What startups can learn from the impact of Indonesia’s frequent regulation changes

Photo credit: Bagus Ghufron.

When 7-Eleven’s iconic storefronts first emerged in Indonesia in 2009, it was anticipated that the stores would appeal to the country’s growing young urban population with its unique restaurant-cum-convenience store hybrid model. Offering fuss-free, ready-to-eat meals, free wireless internet, seating, and air-conditioning, “Sevel”, as 7-Eleven is known to the locals, soon became a popular haunt for young Indonesians.

The convenience store’s parent company, PT Modern Internasional Tbk, is controlled by the Indonesian Honoris family, who first made a name for themselves as the sole distributor of Fujifilm Japan products in the country. The family acquired the license to operate the franchise at a time when the photo processing business was declining with the advent of digital technology. In 2013, 7-Eleven had accounted for over 60 percent of PT Modern Internasional’s US$127 million sales.

However, business is rarely straightforward in Indonesia and although the franchise is not foreign-owned, there is little local entrepreneurs like PT Modern Internasional Tbk can do in the face of the country’s frequent regulatory changes.

Local opposition, local competition

The introduction of an alcohol ban in April 2015 dealt a significant blow to 7-Eleven’s earnings. Caving in to the pressures of media and religious groups in Indonesia, the government banned the sale of alcohol by any mini-market and convenience store in the country under Trade Regulation No. 06/M-DAG/PER/1/2015 on the Control and Supervision of Procurement, Distribution, and Sale of Alcoholic Beverages. For a company that relies on sales of alcohol for 10 percent of its earnings, the ban was a great setback for the chain, especially as it had a multiplier impact on the sale of snacks frequently purchased together with alcohol.

Indonesia’s retail market has long featured key players like Indomaret and Alfamart, backed by the Salim and Djoko Susanto families, respectively. The alcohol ban only served to further edge 7-Eleven out of the sector while its competitors remained largely unscathed, as consumers more frequently associated them with household goods and necessities—market segments that were untouched by regulatory hurdles.

In June 2016, after two years of declining revenue and intense competition, PT Modern Internasional announced the closure of 7-Eleven outlets, which numbered 161 nationwide, at the end of 2016. The company’s initial plan to sell the franchise to a unit of PT Charoen Pokphand Indonesia Tbk (of the Thai Charoen Pokphand conglomerate) for US$74 million was also scrapped just six weeks after it was announced, as both parties had failed to reach an agreement.

The case of Uber

In a similar fashion, the growth of app-based ride-hailing services like Uber and Grab is hampered by regulatory restrictions. Pressure from incumbent players such as taxi giant PT Blue Bird Tbk has pushed the government to enact new regulations on the operations of app-based taxi services. The new regulations include setting minimum and maximum prices (a direct attack on Uber’s core business model of dynamic pricing), limiting the number of vehicles operating in a district, and requiring that all drivers possess a vocational license for public transportation, with all cars licensed to a commercial entity or cooperative.

Despite long protracted appeals by ride-hailing services against them, the new regulations were slated to come into force in July 2017. However, the government has since extended the “tolerance phase” for its implementation, giving companies another six months to comply with the new rules. This is not the first time the deadline for regulatory enforcement has been extended since the rules were released over a year ago.

Public sentiment and its effect on regulation

Both cases of 7-Eleven and Uber in Indonesia have demonstrated something that investors have long known about the country—regulatory uncertainty can cause dramatic swings in company performance and, when faced with such hurdles, there is little that the company can do to avoid its pitfalls.

However, what is perhaps more pertinent is the impact of public sentiment in swaying these governmental regulations. In the case of 7-Eleven, the alcohol ban was preceded by protests by hardliner Islamic parties and groups like Indonesia’s Islamic Defenders Front, who pressed the government to ban alcoholic beverages in a bid to push for Islamization of the secular state. These measures culminated in the ban that was deemed necessary to protect young people in the Muslim-majority country, as alcohol consumption had been rising.

The presence of ride-hailing services in Indonesia was met with large-scale protests by taxi drivers and unions like the Land Transportation Drivers Association (PPAD), who decried—in some cases violently so—on the streets the apps for unfair business competition practices.

Moving forward with foreign investment

Investments into a foreign country have to always be accompanied with an acute understanding of the local market and landscape. Foreign investors frequently have to contend with changing regulatory regimes in Indonesia, which can even impact long-standing contracts, as in the ongoing case with PT Freeport Indonesia. As a young democracy, these regulatory changes can be mired by vehement public opposition, which tie the hands of the ruling government.

Under the regime of President Joko Widodo, Indonesia is increasingly becoming open to foreign investment. A “Big Bang” in the country’s economic liberalization took place in early 2016, which included the easing of foreign ownership restrictions on sectors such as tourism, transportation, and retail. With the size of the domestic market—many sectors within remain underserved—the potential for foreign companies looking to invest is immense.