Tallying the Cost of Compliance

It was never going to be cheap, but adding up the cost of compliance with government rules and regulations is proving to be quite exasperating for businesses and researchers alike. There is no precise price tag. It varies from one company to another even in the same industry and depends on a variety of factors, including business location, markets and regions served, and level of internal expertise.

There's a cost to enterprises even when they decide to exit or pull products from a market or region to avoid falling afoul of environmental laws, as some companies chose to do when the European Union first introduced its Restriction of Hazardous Substances (RoHS) directive. Some suppliers that took steps to make their components compliant with RoHS found themselves squeezed nonetheless when an OEM customer opted to exit the market because some other partners couldn't make the cut. Plus, when an enterprise leaves money on the table for rivals to pick up, the costs add up in the form of lost sales and market share.

The Challenge to industry
And, just in case, anyone is in doubt about the likely impact of these rules and regulations on a business, the EU itself in a statement made it clear that it understands the RoHS directive can be a double-edged sword which would achieve some positive goals but also have the potential for leaving wounds and scars on enterprises. The European Commission highlighted the challenge to industry as follows:

The regulatory environment in which businesses operate influences their competitiveness, and their ability to grow and create jobs. Achievement of the RoHS Directive's objectives is hindered and made more costly by problems related to uncertainties in implementation, such as lack of harmonization in interpretation of definitions and diverging requirements for demonstration of product compliance; problems with enforcement, such as suboptimal market surveillance activities; and problems related to perceived inconsistency with other Community legislation or technical/scientific progress, such as potential overlaps with REACH [Registration, Evaluation, Authorization and Restriction of Chemicals Directive] or EuP [Energy-using Products Directive], and [the] need for extending the scope to cover medical devices and control and monitoring instruments.

Pile of money
In the electronics industry, the costs of complying with rules related to environmental pollution, disposal of electronic waste, counterfeiting, use and disposal of chemicals, energy consumption, economic sanctions on certain nations, rules governing or prohibiting the transfer of technology to certain countries, and minerals mined in war zones are adding up to a huge pile of money. Research organizations and industry bodies are scrambling to keep up with the spiraling costs even as many companies -- concerned about exposing their internal operations to rivals -- strive to keep quiet about their actual costs.

Pile-Up

The industry is paying a hefty price, no matter which
assumptions are used to estimate compliance costs.

Often, companies just simply don't know their actual compliance costs for various reasons. For one, some don't even keep tabs on these because they don't break out the costs from daily operational expenses, as Technology Forecasters Inc. (TFI) found out in a landmark survey carried out recently. The research firm noted that "the vast majority of companies hired zero or one employee for RoHS compliance, relying instead on internal resources."

If the time these employees spent on helping the firm achieve compliance was not properly assigned, then the cost becomes virtually hidden and unknown. Here are some additional findings from the TFI survey, which focused primarily on the cost of complying with RoHS:

• Total average cost was $2.64 million for initial compliance; $482,000 for annual maintenance.
• Total median cost was $721,000 for initial compliance; $118,000 for annual maintenance.
• Total weighted average cost was $5.94 million for initial compliance; $1.44 million for annual maintenance.
• Contract manufacturers (CMs) and electronics manufacturing services (EMS) had to spend the most effort on business process and system updates.
• Component manufacturers and OEMs had to spend the most effort on bill-of-materials (BOM) reviews and product redesign.
• Everyone had an equal burden in R&D.

A lot of other costs also cannot be accurately estimated. In the TFI survey, many of the respondents reported a hit on inventory and other costs, including retooling and redesign of manufacturing processes. Some of the expenses were charged only once, while others are recurring and continue today.

As is typical in the manufacturing sector, the impact on actual inventory and the uncertainty introduced into the supply chain can be even more difficult to ascertain. TFI said in its report that "inventory increased 21 percent on average over pre-RoHS inventory level; the average reported cost of carrying the extra inventory was $688,000; the average reported value of scrapped inventory was $698,000."

Compliance costs soar
Regulators themselves are aware that these rules do have an impact on sales but haven't been able to determine the actual hit on revenue or any other operational effects. The EU in its position paper admitted that "there is little experience of actual compliance costs for industry," but estimated this could be as high as one to 4 percent of sales. "More recent surveys give an average overall cost related to RoHS of 1.9 percent of turnover (past cost and one-off future costs)," it said. Here's more from the EU report:

In the case of medical devices and control and monitoring instruments, some of which are produced in low numbers or have critical applications and hence increased testing and reliability requirements, approximate yearly compliance cost is estimated to 400-1600 million€; it is even claimed that cost of RoHS compliance for some complex products could be as high as 7-10% of turnover (new product) or 1-10% (modification of existing product). A large part of this cost is attributable to the long development, testing and approval cycles of the more complex products.

Similarly high costs are projected for compliance with other regulations, including the Dodd-Frank Wall Street Reform and Consumer Protection Act, which, among other issues, addressed the contentious subject of conflict minerals mined in the Democratic Republic of Congo and other war-torn countries. A study published by Tulane University estimated it would cost the electronics industry approximately $7.93 billion to comply with the conflict minerals requirement of the Dodd-Frank legislation. The Tulane report drew on documents provided by the IPC, an industry association.

The Tulane University report noted that the US Securities and Exchange Commission (SEC) had initially estimated the cost of compliance with the conflict minerals rule would be about $71.2 million, a number the researchers said substantially underestimated the potential cost. The Tulane report clearly shows how all parties involved in determining the cost of compliance arrived at drastically different conclusions because of their equally varied assumptions related to the likely affected parties. Here are the three scenarios presented by the Tulane researchers, who also provided a breakdown of how they arrived at their much larger $7.93 billion estimate:

Our analysis shows that the published figure of $71.2 million by the SEC underestimates the implementation cost, in part because it does not take into account the range of actors affected by the statutory law. In light of Section 1502, substantial traceability reforms would need to be implemented throughout the supply chain — from the mine to final product manufacturing — in order for disclosure to work.

On the other hand, the National Association of Manufacturers' (NAM) estimate of $9-$16 billion overstates these costs by inflating the supplier number and not taking into account significant overlap in supplier/customer relationships, as well as cost efficiencies from existing (and developing) information exchange platforms.

We present a third model focusing on the burden to the affected issuers and their first-tier suppliers, estimating that the actual cost to and of implementing the law is $7.93 billion. Almost half of the total cost — $3.4 billion — would be met with in-house company personnel time, and the rest — $4.5 billion — would constitute outflows to third parties for consulting, IT systems and audits. Comparing the costs to the issuers vs. the suppliers, the bulk of the total costs — $5.1 billion or 65 percent — would be incurred by the suppliers (the group not included in SEC's analysis), while the smaller portion of the total — $2.8 billion or 35 percent — would be carried by the issuers.

What's clear is that the industry is paying a hefty price, no matter which assumptions are used in arriving at the estimated costs of compliance. Conversely, in addition to the expected benefits to the larger society, some segments of the industry are also seeing a number of advantages from these rules and regulations, as TFI found out in its survey.

The research company said 49 percent of its respondents "found at least one advantage" in the RoHS directive. These advantages include market share gain, improvement in supply chain processes, improved supply base, and benefits from product-line pruning. Compliance is never going to be cost-free or easy, but it's good to know there are also distinct benefits for some.

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