Grappling with the revised BBBEE codes of good practice

On 5 October 2012 the Minister of Trade and Industry issued revised Broad-Based Black Economic Empowerment Codes of Good Practice for public comment. Much has been written on the impact of these codes for charities and the DTI has already responded on this specific issue. But these revisions could have much wider economic effects and these too need to be understood before these changes are implemented. DNA Economics has identified some potential challenges with the revised codes and has written to the Minister in this regard. Matthew Stern

December 6, 2012

Our main concerns are three-fold:

1. The complexity of the revised Codes and the likely costs of compliance for SMMEs are extreme.

2. There are likely to be severe and unintended consequences arising from the implementation of some aspects of the Codes.

3. The Codes as they have been Gazetted are incomplete and it is therefore impossible for citizens to consider or respond to them in full.

Each of these concerns is dealt with separately and briefly below.

The cost of compliance

With reference to the first point above, DNA Economics is currently rated as a Level 2 QSE. In the last financial year, we calculated that the administrative cost of BBBEE compliance amounted to 40% of our net profit after tax. For larger companies, the relative cost of compliance is clearly much smaller, but for SMMEs it accounts for a disproportionate share of overall profit.

The revised Codes greatly increase the level of complexity involved by requiring SMMEs to report against all 6 elements. Whereas the previous Codes afforded SMMEs the flexibility to select those 4 elements that imposed the lowest cost burden on them, this benefit has now been taken away. For SMMEs that are not used to reporting against all elements and do not have the knowledge and systems in place to immediately do so, this will likely impose a significant and additional burden.

We have already expended significant time and effort in trying to interpret the meaning and implications of the revised codes for our business; and we have come to the conclusion that we are unable to do so. The structure and scoring of the codes; the definitions, principles, and language used; and the way in which they have been presented in the Gazette, make it near impossible for business people (even those with substantial policy experience) to comprehend. This has resulted in the creation of an entirely new industry of BBBEE specialists, who profit only from the increased uncertainty and ignorance in the market that these codes and the impending revisions have caused, and therefore represent a new and deadweight loss to the economy.

Unintended consequences

The Codes have clearly been developed with certain types of businesses in mind, but it is impossible to comprehend how these changes might impact (positively or adversely) on all sectors of the economy. In practice, some of these revisions will require fundamental changes to the structure and operations of South African companies, and it is in the interest of all stakeholders to evaluate the full extent of these costs and benefits before new policies and Codes are implemented. From the available information, it does not seem that a comprehensive cost-benefit analysis has been undertaken, and the time given for comment on the proposed revisions hardly allows for a rigorous stakeholder engagement process.

In the absence of a comprehensive cost-benefit analysis and thorough stakeholder engagement process, there is significant risk that these revisions will contribute to multiple unintended and adverse consequences. The winners and losers from these revisions need to be identified.

Whereas the overall impact of the proposed revisions is unknown, from our company’s perspective, we have already identified one major and undesirable outcome. A large part of our revenue and profits are derived from the management of donor projects in other African countries. On these projects, we are required to employ nationals from these countries, and we compete against foreign (European and American) firms for this business. To date, all of this work is managed from our office in Pretoria and all of the tax and export benefits accrue to South Africa. But as this part of our business grows, and we employ more African (but not South African) staff, our BBBEE rating in South Africa deteriorates. Moreover, as our revenue and profit from this business grows, the more we are expected to spend on skills development, socio-economic development and BBBEE procurement in South Africa, and this makes it increasingly difficult to compete against foreign companies, who do not face the same obligations in these external markets. A further tightening of BBBEE rules and thresholds, as has been proposed, will likely compel us and other entities in similar circumstances, to create a new company, to be based in Mauritius, to manage all of our non-South African business. This was not in our plans and is certainly not in the interest of South Africa, but unless we are able to neatly separate between our domestic and international business in this way, we will be unable to survive in either market.

Looking beyond our own interests, we are equally concerned about the adverse impact these revisions will have on companies based in neighbouring states. With much greater emphasis on supplier development in the revised codes, South African firms will be increasingly reluctant to purchase goods and services from outside of the country, and this is clearly the intent of the Codes. But in doing so, companies based in other SACU and SADC member states could be severely penalised, leading only to a further polarisation of industry in the region. This possibility needs to be seriously explored.

The codes are incomplete

As a Qualifying Small Enterprise (QSE), the revised codes require us to comply with all elements under the QSE scorecard, referred to in the Gazette as Code 600, but this revised scorecard has not been provided. Without this information, it is impossible to know what flexibility or concessions, if any, will be granted to QSEs; or whether small businesses will now be expected to comply with the same scorecard as South Africa’s largest firms. The impact of these revisions, as Gazetted, for business and the economy as a whole, therefore cannot be determined. This is a major and substantive omission which in itself should cause the DTI to withdraw this notice.

Furthermore, since the codes have been Gazetted, the DTI has made further changes to them, altering the make-up of the socio-economic development component of the scorecard in response to public pressure.

By design, these Codes are immensely important for business, especially those involved in public sector work. The on-going tinkering with these Codes creates immense uncertainty for such businesses and makes it extremely difficult to understand the Government’s intention and to plan for the future. Again, this raises serious questions as to whether the proposed revisions are supported by any serious analysis of the problem which they serve to address; or of the different policy options available to address such problems.

Recommendations

Based on the above observations, we have appealed to the DTI to suspend any revision to the existing BBBEE Codes until a comprehensive analysis has been undertaken of the costs and benefits of the current system and of the proposed revisions. These revisions have the potential to alter the incentive structure across large parts of the South African economy and must be supported by the available evidence. This analysis should include an evaluation of the cost of compliance of the current system, especially for SMMEs, and how this might be impacted by these revisions. Alternatively, if such analysis has been completed, this too should be shared for public scrutiny and comment.

If the DTI is unwilling or unable to suspend these revisions, then we have asked that all foreign-based activities, employees and revenue of South African-based businesses be exempted from BBBEE scoring. Without such an exemption, many successful exporting companies (especially exporters of high-value services) are already unfairly prejudiced by the Codes, and an unanticipated effect of the Codes is to create a strong incentive to divest export-orientated business from South Africa. This could contribute towards a sizeable leakage from the South African fiscus and economy.

Moreover, we have suggested that the Codes continue to give SMMEs (QSEs) the flexibility to select between those 4 elements which are least costly to them. This will go some way towards reducing the cost of compliance for small businesses.

Finally, we have proposed that the DTI review the impact of the implementation of BBBEE in South Africa on companies based in SACU and SADC member states, and consider how such companies might be affected and accounted for in the revised Codes.