy up to 60 percent of
existing banks or establish new bank subsidiaries with a local partner on a 60-40 basis.
Maximum foreign equity participation in an existing local bank or subsidiary was also
raised to 60 percent from the 40 percent set in the early 1970s. There were twenty two
applicants, and the ten chosen banks were announced in February 1995. Applicants had
to belong to the top 150 banks in the world, or the top 5 banks in their own country.
Minimum capitalization was set at P210 million.
114
The liberalization of entry rules for foreign banks was intended to increase overall
efficiency in the banking sector, which was deemed as operating very much like a cartel.
By introducing greater competition from foreign banks, the expectation was that the wide
margin between savings and loans rates would be narrowed. Borrowing costs were
expected to fall, while interest rates on deposits were expected to increase, which would
in turn serve to encourage a rise in domestic savings. Competition, particularly in the area
of wholesale banking, was expected to heighten since most of the new foreign banks
indicated that they would commence their activity in that area. Better customer service
and the introduction of new financial products/instruments were the other expected
benefits of the entry of new foreign banks into the system. Furthermore, it was hoped that
the presence of more foreign banks in the system would help to lessen the vulnerability of
the banking system to outflows of foreign capital, as what happened in early 1995 in the
aftermath of the Mexican crisis.
Very recently, the Senate conducted a hearing on proposed amendments to the
General Banking Act. In particular, there is a Senate proposal to allow 100 percent
ownership of banks established in the Philippines. This policy direction is being
considered as a way of improving the delivery of banking services in the country, which
is deemed as continuing to be seriously inadequate. Although 60 percent already
represented majority control, this was not considered attractive enough for foreign banks.
The law has a bias for buyouts, but there is still the remaining 40 percent stake whose
holders the foreign banks might not know of. Clear lessons from the country’s experience
with financial liberalization to date need to be drawn in order to come up with an
informed, well-founded and definitive stance on the issue of further financial sector
liberalization.
B. Insurance sector1
As in the commercial banking sector, the first insurance enterprise operating
along modern principles was also foreign-owned. In 1829, Lloyd’s of London appointed
1
This section draws on World Bank (1992).
115
Stracham, Murray and Co., Inc., as its representative in the Philippines. Early companies
offered non-life insurance, and life insurance was not available locally until Sun Life
Assurance of Canada began to operate in the Philippines in 1898. The first domestic nonlife insurance company, Yek Tong Lin Fire and Marine Insurance Company, was
established in 1906; the first domestic life insurance company, Insular Life Assurance
Company, was organized in 1910. There was a substantial increase in the number of
insurance companies through the years. In 1915, they numbered 44; by 1957, their
number increased to 107; ten years later, there were 178 insurance companies in the
Philippines. Of these, 25 were life insurance companies, while 153 companies offered
non-life insurance. Domestic companies outnumbered foreign companies in both
categories: 19 of the former, and 113 of the latter. During 1965-67, there was a
mushrooming of insurance companies. This was followed by a wholesale suspension by
the authorities of a large number of the new companies, which were found to be
inadequately capitalized, as well as engaged in fraudulent activities. Thus, authorities
closed down 30 insurance companies towards the end of 1967 (Emery 1976).
Regulation of the insurance industry is the responsibility of the Office of the
Insurance Commissioner. The Commission was set up as an autonomous body in 1949
when it was split from the CB. As a result of the rather haphazard state of operation of
the industry, the Insurance Act, which embodied the overall regulatory framework of the
industry, was enacted in 1966. Because of the uncontrolled growth of the number of
insurance companies in the mid-1960s, one of the provisions of the Insurance Act was to
ban the entry of new insurance companies. Industry regulation was replaced by the
Insurance Code of 1978, which was modeled on earlier US legislation. The restriction on
entry was also retained. Changes to the 1978 Code had been very few, with none in
recent years.
The Commission itself falls under the jurisdiction of the Department of Finance
(DOF), although the latter’s role is not well-defined and weak, especially with respect to
its oversight functions. When it comes to the role and functions of the Commission vis-àvis the industry, the approach and emphasis seemed to be on conservatism and playing
116
safe. A positive result of this approach had been the overall financially sound status of the
industry.
But it could be argued that the approach was overly cautious and not sufficiently
development oriented, with the result that the growth of the industry was constrained.
With respect to entry, for instance, the Insurance Code did not provide specific conditions
for approval to engage business and the Code itself was not particularly restrictive. But
there was also a provision in the Code that granted the Commission the right to refuse a
Certificate of authority if this would best promote the nation’s interests. Thus, it was
possible to maintain a tight control on a continuing basis because the Certificate of
authority had to be renewed annually, subject to the insurance company’s compliance
with the provisions of the Code or the circulars, instructions, rulings or decisions of the
Commissioner.
The Omnibus Investment Code regulates foreign investment in the Philippines,
including in the insurance industry. Within this legal framework, the Commission’s
policy had been to allow foreign equity participation only in non-life insurance
companies up to the maximum allowed by the Omnibus Investment Code. This used to
be 30 percent and was raised to 40 percent in 1987, without the foreign investor having to
obtain prior authority from the Board of Investments. The Commission’s expressed
policy of allowing foreign investments only in non-life insurance was seen as a means to
increase the sector’s paid-up capital, which was deemed as highly inadequate. On the
other hand, foreign equity participation in life companies was disallowed because this
sector was seen as adequately capitalized. As in the banking sector, only foreign
insurance companies that were already operating before the law was set in place could
transact business in the Philippines. Also, domestic savings mobilization, which is one of
the activities that life insurance companies undertake, was preferred to be left entirely in
the hands of companies owned 100 percent by Filipinos. Furthermore, the Commission
deemed the life insurance industry to be overcrowded; thus, no new life insurance
company had been licensed to operate in the recent past. The dichotomy in the way life
and non-life insurance companies was regulated was stark.
117
The Commission’s conservative and restrictive management led to the Philippine
insurance industry lagging behind many other countries, for example, in terms of the
range of insurance products and investment portfolio composition. An important factor
was its tight restriction on foreign participation in the industry. Lack of expertise and
experience was a major issue, especially for the smaller locally owned companies.
Foreign investment and management input could go a long way in improving this
situation. Also, the government already controlled the level of foreign investment in the
Philippines through the Omnibus Investment Code. Thus, the Commission’s additional
level of restriction seemed unwarranted. The prudent and safe provision of insurance is
not constrained or endangered by foreign ownership of insurance companies as long as
this is done within the broader policies of the government. On the other hand,
encouraging foreign investment, without further restrictions on the level of foreign
ownership beyond what is already legally provided, would help increase the
capitalization and level of expertise of the industry, and assist in the reduction of the
volume of reinsurance premiums passing through the industry. A more pragmatic
viewpoint towards foreign investment was clearly called for.
Internationally, the insurance industry, especially life insurance, has changed
radically as a result of marketing innovation and advances. Laws and regulatory
frameworks have also been changed to keep pace with the industry. In the case of the
Philippines, the conclusion must be that the development of the market for insurance has
outstripped the capacity of regulations.
The entry of new insurance companies was finally deregulated in 1994.
Furthermore, liberalization of the sector also meant 100 percent ownership by foreign
investors, as opposed to the maximum 40 percent from 1987, giving the Philippines one
of the most liberal investment regimes in the region. The policy thrust, as in banking, is
to encourage companies with stronger capital bases so that more of the population may
avail of insurance services. Stronger companies can open more branches and the
Insurance Commission seeks to increase the percentage of insured people to 20 percent of
the population by 2000 from the current estimated 14-15 percent. Consequently, where
118
insurance companies could operate on only P10 million paid-up capital before, new
domestic companies now need P100 million, while foreign companies are required to
have P300 million. Domestic companies are encouraged to increase their capital base by
putting a limit on the amount of insurance they can write, up to P50 million. For example,
non-life companies with paid up capital of less than P50 million can only insure risks up
to a maximum 3-4 times their capital base. Life companies can write term insurances
only, and not permanent plans, if paid up capital is less than P50 million. As a result,
several foreign and domestic companies have been established since the deregulation
(Table 2).
Table 2. New insurance companies established since the deregulation
Year
Name of company
Foreign capitalization
Nationality
1995
Aetna Life Insurance Co.
99.99
American
1996
PCIB-Cigna Life Insurance Corp.
Pru Life Corp of UK
ING Life Insurance Co. (Phils.) Inc.
Aegon Life Insurance Co. (Phils.) Inc.
Petrogen Insurance Corp.
50.00
99.99
99.99
99.99
100.00
American
British
Dutch
Dutch
Filipino
1997
Ayala General Insurance Corp.
Zurich Life Insurance Phils., Inc.
Urbancorp Life Insurance Inc.
Capgen Insurance Corp.
Nippon Life Insurance Co. of the Phils.
Philippine General Insurance Corp.
John Hancock Life Insurance Corp.
Corporate Guarantee & Insurance Corp.
Berkley International Life Insurance Inc.
Zurich General Insurance Phils.
100.00
99.99
100.00
100.00
50.00
100.00
99.78
100.00
58.00
99.99
Filipino
Swiss
Filipino
Filipino
Japanese
Filipino
American
Filipino
American
Swiss
1998
Pioneer Allianz Life Assurance Corp.
50.00
German
Source: Insurance Commission.
119
II.
The impact of foreign investments in the banking and insurance
industries
A. Banking sector
As was noted earlier, there is a current Senate proposal to further amend the
General Banking Act in order to allow 100 percent ownership of banks established in the
Philippines. The merit of this proposal clearly depends on the country’s experience with
the partial liberalization of foreign bank entry in 1995. In particular, whether the
supposed benefits of increased competition and efficiency were actualized needs to be
assessed.
Table 1 shows the distribution of the total assets, deposits and loans of the
commercial banking system between domestic and foreign banks from 1990 to 1997.
Expectedly, the share of foreign banks in all three went up following the entry of the new
foreign banks in 1995, which would indicate a lessening dominance of domestic banks in
the system.
Table 3. Distribution of total assets, deposits and loans of commercial banks, 199097
Total Assets (bil P)
% Domestic KBs
% Foreign KBs
1990
488.9
88.6
11.4
1991
562.1
88.6
11.4
1992
630.0
90.2
9.8
1993
775.9
90.2
9.8
1994
959.3
91.2
8.8
1995
1374.1
91.1
8.9
Total Deposits (bil P)
% Domestic KBs
% Foreign KBs
306.1
92.5
7.5
356.7
93.4
6.6
415.5
93.3
6.7
520.2
93.7
6.3
654.4
93.5
6.5
891.5
95.1
4.9
Total Loans (bil P)
% Domestic KBs
% Foreign KBs
141.0
89.6
10.4
221.8
90.8
9.2
297.6
91.8
8.2
406.2
91.6
8.4
514.9
92.4
7.6
810.0 1177.119 1507.086
91.5
90.4
88.3
8.5
9.6
11.7
Source of basic data: Bangko Sentral ng Pilipinas.
1996
1885.6
87.3
12.7
1997
2581.1
83.5
16.5
1238.3 1468.358
95.1
92.8
4.9
7.2
120
It is important that the banking industry be sufficiently competitive if financial
intermediation is to be carried out efficiently. Excessive concentration is a potential
source of monopoly power.
Notwithstanding the World Bank (1988) report's concern over the lack of
competitive behavior of banks, the report also took the position that there was no
evidence of undue concentration in the banking industry. The Herfindahl index1, which is
a commonly used measure of industrial concentration, was calculated. A value of 0.10
was obtained in 1986 and it was deemed as relatively low. Furthermore, the report also
noted that:
‘The size of individual commercial banks in the Philippines is much smaller than
that
in other Asian countries; the two largest Philippine banks, i.e., PNB and the
privately-owned Bank of the Philippine Islands, rank 82nd and 99th in a recent survey
(1987) of the 200 biggest banks in Asia. Thus, the largest banks in the Philippines are,
relatively, not very big; conversely, the smallest banks are very small indeed ... In sum,
the number of banks and the relatively small size of the biggest banks suggests that
concentration in the banking industry is not a problem.' (para.4, pp.ii)
Therein lies the weakness of the Herfindahl index (HI). While it is a good
measure of a monopoly, it does not adequately capture the existence of an oligopoly,
more specifically a cartel, because of the relatively greater weight it gives to very large
firms. For instance, if one firm has an industry share of 90 percent, then the HI will be
higher than 0.81. But if an industry is controlled by three firms with a 30 percent industry
share each, the HI will only be around than 0.27, thus belying the existence of a highly
concentrated industry.
1
The Herfindahl index is calculated by squaring and summing the share of industry size accounted for by
every firm in the industry, with a maximum of one indicating a monopoly.
121
In another study cited by Tan (1989), the HI was calculated this time only for
private commercial banks. From 0.045 in 1982, the HI rose to 0.074 in 1988, or at an
annual average rate of around 9 percent, which was a rather fast rate of concentration.
Although these concentration indices appear small, Tan (1989) also noted that they do not
capture the institutional setting, which was likely to enhance the power of dominant
banks in the industry. First, all the head offices of commercial banks were located in
Metro Manila. Second, their owners/managers belonged to a loosely-knit and
geographically proximate social group. And in a number of cases, their business
interdependence extended beyond banking and included banking conglomeration in
production and trade. Interlocking directorates among financial and industrial
corporations in the Philippines is well documented (e.g., Doherty 1980; Hutchcroft 1991;
Tan 1991).
The question of collusion and cartelization is a key issue in the discussion of the
Philippine banking system. However, this is difficult to document, much more to
empirically test, although anecdotal evidence abounds (Hutchcroft 1993). But the
predictable results of such agreements are observable. Interest rates are likely to be
sticky, abnormal profits tend to persist, and in lieu of price or interest competition,
advertisement or product differentiation is used (Tan 1989).
Figure 1 presents some measures of asset concentration of the Philippine
commercial banking system. Although the actual value of the HI may not be indicative of
undue concentration, it would also be useful to look at the trend. From 1982-87, the HI
fell from 0.14 to 0.054, indicating that the system was becoming less concentrated.
However, this decline had to do with the rehabilitation of the government-owned
Philippine National Bank (PNB) in 1986, which led to a substantial reduction in its total
assets as its nonperforming assets were written off, as well as mandated increases in the
minimum capital requirements of banks. The PNB was the biggest commercial bank in
the Philippines, accounting for almost 20 percent of total commercial bank assets in
1980. The sorry state of the PNB, in turn, was due to its heavy involvement in the rescue
of both ailing financial and nonfinancial institutions during the crises years in the 1980s.
122
The period from 1987-94 again saw an increasing concentration of commercial bank
assets. And in 1995, the index began to decline, with the entry of the new foreign
commercial banks. On the other hand, the five-bank concentration ratio based on total
commercial bank assets was at least 50 percent from 1982-94, with the ratio reaching a
high of 66 percent in 1993. Again, the ratio began to decline with the entry of new
commercial banks, particularly foreign banks in 1995.
The reciprocal of the Herfindahl index gives the number of equally-sized banks
that would generate a degree of concentration equivalent to the actual concentration. For
1982, this was around 7 banks; for 1996, it was around 21. This means that the
distribution of resources among the 49 commercial banks existing at the end of 1997 was
equivalent in concentration terms to an industry of 21 equally-sized banks. Thus, there
could be some truth to the observation that there are too many small commercial banks in
the Philippines.
Figure 1. Measures of asset concentration in the commercial banking system,
1982-97
70
0.16
0.14
0.12
0.10
0.08
0.06
0.04
0.02
0.00
60
50
Herfindahl index
40
30
20
Share of 5 largest
banks
10
0
1982
1986
1990
1994
Note: The Herfindahl index is plotted on the left scale, and the asset share (in percent) of
the five largest commercial banks on the right scale.
Source of basic data: Business Day's Top 1000 Corporations, 1981 to 1985; SEC's Top
1000 Corporations, 1986; CBP’s Fact Book of the Financial System, 1987 to 1990; PNB
published financial reports, 1991 to 1995; published balance sheet statements of
commercial banks, 1996-97.
123
Table 4 shows the five largest and five smallest domestic commercial banks in
terms of assets. The wide gap between the two groups is painfully obvious. Thus, the
Philippine financial system continued to consist of many small weak banks, a few big
strong banks, and a still fairly underdeveloped capital market, following more than 15
years of financial reforms. The ultimate effect of the monetary authorities’ policy of
restricted entry, especially of foreign banks, had been to shelter both the big and the small
banks from competition, allowing the former to earn abnormal profits, and the latter to
operate at high cost (Tan 1989). On the other hand, the entry of more local and foreign
banks did result in less concentration. Whether it would lead to further improvements in
financial intermediation still remains to be seen. Similar to the financial sector reforms of
the early 1980s, the deregulation of foreign bank entry in 1995 was followed by a
currency crisis in mid-1996, although the latter was primarily due to external factors.
Table 4. The five largest and five smallest commercial banks, 1990 and 1997a
(in million pesos)
Assets
1990
Deposits
1997
Assets Deposits
Loans
Largest
PNB
BPI
MetroBank
FarEast
PCIBank
67590
45174
43598
42204
33261
44731
34972
13746
30590
20436
24551
12430
13746
10869
8711
Smallest
AsianBank
Associated
Pilipinas
Producers
Boston
2184
2565
2814
3255
3295
1054
1984
1413
1185
2123
474
678
428
766
563
Largest
MetroBank
PNB
BPI
LBP
PCIBank
Smallest
Al-Amanah
AUBank
TA Bank
GBB
Dev Bank of Singapore
247087
242295
166163
156179
152300
569
1368
2954
3908
4369
Loans
165283 164893
163021 149991
120356 88726
112284 90778
94032 83900
486
85
578
1224
82
86
775
1851
3541
2108
Source: CBP’s Fact Book of the Financial System, 1990; published balance sheet
statements of commercial banks, 1997.
In terms of the impact of the entry of new foreign banks on the interest rate
spread, the result is less reassuring. Figure 2 graphs the average lending and deposit rates
124
of commercial banks from 1982-98. It shows that the interest rate differential between
average lending and savings deposit rates significantly widened in the years following the
liberalization of interest rates. This was due to a relatively constant savings deposit rate,
which has been attributed to some monopoly power of the commercial banks (Tan 1989).
It was only in the 1990s that the gap narrowed to around 7 percent. Overall, there has
been no perceptible narrowing of interest rate spreads, both following interest rate and
bank entry regulation.
Figure 2. Lending and deposit rates of commercial banks, 1982-98 (in percent)
30
25
Ave lending rate
Savings deposit rate
Time deposit rate (ave)
20
15
10
5
0
1981
1984
1987
1990
1993
1996
Source: Bangko Sentral ng Pilipinas.
B. Insurance sector
The insurance industry is mainly private sector owned and operated. But there are
also 3 public sector institutions – the GSIS, which also offers life insurance in addition to
providing social security for government employees and general insurance for
government; the Philippines Crop Insurance Corporation; and the Home Insurance and
Guarantee Corporation. Prior to deregulation, there were a total 127 private insurance
companies in the Philippines, of which 24 were life insurers and 97 non-life insurers
(Table 5). This number rose to 145 in 1997 following the deregulation of entry into the
insurance sector.
In classifying an insurance company as either a domestic or foreign company, the
Commission’s basis is its place of registration. Thus, domestic companies are those that
125
are formed, organized or existing under the laws of the Philippines, even if they are
foreign-owned. That is, the Code treats foreign registration, not foreign ownership, as the
deciding factor. For the purpose of this paper, however, the terms domestic and foreign
are used to refer to ownership. Thus, while only 10 of the 127 companies in 1994 are
classified as foreign (i.e., not registered in the Philippines), 6 others are fully foreign
owned but domestically incorporated.
Table 5. Market structure of the private insurance industry, 1990-97
1990a
1993
1994
1995
1996
1997
130
127
127
129
134
145
117
109
111
113
115
121
13
18
16
16
19
24
13
6
12
6
10
7
9
10
9
15
9
Direct-writing
4
123
123
125
130
141
Composite
2
2
1
1
2
2
Domestic
2
2
1
1
1
0
Foreign
Dom. incorporated
Branch
0
0
0
0
0
0
0
0
0
0
0
1
1
0
2
2
0
23
24
25
26
29
34
21
20
21
21
22
24
2
2
4
2
2
4
2
2
5
3
2
7
5
2
10
8
2
101
97
98
98
99
105
Domestic
91
84
86
88
89
94
Foreign
Dom. incorporated
Branch
10
10
13
4
9
11
4
7
10
4
6
10
4
6
11
5
6
4
4
4
4
4
4
3
1
3
1
3
1
3
1
3
1
3
1
Total
Domestic
Foreign
Dom incorporated
Branch
Life
Domestic
Foreign
Dom. incorporated
Branch
Nonlife
Professional Reinsurers
Domestic
Foreign branch
Note: For 1990, domestic insurance companies also included domestically incorporated
foreign companies.
Source: Insurance Commission.
126
Although domestic companies far outnumbered foreign companies in terms of
number, there was significant foreign ownership in the industry. Table 6 shows fairly
comparable asset shares of domestic and foreign insurance companies. The latter’s share
even exceeded the former share’s in the life insurance sector. The dominance of foreign
companies is more apparent when one looks at their market share based on premiums in
force (Figure 3). The difference in the average size of domestic versus foreign companies
is thus striking. Overall, the average asset size of the foreign firms was around four times
that of the domestic firms. When one distinguishes between life and nonlife, a different
picture emerges. The average size of foreign life insurance companies was around six
times that of domestic firms in 1993, while their average sizes were comparable for the
non-life sector. The growth of the life sector was also more rapid than the non-life sector.
Following the 1994 entry deregulation, the distribution of total assets between domestic
and foreign firms was basically unchanged. On average, however, the size of domestic
life insurance companies significantly increased. The average asset size of foreign life
insurance companies fell to just three times that of their domestic counterparts in 1997. In
contrast, the average size of foreign non-life insurance companies increased to around
twice that of their domestic counterparts.
127
Table 6. Asset structure of the private insurance industry, 1993-97 (in percent)
1993
1994
1995
1996
1997
75.807
83.933
100.269
120.234
140.204
Domestic
59
59
58
59
57
Foreign
41
41
42
41
43
28
14
27
14
27
14
27
15
28
15
67
67
67
69
66
Domestic
31
31
30
32
30
Foreign
Dom. incorporated
Branch
36
24
12
37
24
12
37
24
13
37
24
13
37
23
13
31
31
32
29
32
Domestic
26
27
27
25
26
Foreign
Dom. incorporated
Branch
5
3
2
4
3
1
5
3
1
4
3
1
6
5
1
Professional Reinsurers
2
2
2
2
2
Domestic
Foreign branch
2
0
2
0
2
0
2
0
2
0
Total assets (bil pesos)
Dom incorporated
Branch
Life
Nonlife
Figure 3. Premium income in insurance by ownership, 1993-97 (in million pesos)
20000
15000
Foreign
10000
Dom est ic
5000
0
1993
1994
1995
Source: Insurance Commission.
1996
1997
128
In terms of concentration in the industry, Table 7 shows the market share of the
ten largest life and non-life insurance companies in 1989, based on premiums in force.
Concentration in the industry was not deemed as unusual nor did it pose problems, even
though the single largest life company (foreign) accounted for 35 percent of the market
and the 10 largest for 93 percent market share. This kind of market share distribution was
quite common in other countries also. The increase in the average size of domestic
insurance companies, and the entry of new foreign insurance companies most like
resulted in reduced concentration in the life insurance industry. Concentration would
seem to be less of a problem in the non-life sector. In fact, the major issue related to size
distribution of non-life companies was that there were too many very small domestic
companies. These companies were inadequately capitalized and operationally weak. Most
of them were family owned and, while unable to strengthen their capital, were also quite
unwilling to merge. These small weak companies had resulted in inefficiencies and even
abuses in the non-life sector in the past. The increasing participation of foreign insurance
companies should result in a stronger and sounder financial condition in the non-life
sector.
Table 7. Share of ten largest life and nonlife insurers in premium income,
1989
Life
Firm ranking
Premiums
(P mil)
Share
(%)
Nonlife
Firm ranking
Premiums
(P mil)
Share
(%)
Philam
Insular
Sun
Filipinas
Unicoco
Manufacturers
Manila Bankers
Great Pacific
Lincoln Phil.
Fortune
1,452
820
596
260
148
141
137
126
124
48
35.0
19.8
14.4
6.3
3.6
3.4
3.3
3.1
3.0
1.2
American Home
Ins.Co. of NA
Malayan
FGU
Philam
Prudential
Pioneer
Comm. Union
Oriental
Perla Companie
325
261
243
203
151
115
91
72
70
65
10.2
8.2
7.7
6.4
4.8
3.6
2.9
2.3
2.2
2.0
Total
93.1
Total
50.3
Total no. of firms
23
Total no. of firms
101
Source: World Bank (1992).
129
II.
Insights for the retail trade liberalization issue
Overall, the general objective for easing entry restrictions on foreign investors in
the banking and insurance industries was achieved. That is, the policy led to less industry
concentration and, presumably, to increased competition and efficiency. With respect to
the speed of the deregulation, the banking sector was more conservatively managed. This
may be warranted by the fact that it accounts for a large proportion of the Philippine
financial system, and any instability that may be brought about by deregulation will have
wide repercussions in the economy. On the other hand, the deregulation of entry
restrictions in the insurance industry was quite drastic. Furthermore, the deregulation of
entry restrictions was complemented by reforms in the banking sector’s regulatory
framework. In contrast, there were no corresponding changes in the regulatory
framework of the insurance industry. The latter could lead either to continued restricted
operations, if the Commission maintains its highly conservative regulatory stance, and/or
increased instability if the Commission is unable to cope with market innovation.
In the case of retail trade liberalization, the main lesson to be gained from
financial sector liberalization is the importance of having a well-defined competition
policy. The reform of policies dealing with restrictive business practices resulting from
concentration, dominant market positions or anti-competitive cooperation agreements, is
just one aspect of encouraging or providing more scope for competition. A generally
supportive policy attitude towards strengthening market elements and intensifying market
competition is also a crucial factor. Indeed, market developments have in recent years
had a major impact on policy, and authorities have often reacted to market forces rather
than taking a lead. Thus, in addition to the market structure, liberalization policy should
also take into account the overall regulatory regime and regulatory capacity because these
affect competition and efficiency as well.
130
References:
Bautista, E.D., 1992. A Study of Philippine Monetary and Banking Policies, PIDS
Working Paper Series No. 9211, Philippine Institute for Development Studies,
Manila.
Doherty, J.F., 1980. A preliminary study of interlocking directorates among financial,
commercial, manufacturing and services enterprises in the Philippines,
Manila.
Emery, R.F., 1976. The Financial Institutions of Southeast Asia: A Country-byCountry Study, Praeger Publishers, New York.
Hutchcroft, P.D., 1991. The politics of finance in the Philippines, Paper prepared for the
conference
on Government, Financial Systems, and Economic Development:
A Comparative Study of Selected Asian and Latin American Countries, EastWest Center, Honolulu, 18-19 October.
________, 1993. Predatory oligarchy, patrimonial state: the politics of private domestic
commercial banking in the Philippines (in 2 volumes), unpublished dissertation,
Yale University, New Haven.
Lamberte, M.B., 1989. Assessment of the Problems of the Financial System: the
Philippine Case, PIDS Working Paper Series No. 89-18, Philippine Institute for
Development Studies, Manila.
131
________ and Llanto, G.M., 1993. A study of financial sector policies: the case of the
Philippines, Paper presented at the Conference on Financial Sector Development
in Asia, Asian Development Bank, Manila, 1-3 September.
Laya, J.C., 1982. A Crisis of Confidence and Other Papers, Central Bank of the
Philippines,
Manila.
Milo, M.M.R.S., 1998. Dissertation submitted to the Australian National University,
Canberra for examination.
Park, Y.C., 1991. 'Financial repression and liberalization', in Krause, L.B. and Kihwan,
K. (eds)., Liberalization in the Process of Economic Development,University of
California Press, Ltd., Los Angeles: 332-65.
Remolona, E.M. and Lamberte, M.B., 1986. 'Financial reforms and balance-ofpayment crisis: the
case of the Philippines', Philippine Review of Economics
and Business, 23(1&2): 101-41.
Tan, E.A., 1989. Bank Concentration and the Structure of Interest, UPSE Discussion
Paper No. 89-15, School of Economics, University of the Philippines, Diliman.
132
________, 1991. Interlocking Directorates, Commercial Banks, Other Financial
Institutions and Non-financial Corporations, UPSE Discussion Paper No. 91-10,
School of Economics, University of the Philippines, Diliman.
The World Bank, 1988. Philippines Financial Sector Study (In Three Volumes), The
World Bank, Washington, D.C.
________, 1992. Philippines Capital Market Study (in 2 volumes, Vol. 1: Main Report;
Vol. 2: Contractual Savings Sector), The World Bank, Washington, D.C.
133
Study III
Technology Transfer and
Franchising: The Philippine
Case
By: Myrna S. Austria
134
Technology Transfer and Franchising: The Case of the Philippines
Myrna S. Austria*
The on-going debate on the pending liberalization of the retail trade sector of
the Philippines open avenues for analyzing the possible benefits or threats that this may
bring to the economy.
But doing this would entail dissecting the whole gamut of
concerns of the retail trade sector. This paper focuses on just one aspect of retail trade,
franchising. In almost all cases, franchising involves the retail of products or services.
In most discussion on franchising, the common cited benefits from
franchising are profits for business owners and investors, job creation for the country and
improved quality of products and services for the people. What is often neglected in the
literature, however, is a discussion on the impacts that franchising may have on
technology transfer, especially by foreign franchises. This paper addresses precisely this
issue, whether franchisees get the technology transfer they need from their foreign
franchisors and what kind of technologies are being transferred.
The next section of the paper is a discussion on the overview of the
Philippine franchising industry, including the recent trends and innovations in
franchising. This is followed by the results of the interview and survey conducted to
assess whether there is technology transfer in franchising. Also discussed under this
section are the perceptions of franchisees on the possible effects the retail trade
liberalization may have on franchising. The last section is conclusion.
Overview of the Philippine Franchising Industry
Franchising in the Philippines started as early as 1910 through the product
distribution scheme of the Singer Sewing Machine. The growth of the industry, however,
*
Research Fellow, Philippine Institute for Development Studies. The research assistance provided by
Euben Paracuelles is gratefully acknowledged.
135
has been more pronounced in the 1980s and more so in the 1990s. The number of
franchises grew from an average of 20 in the 1970s to 50 in the 1980s (Lim, 1998). By
1998, there are about 320 franchises operating in the country (Table 1). These enterprises
employ a total of around 300,000 employees. The increase in the number of franchises
amidst the economic crisis during the last two years has shown that franchising is one
investment area that is “recession proof”. The study by Lim (1998) in fact shows that the
success rate in the Philippine franchising industry is 95 percent, i.e. only 5 percent of the
franchises had ceased operation.
Foreign franchises have increased their share from 42 percent in 1995
to 57 percent in 1998 (Table 1). The enhanced competition posed by the successful
foreign franchises in the country has fueled local companies to become competitive and
expand their operations for them to keep their market shares in tact. This is shown by the
growth of local franchises for the past two years (Table 1). A very good example of this
is the Jollibee vs. McDonald’s competition. McDonald’s has faced tough competition
with Jollibee in the hamburger chain segment of the fastfood industry.
Up until the mid-1990s, most franchises in the country are in the food business
(Figure 1). The trend has been reversed, however, during the past 2-3 years. In 1998,
about 57 percent of the total franchise are in the non-food business like car rental,
printing, copying service, dry-cleaning and laundry, delivery courier service, educational
services, etc. The rise in the non-food franchise can be attributed to the increase in
income levels and increased preference for communication, educational and recreational
services during the past 2-3 years. Even among the foreign franchises, the non-food
business is growing much faster than the food sector (Figure 2).
136
Table 1. Number of franchises, local and foreign.
Year
Local
Number
Foreign
1970s
1980s
1995
1996
1997
1998
ND
ND
64
96
115
138
ND
ND
47
94
136
182
Total
% Distribution
Local
Foreign
Annual Growth Rate (%)
Local
Foreign
Total
15-20
45-50
111
190
251
320
57.6
50.5
45.8
43.1
50.0
19.8
20.0
42.4
49.5
54.2
56.9
200.0
44.7
33.8
71.2
32.1
27.5
Source: Philippine Franchise Association.
Figure 1. Percent distribution of franchises, food and non-food, 1994 & 1998.
1994
1998
30%
43%
Food
Nonfood
57%
70%
Figure 2. Number of foreign franchises, 1995-1998.
182
200
no. of franchises
180
160
N o n -F o o d
140
Food
136
54%
120
94
53%
100
80
52%
47
60
40
20
46%
30%
47%
48%
70%
0
1995
1996
Source: Philippine Franchise Association.
1997
1998
137
The favorable trend in the franchising industry even during difficult times is
shown not only by the increase in the number of franchises operating in the country but
also by the expansion in the number of outlets of the franchises (Table 2). This could be
attributed to the increased urbanization of the different regions and provinces of the
country. Several franchises have expanded and moved into the country’s key cities like
Cebu, Davao and Baguio, and to the emerging urban centers where industrial and
economic zones have been expanding like in Cavite, Batangas, Laguna and Zambales.
The more successful franchises that have expanded in the regions are McDonald’s, Pizza
Hut, Kodak and 7-11 among foreign franchises; and Jollibee, Greenwich Pizza and
Chowking among local franchises.
Table 2. Number of outlets of selected franchises.
Food
No. of Outlets
1997
1998*
Growth Rate
(%)
Burger Machine
Jollibee
Chowking
Shakey's
Mc Donalds
Greenwich Pizza
Pizza Hut
Goldilocks
Texas Chicken
466
209
114
108
108
70
61
50
22
500
212
120
109
172
128
74
64
28
7.3
1.4
5.3
0.9
59.3
82.9
21.3
28.0
27.3
450
294
120
107
116
59
27
26
503
300
253
144
120
79
44
28
11.8
2.0
110.8
34.6
3.4
33.9
63.0
7.7
Non-Food
Eastman Kodak
Mercury Drug
Agua Vida
Seven Eleven
Zenco Footsteps
Kameraworld
Electronic Realty Associates
Laundry Express
*As of March 1998
Source: Philippine Franchise Association.
138
Another indication of the favorable performance of the industry is the fact that 32
of the franchises belong to the top 1,000 corporations in the country (Table 3). These
franchises have a combined sales of P112.4 billion and P130.2 billion in 1996 and 1997,
respectively; and combined income of P6.2 billion and P1.3 billion, respectively, during
the same period. In real terms (1994 prices), this implies an 8.4 percent growth in sales
but a decline of 80 percent in income.
Franchising Arrangements
Franchising arrangements in the country take various forms.
Most of the
franchises in the country are “company-owned” where the master licensee owns and
manages the different outlets of a franchise in the country.
Other franchises also allow owner-operator franchises where a particular
outlet of a franchise is owned and managed by a franchisee. This applies particularly to
outlets that are located outside of Metro Manila.
139
Table 3. Sales and income performance of selected franchise companies, 1996 &
1997.
Company
Rank
1997
Gross Sales (in Pm.)
Income (in Pm.)
1996
1997
1996
1997
Change in
Change in
1996
Sales (%)
Income (%)
Caltex
5
6
38086
33820
-2360
740
12.6
-418.9
Coca-cola
12
11
25593
23948
2406
2947
6.9
-18.4
Mercury
19
18
18275
15830
284
246
15.4
15.4
Jollibee
62
59
7205
5772
442
602
24.8
-26.6
Pilipinas Makro
96
192
4667
2165
102
45
115.6
126.7
Avon
105
113
4216
3363
609
466
25.4
30.7
McDonald's
147
207
3102
2022
14
11
53.4
27.3
Phil. Seven Corp.
192
218
2467
1957
57
75
26.1
-24.0
Goodyear
209
140
2310
2695
-527
449
-14.3
-217.4
Monterey Farms Corp.
222
191
2190
2166
21
35
1.1
-40.0
Goldilocks
246
241
2026
1781
46
68
13.8
-32.4
Kodak
251
230
1978
1878
-47
148
5.3
-131.8
Tropical Hut
263
236
1873
1811
10
25
3.4
-60.0
Sara Lee
318
255
1533
1668
5
74
-8.1
-93.2
Pizza Hut
344
313
1415
1300
156
131
8.8
19.1
Zenco
368
346
1322
1172
-24
-53
12.8
-54.7
Chowking
422
460
1166
854
64
54
36.5
18.5
Levi's
425
368
1157
1074
113
161
7.7
-29.8
Greenwich
504
794
941
420
30
8
124.0
275.0
Wendy's
510
473
929
819
23
15
13.4
53.3
Cinderella
524
503
898
772
7
13
16.3
-46.2
Store Specialists
607
419
771
939
43
44
-17.9
-2.3
California Clothing
621
627
751
593
19
15
26.6
26.7
Rustan Mktg. Specialists
642
-
730
-
14
-
-
-
Golden Arches Dev't Corp.
662
756
710
448
-58
28
58.5
-307.1
Singer
725
598
631
627
8
49
0.6
-83.7
Gift Gate
744
669
613
547
6
9
12.1
-33.3
Dunkin Donuts
771
658
584
558
16
27
4.7
-40.7
FedEx
773
861
584
360
-182
-263
62.2
-30.8
Waltermart Damarinas
887
777
502
429
3
3
17.0
0.0
Roasters
903
912
490
211
2
2
132.2
0.0
Shakey's
981
828
448
390
19
15
14.9
26.7
Source: Businessworld, 1998. “Top 1000 Corporations,” Vol. 12.
Other franchises operate on a product distributorship arrangement where the
franchisors market their products through the franchisees.
Franchising fee also varies. Some franchises involve a one-time franchising fee
plus a royalty fee, usually a fixed percentage of the monthly gross sales. The one-time
140
franchising fee allows the franchisee to operate the business for as long as he wants.
Other forms of franchising fee take the form of a fixed amount of fee that allows the
franchise holder to operate for a particular number of years and is renewable, plus a
royalty fee. Product distributorship arrangements do not involve franchising fee nor
royalty fee; but the franchisee has the sole access to the products of the franchisor.
Trends and Innovations in the Franchising Industry
New trends and innovations have emerged in the Philippine franchising industry
as a result of the changes in lifestyle, tastes and preferences of Filipinos. For example,
franchise outlets have moved towards non-traditional locations like gasoline stations and
schools (Limjoco, 1998). Convenience stores are also increasingly becoming more and
more important to the growing middle class. This only shows the increase in profitable
market niches in the country.
Likewise, co-branding outlets where complementing franchises are housed under
one roof have become popular recently. A very good example of this is the Jollibee and
Greenwich Pizza co-branding stores.
The services sector has also shown strong potential for franchising. This could
include the areas in plumbing, electrical repair, carpentry and “lipat bahay” (Lim, 1998)
While there are no franchises in these areas yet, the potential for their development is
strong as Filipinos are becoming more and more concerned with guaranteed results and
reliable network.
International Franchising: The Next Generation Exports
Four of the country’s homegrown franchises have gone global in their operations
and they have done it successfully such that they have become a new source of foreign
141
exchange for the country.
These franchises include Jollibee, Bench, Josephines’
Restaurant and Goldilock’s. These enterprises have capitalized on the proliferation of
Filipinos working and residing abroad. But more importantly, the more open global
environment has paved the way for the “internationalization” of these local franchises.
This development shows that the Filipino can be at par with the global standards of
franchising.
Other local franchises that have the potential to go global include Cinderella, STI
or AMA, Max’s Restaurant, Penshoppe and Mr. Quickie (Lim, 1998).
Government Policies and Regulations
Franchising in the country is governed by the following three laws: (i) Intellectual
Property Code of the Philippines; (ii) Civil Code of the Philippines; and (iii) Retail Trade
Law in relation to foreign franchisors.
Intellectual Property Code of the Philippines. To encourage more investments in
franchising in the country, the Intellectual Property Code of the Philippines or RA 8293
(or IP Code) took effect in January 1, 1998. The IP Code repealed the three major
intellectual property laws namely: (i) Copyright Law or PD 49; (ii) Patent Law or RA
165; and (iii) Trademark Law or RA 166.
The IP Code defines technology transfer arrangements as “contracts or
agreements involving the transfer of systematic knowledge for the manufacture of a
product, the application of a process, or rendering of a service including management
contracts; and the transfer, assignment or licensing of all forms of intellectual property
rights including the licensing of computer software except computer software developed
for mass market” (p.2 of RA 8293).
142
Under the IP code, royalty arrangements are no longer regulated. Likewise,
franchisors are no longer mandated to register their franchises as long as their agreements
do not contain any of the prohibited clauses under Section 87 of the Code and contain all
the mandatory provisions under Section 88 of the Code (p.24 of RA 8293).
Civil Code of the Philippines.
All franchise agreements, whether between
foreign franchisors and Philippine franchisees, or between Philippine franchisors and
Philippine franchisees are subject to Philippine laws including, among others, the Civil
Code provisions on obligations and contracts. Under the general principle on contracts
under the Civil Code, the franchisor and franchisee may agree on such terms and
conditions as they may deem convenient provided, however, that these are not contrary to
law, morals and public order.
Retail Trade Law or RA 1180. Franchises, in almost all instances, involve the
sale at retail of products; and hence the retail trade law applies. Under this law, a
franchisee which is not 100 percent Filipino-owned cannot operate an outlet which is
engaged in retailing defined as “any act, occupation or calling of habitually selling direct
to the general public merchandise, commodities of goods for consumption.
There is a bill pending in Congress that proposes to liberalize the retail trade law,
allowing foreign ownership in retail.
Technology Transfer and Franchising
This section of the paper discusses the results of the interview and survey made
on the major franchise holders in the country. The survey and interview were carried out
to determine whether there is technology transfer in franchising.
143
Thirteen major foreign franchise holders were interviewed for the
study, including one franchisee who is a holder/owner of 13 different franchises. Eight of
the franchisees are in the food business and the rest are either in car rental, RTW/retail or
film/photo services. Most of them started operation in the mid-1980s and early to mid1990s. Most of them employ less than 1,000 persons although one of them has a work
force of around 4,700.
Except for one, which is an owner-operator franchise, all of the franchises are
company-owned franchises. Two of the company-owned franchisees, however, sell
franchises outside of Metro Manila. Furthermore, two of them are involved in a product
distribution arrangement and hence, they do not pay any franchising fee or royalty fee.
Another two franchisees do not pay any franchising fee but they pay a royalty fee of 6-10
percent of monthly gross sales. For those that pay a franchising fee, the fee ranges from a
low of US$150,000 to a high of US$1 million, plus a royalty fee of 5-7 percent of
monthly gross sales.
Technology Transfer
All the franchisees acquired from their franchisors the technology they need for
their business. In fact, except for one, all of them considered that franchising is enough
for them to be able to acquire the technology that they need. Franchising provides a
proven system with track record in running the whole business and this is already enough
to enable them run their business.
Furthermore, 75 percent of them considered that without franchising, they
would not be able to acquire the same technology from other sources. The remaining 25
percent, however, thinks that they can acquire the same technology from other sources
but they opted for franchising because the brand name that goes with franchising is a sure
guarantee for greater sales and profits.
144
Areas of technology transfer. Technology transfer in franchising is found in three
major areas namely, (i) operations, (ii) human resource development, and (iii)
management and administration (Table 4). For the food sector, the three most important
areas under operations where technology transfer occurs are in processing, physical layouting and quality control, in that order. For the non-food sector, physical lay-outing was
ranked the most important; followed by other areas like access to fashion design. For
both sectors, foreign franchisors usually have a standard physical lay-outing that they
require their franchisees to follow. Likewise, not only is the quality of product or service
provided monitored by the foreign franchisors, but also the quality of equipment or
utensils used.
In terms of human resource development, training for operations personnel
was considered the most important benefit that non-food franchisees get from their
foreign franchisors. On the other hand, training for managerial staff was ranked first for
the food sector. For both sectors, training for operations personnel are usually done
locally but are conducted by the foreign franchisors. This occurs usually prior to the
opening of the franchise and occasionally after opening. Training for managerial staff is
usually done abroad, where the franchisor is located, before the start of operation.
145
Table 4. Areas of technology transfer in franchising.
Type of Technology
FOOD (F)
Statistical
Points
Rank
NONFOOD (NF)
Statistical
Points
Rank
F & NF
Statistical
Points
Rank
I. Operations
Processing
Physical Layouting
Quality Control
Equipment
Inventory
Packaging
Others*
Waste Disposal
49
46
47
37
32
30
1
3
2
4
5
6
12
21
12
8
3
3.5
1
3.5
5
6
20
7
20
30
26
0
68
66
58
45
38
30
23
20
1
2
3
4
5
6
7
8
16
2
3
1
2
16
7
4
0
1
2
3
40
37
30
0
1
2
3
1
2.5
2.5
4
22
9
5
10
0
1
3
4
2
48
35
31
31
0
1
2
3
4
II. HRD
Operations
Managerial
Supervisory
Others
III. Management & Administration
Marketing
Pricing
Accounting System
Raw Materials Sourcing
Others
31
26
26
21
0
* composed of Executive information systems & Fashion design for nonfood industry.
Note: Ranking was made in their order of importance, with 1 as the most important, 2 as second, etc.
Source: Results of interview/survey.
In the area of management and administration, technology transfer in marketing
was considered the most important for both sectors. The “brand name” is an important
marketing strategy in itself, especially that Filipinos are brand conscious. Marketing
materials (e.g. posters) are usually provided free. In terms of pricing, while there are no
standard mark-up, franchisors usually teach their franchisees how to price their products
or services. For accounting system, forms are usually provided for which franchisees only
need to fill up. Raw material sourcing was ranked second for the non-food sector. This
is especially true for those engaged in product distribution arrangement in retail since
146
only by being a franchise holder can they have access to the products of the franchisor.
However, raw material sourcing was ranked the least in the food sector since franchisees
are usually allowed to source their raw materials locally provided the quality is good.
Brand management vs. technology transfer. The profitability of a franchise was
ranked the most important reason for acquiring a franchise (Table 5). The proven system
of running the business is enough assurance that a franchise is more likely to succeed
than a starting-up and stand-alone business. However, while franchising is an enough
source of technology transfer, it appears that in the franchising relationship, brand
management is more important than technology transfer. This can be attributed to the
fact that the Filipino culture of being brand conscious (especially foreign brand) makes
franchising more profitable than any other type of doing business. Only four of the
franchisees interviewed considered technology transfer as more important than brand
management.
Other support from foreign franchisors. Franchisees also get support from their
foreign franchisors in terms of advertising, research and development and monitoring
system. R& D usually take the form of research on how to use local materials as inputs.
Table 5. Reasons for acquiring a franchise.
Statistical
Points
Profitable business
Brand management
Technology transfer
Others
Note: Same as Table 4.
Source: Results of survey/interview.
43
35
31
0
Rank
1
2
3
147
Likely Effects of Retail Trade Liberalization on Franchising
Except for one, all the franchisees interviewed considered that the
liberalization of the retail trade will not pose any threat to their business. Allowing
foreign franchisors to operate their own outlets here or allowing foreign investors to be
franchise holders here will all the more increase the competition that already exists in the
industry. The franchisees interviewed for the study considered this as good for the
industry. But nonetheless, they think that their foreign franchisors will not go the extent
of establishing their own outlets here. They think that one must know the tastes,
preferences, eating habits, expenditure pattern, culture, management and marketing
styles, etc. of Filipinos to be able to run a franchise/outlet successfully. Hence, foreign
franchisors will be better off it they just leave the franchising of their business to the
Filipinos. Even in Hong Kong, which is relatively an open economy, foreign franchisors
find franchising to the locals profitable.
Furthermore, for high-end products and services, the market is so small
that competitors or foreign franchisors would not find it profitable to come in and
compete. For those under the product distribution arrangement, the current set-up of
using franchising as a marketing strategy is already efficient and changing the system
might prove it costly for foreign franchisors.
Conclusion
Retail trade liberalization will not pose a threat to the local franchising industry as
local franchisees know where their competence and comparative advantage lie in this
kind of business. The increased competition that comes with liberalization is good for
the growth of the industry. But more importantly, if the opening of the country’s retail
trade sector will pressure other countries to liberalize theirs, then liberalization will pave
the way for the faster internationalization of the country’s home-grown franchises and
this would mean more foreign exchange for the country. As shown by the local industry
148
that have gone global in their franchise, the Filipino can be at par with the international
standard of franchising.
149
References:
Coopers & Lybrand. Assessment of Prospects for U.S.-Based Franchises in the
Philippines (Phase I). USAID. December 1992.
Lim, Samie. Philippine Franchise Study 1998. Philippine Franchise Association, 1998.
Minihane, Mike. “Best Practices in Successful Franchising.” Paper presented during the
6th Philippine International Franchise Conference and Expo. November 1998.
Republic Act No. 8293. An Act prescribing the intellectual property code and
establishing the intellectual property office, providing for its powers and
functions.
Sibal-Limjoco, Bing. “Philippine Franchising Trends.” Paper presented during the 6th
Philippine International Franchise Conference and Expo. November 1998.
Vevstad, Vegard. “Operation a Franchise System.” Paper presented during the 6th
Philippine International Franchise Conference and Expo. November 1998.
150
Study IV
The Trade Sector in the
Philippines
By: Caesar B. Cororaton and Janet Cuenca
August 1999
151
The Trade Sector in the Philippines1
Caesar B. Cororaton and Janet Cuenca2
August 1999
I.
Objective of the Paper
The objective of this paper is to analyze the link of the trade sector with the rest of
the economy. Also, it seeks to examine the impact on other major sectors of the economy
of increased activity as a result of higher foreign investment in the trade sector. The
paper uses input-output (IO) table analysis in determining the sector’s link with the rest
of the economy. In particular, forward and backward linkages were computed. Output,
income and employment multipliers were examined. Finally, simulation exercises
wherein different scenarios of foreign investment in the trade sector were conducted.
II.
Definition of the Trade Sector
The trade sector discussed in the paper is composed of wholesale and retail trade
sectors. While finer breakdown into wholesale and retail is desirable for analysis because
of differences in characteristics, it may not be possible because of data unavailability.
The Philippine Statistical Industrial Classification (PSIC) defines wholesale trade
and retail trade as follows:
(1) Wholesale Trade. Wholesale trade is the resale or sale without transformation
of new and used goods to retailers, to industrial, commercial institution or professional
users, to other wholesalers; and to government, wholesale merchant, industrial
distributors, exporters and importers. It includes sales offices separately maintained by
1
Part of the retail trade sector study. It is funded by Philexport.
2
Research Fellow and Research Analyst, Philippine Institute for Development Studies.
152
manufacturing enterprises and their agents, commodity exchanges, petroleum bulk
station, assemblers, buyers, and cooperative marketing associations for the selling of farm
products at wholesale price. Wholesalers who physically assemble, sort and grade goods
in large lots, break bulk, repack and bottle, (except in air tight containers) and redistribute
in smaller lots, store, refrigerate, deliver and install goods, and engage in sales promotion
for customers. Scrap metal waste and junk dealers and yards are included.
(2) Retail Trade. Retail trade is the resale or sale without transformation of new
and used goods for personal or household consumption. This includes regular retail stores
such as gasoline filling stations and retail motor vehicle dealers and consumer
cooperatives. Establishments engaged in selling to the general public, from displayed
merchandise products such as typewriters, stationery, lumber or petrol, are classified in
this group although these sales may not be for personal or household consumption or use.
However, establishments which sell such merchandise to institutional or industrial users
only are classified in wholesale trade. Also, classified in retail trade are establishments
primarily engaged in renting goods to the general public for personal or household use,
except amusement and recreational goods such as boats and canoes, motorcycles and
bicycles and saddle horses.
Contribution of the Sector
III.1
Sector's Contribution to GDP
The trade sector is one of the major sub-sectors in the overall service sector.
Table 1 shows that the share of the total service sector to the total gross domestic
product (GDP) is almost 42 percent. Although this share is an improvement relative to
the 38 percent share during the period 1980-1985, it is almost constant during the last
ten years. On the other hand, the trade sector is contributing almost 15 percent to GDP
over the past ten years. This share is an improvement though relative to the period 19801985 of 13.6 percent.
153
The trade sector is a major sub-sector in the overall service sector. Its share for
the last 15 years is about 35 percent.
III.2
Sector's Contribution to Employment
Table 2 shows the contribution of the service sector and the trade sector to the
total employment in the economy. The overall service sector has increasingly been a
major employer of Philippine labor. From 19 percent in 1993, its contribution to the total
employment increased to 21.4 percent in 1997. Similarly, the trade sector has
increasingly been contributing to employment. Its share increased from 14 percent in
1993 to 15.1 percent in 1997.
Indeed, within the service sector, the major employer is the trade sector with a
share of 71 percent in 1997. This, however, is a slight decline from 73.1 percent in 1993.
III.3
Trade Sector as Destination of FDI
There was a surge in capital inflow into the country before the 1997 regional
financial crisis. Foreign direct investment (FDI) alone reached high levels from about
US$3 billion in 1990 to about US$7.5 billion in 1996 (Figure 1).
Based on the trend, the service sector in general and the trade sector in particular
have not been as attractive as the other sectors as destination of FDI into the economy.
Figure 2 shows the historical share of the service sector and the trade sector to the total
FDI. In 1974, the share of the service sector was about 55 percent. The share dropped
significantly since then until it stabilized at about 22 percent in the second half of the
1980s and in the first half of the 1990s. However, the share increased slightly to about
28 percent in 1996.
154
On the other hand, historical share of the trade sector has not been very
encouraging either. In 1974, its share to the total FDI inflows was about 5 percent.
Although the share improved to about 17 percent in 1980, it dropped consistently since
then to less than 10 percent of the total FDI in 1996.
III.4
Trade Sector's Link With Rest of Economy
Table 3 shows an indicator of the linkage of the trade sector with the rest of the
economy. The linkage is in terms of both forward and backward linkage based on the
different input-output (I-O) tables. The higher the level of the index (forward or
backward), the higher is the link of the sector with the rest of the economy.
Based on the results, the trade sector has stronger forward linkage than backward
linkage. For example, in 1988, it is the 4th in the ranking of forward linkages among the
different sectors of the economy. The sector that is at the top is the manufacturing. On the
other hand, in terms of backward linkage, it has one of the lowest, in particular the 10th
among 11 sectors. Manufacturing sector again has the highest forward linkage. The same
general ranking is seen in 1990.
IV.
Multipliers
There are three multipliers discussed in this section: output, income, and
employment multipliers. Furthermore, there are two types of multipliers calculated in
the paper, simple and total multipliers. The former considers the household sector as
exogenous, while the latter as endogenous1. This section discusses the results of the
simple multipliers only. Appendix A presents the results of the total multipliers.
1
The simple output multiplier is derived from an open input-output (IO) table where the household sector is
exogenous. This means that the household sector is one of the columns under the final demand column. In
a closed IO, the household sector is moved from the final demand column into the technologically
155
IV.1
Output Multiplier
An output multiplier for sector j is defined as the total value of production in all
sectors of the economy that is necessary in order to satisfy a peso's worth of final demand
for sector j's output. For the case of a simple output multiplier for sector j, the multiplier
can be written as,
(1)
Oj = Σni=1 αij
where αij refers to the elements of the Leontief inverse, and i, j refer to sectors.
How is this multiplier analysis applied? If the government would like to investigate what
sector of the economy would generate the greatest output effect for every additional peso
of investment, then the sector with the highest output multiplier would indicate the
greatest impact in terms of total peso value of output generated throughout the economy.
Thus, the output multipliers can aid in ranking sectors in terms of their impact on total
output. We adopted the output multiplier analysis to 1995, 1988, and 1990 IO tables. The
results are shown in Table 4.
In 1985 the manufacturing sector is the 8th in the ranking while in 1988 and 1990,
it is at the top among the major sectors of the economy. The reason for this is that IO
analysis is sensitive to business cycle. Because of the deep recession in mid 1980s, it
generated a very low multiplier for the manufacturing sector. Thus, the case of the 1985
can be considered as an outlier with respect to the manufacturing multiplier. In both 1988
and 1990 it consistently has the highest multiplier value.
What is interesting is that the trade sector shows up as one of the sectors with the
lowest output multiplier; both during recession and “normal” years. These results are
generally consistent with its weak link (forward and backward) with the rest of the
economy as shown above.
interrelated table. This is known as endogenizing the household sector. The multiplier derived from this IO
is called total output multiplier.
156
IV.2
Income Multiplier
Income multiplier translates the impact of final demand changes into income
received by households (labor supply). The resulting change in income is the outcome of
direct and indirect effects of the final demand change. Income multiplier can be
interpreted as the new household income that will be generated by an additional peso
worth of final demand in a sector. In general, the simple household income multiplier, Hj,
for sector j is given by
(2)
Hj = ∑ an+1,i αij
where an+1,i are the elements of the (n+1)th row, which is the household row, and
αij are the elements of the Leontief inverse(I-A)-1. This was used to calculate the simple
household income multiplier for the 1990 I-O model.
Also, total household income multiplier1, H′j, was estimated using the equation
(3)
H′j = ∑ an+1,i α′ij for i = 1,n + 1 sector
where an+1,i are the elements of the (n+1)th household row and α′ij are the
elements of the Leontief inverse(I-A′)-1.
We applied the income multiplier analysis to the 1985, 1988 and 1990 IO tables.
The results are shown in Table 5.
The results are quite different from the results of output multiplier. The sector
with the highest income multiplier is the government sector in all three years.
Interestingly, its income multiplier value is way above the value of the other sectors.
Meanwhile, the manufacturing sector which is at the top during 1988 and 1990 in terms
of output multiplier has relatively low income multiplier, even lower than the income
1
The household is endogenized in a closed IO model, see footnote 2.
157
multiplier of the trade sector. In 1990, the trade sector ranks the 5th, but in terms of value
its not very far from the income multiplier of the manufacturing sector.
IV.3
Employment Multiplier
Employment multipliers can be used to analyze the job creation potential of
different sectors arising from additional final demand. It can also be used to depict the
relationships between the value of output of a sector and employment in that sector (in
physical, not monetary, terms). In general, for an n-sector IO model, the physical labor
input coefficient is
(4)
Wn+1,i = ei/Xi
where ei is the number of employees in sector i, Xi is the value of output of the sector,
and Wn+1,i is one component of WR, i.e., the row vector [Wn+1,1,…,Wn+1,n], which
represents the peso value of labor inputs to each of the n sectors per peso’s worth of
sectoral output. Moreover, the simple employment multiplier is given by
(5)
Ej = ∑ Wn+1,i αij for i = 1…n sector
We also applied the employment multiplier analysis to the 1985, 1988 and 1990
IO tables. The results are shown in Table 6.
The agricultural sector has the highest employment multiplier in all the three
years. In general, the service sector, including the trade sector, has relatively high
employment multiplier. These results are expected since these sectors are labor
intensive.
158
V.
Impact Analysis
Data from the Security and Exchange Commission (SEC) indicates that 21
percent of total investment in the trade sector is foreign investment, while 79 percent is
domestic investment. What would be the impact if, as a result of trade sector reforms, e.g.
retail trade liberalization, foreign investment into the sector improves? This section
presents a number of simulation results based IO multipliers concerning different shares
of foreign investment into the trade sector. In particular, the sector’s gross fixed capital
formation (GFCF) was adjusted to capture the following scenarios or cases: (1) the base
case, in which 79 percent share of the sector’s investment is domestic and 21 percent
foreign; (2) Case A, 70 percent domestic and 30 percent foreign; (3) Case B, 60 percent
domestic and 40 percent foreign; (4) Case C, 50 percent domestic and 50 percent foreign,
(5) Case D, 40 percent domestic and 60 percent (6) Case E, 30 percent domestic and 70
percent foreign. However, it must be noted that in all cases the level of the sector’s
domestic investment is held constant. Thus, changes in the sector’s foreign investment
result in changes in the total investment in the sector. The multiplier impact analysis was
applied to the 1990 IO table. A more detailed discussion of the method and the
calculations is shown in Appendix B.
Table 7 shows the simulation results. The upper panel of the table presents the
levels, while the second panel shows the percentage differences from the base scenario.
Note that in all scenarios, the level of domestic investment in the trade sector is held
fixed. Thus the increase in the share of foreign investment to the total automatically
translates into higher total investment in the sector.
Scenario with the biggest impact on the sector’s investment is Case E wherein
foreign investment is allowed to increase and to capture an investment share of 70
percent. On the other hand, Case B has the lowest impact. This is expected since it is the
case wherein the deviation from the base is the least.
159
The impact on the rest of the sectors varies. The sector that benefits greatly from
the increased participation of foreign investment in the trade sector is the financial sector.
This is followed by utilities sector, and then transportation, communication and storage.
Agriculture and manufacturing sectors have small effects.
VI.
Summary
The paper shows a number of IO-based analyses that attempt to examine the
impact of increased activity in the trade sector. The trade sector includes both wholesale
and retail sectors. While further decomposition into these sub-sectors is desirable because
they have differences in characters and behavior, it may not be possible because of data
unavailability.
Based on the results, it was observed that the sector’s link with the rest of the
economy is not very high. Compared to the sectors like manufacturing and agriculture, its
forward and backward linkages are relatively smaller. It follows therefore that its
multipliers are also relatively smaller.
Furthermore, based on the IO-based simulation exercises, it was observed that if
indeed trade reforms like the retail trade liberalization brings about increased foreign
participation, its impact on both agriculture and manufacturing is relatively small. It will
have bigger impact though on sectors like finance, utilities and transportation.
160
APPENDIX A
Two further categories of multipliers were calculated: simple multiplier and total
multiplier. The first one is the multiplier that uses direct and indirect effects. In this case,
household is treated as exogenous. On the other hand, total multiplier uses direct,
indirect, and induced effects wherein household is assumed to be endogenous. This
appendix presents the results of the total multiplier calculations. The simple multipliers
are presented in the main text. Total output multipliers are shown in Table 1A. Table 2A
presents the total income multipliers, while Table 3A total employment multipliers.
161
APPENDIX B
The general form for impact analysis using IO multiplier is:
(1A)
X = (I-A)-1Y
where X is the column vector of total output, Y is the column vector of final
demand, I is the identity matrix, A is the matrix of “average propensities to spend” (aps),
and (I-A)-1 is the Leontief inverse matrix. It should be noted that Y vector incorporates
the assumed or projected behavior of one or more final-demand elements. Also, the
accuracy of the result, X, depends on the “correctness” of both Leontief inverse matrix
and Y-vector. For a Leontief inverse matrix to be correct, matrix A should be accurately
computed.
Considering that the column entries of the I-O model represent sectoral
expenditures on intermediate input or material input and factor input payments (sectoral
value added), A is just a matrix with elements aij where aij are the “average propensities
to spend”, i.e. the ratios between particular expenditures, xij and the total expenditure, xj
belonging to the same account.
(2A)
A = xij /xj for i, j = 1,n sector
In the paper, (1A) was calculated for each of the six cases which resulted in
different X, which is “11 x 1”. All cases have common “11 x 11” matrix A but the
difference lies on the level of investments in Y, which is also “11 x 1”. Matrix A was
obtained using Equation (2A). Take for instance getting the “aps” for the first sector
with respect to trade. The entry for agriculture is 8,855,025 with respect to trade and the
total expenditure for agriculture is 397,260,699. Thus,
aps = 8,855,025/397,260,699 = 0.022290
162
Same formula was used to get other elements of A. Consequently, the Leontief
inverse was obtained by getting the inverse of the difference between the identity matrix
I, which is “11 x 11” and matrix A.
Part III
Appendix Tables
Table 1A
Comparison of Total Output Multipliers for the Philippines
1985, 1988 & 1990
Sector
Number
1
2
3
4
5
6
7
8
9
10
11
Description
Agriculture_Fishery_and_Forestry
Mining_and_Quarrying
Manufacturing
Construction
Electricity_Gas_and_Water
Transport_Communication_and_Storage
Trade
Finance
Real_Estate
Private_Services
Government_Services
1985
Multiplier Rank
2.061
1.967
1.772
2.426
2.007
2.284
1.937
2.182
1.558
2.205
2.851
6
8
10
2
7
3
9
5
11
4
1
1988
Multiplier Rank
2.494
2.706
2.992
2.892
2.377
2.481
2.226
2.226
1.527
2.704
3.600
6
4
2
3
8
7
9
9
11
5
1
1990
Multiplier Rank
2.287
1.933
2.154
2.229
1.921
2.084
1.939
1.861
1.348
2.177
3.323
2
8
5
3
9
6
7
10
11
4
1
Table 2A
Comparison of Total Income Multipliers for the Philippines
1985, 1988 & 1990
Sector
Number
1
2
3
4
5
6
7
8
9
10
11
Description
Agriculture_Fishery_and_Forestry
Mining_and_Quarrying
Manufacturing
Construction
Electricity_Gas_and_Water
Transport_Communication_and_Storage
Trade
Finance
Real_Estate
Private_Services
Government_Services
1985
1988
1990
Multiplier Rank Multiplier Rank Multiplier Rank
0.493
0.351
0.235
0.480
0.260
0.426
0.394
0.513
0.189
0.455
0.936
3
8
10
4
9
6
7
2
11
5
1
0.532
0.446
0.417
0.485
0.330
0.468
0.429
0.403
0.126
0.487
1.072
2
6
8
4
10
5
7
9
11
3
1
0.361
0.189
0.180
0.241
0.152
0.187
0.233
0.181
0.048
0.235
0.792
2
6
9
3
10
7
5
8
11
4
1
Table 3A
Comparison of Total Employment Multipliers for the Philippines
1985 & 1988
Sector
Number
1
2
3
4
5
6
7
8
9
Description
Agriculture_Fishery_and_Forestry
Mining_and_Quarrying
Manufacturing
Construction
Electricity_Gas_and_Water
Transport_Communication_and_Storage
Trade
Finance, Insurance, Real Estate
Private, Government Services
1985
1988
Multiplier Rank Multiplier Rank
0.072
0.020
0.016
0.030
0.015
0.031
0.033
0.016
0.052
1
6
7
5
9
4
3
7
2
0.065
0.029
0.036
0.036
0.022
0.038
0.036
0.015
0.050
1
7
4
4
8
3
4
9
2
Figure 2
Trade Sector as Destination of Foreign Direct Investments (FDI)
(In Percent)
Figure 1
Foreign Investments
(In dollars)