Compliance involves cost, and hence, it has always been regarded as a Cost Centre. However, I have always had a different opinion. As a prolific writer, I have had a desire to address this issue for more than a decade now. I am happy to be able to do it finally. I hope the following paragraphs on the captioned subject will be self-explanatory.
What Is Compliance Cost?
Compliance cost includes all the expenses an organisation or entity incurs in order to comply with all the regulations applicable to the industry it belongs to. In a broader sense it would also include salaries of employees assigned the task of compliance, the cost of time spent on complying and the money spent in preparing various reports, new software systems introduced to make the compliance work faster and so on.
The common areas of compliance for companies in all industries include company law compliances and regulatory filings, CSR (where applicable), environmental compliances, human resources and labour law compliances, mandatory health and safety compliances, various types of audits, adhering to various applicable standards (e.g. auditing standards, accounting standards, secretarial standards, etc), various types of taxes and so on.
Compliance cost rises as regulatory requirements in an industry increases. These regulations may be local, national as well as international in nature. Some apply to all industries, some are based on market capitalisation of the company while others are sector specific. Certain others are applicable based on the financial results of a company. So as the organisation increases its reach to various geographical jurisdictions globally, its compliance cost also increases.
Compliance Cost vs. Regulatory Risk Cost vs. Conduct Cost
Compliance cost is not the same thing as regulatory risk or conduct cost. Regulatory Risk Cost is the cost associated with the risk that companies face due to potential change in the existing regulations in future. Conduct costs are the costs a company incurs for breaking the extant regulations.
Rising compliance cost
Compliance costs for companies globally have been rising as regulatory requirements are becoming more stringent. With the advent of the concept of corporate governance, the ‘stakeholders’ view replaced the traditional ‘shareholder’ view that was much narrower in approach, and entailed much lesser compliance cost. There are other factors also that have resulted in increase in compliance cost of companies. Some such factors are globalisation of business, modernisation, increased awareness about environmental pollution and climate change, increased acceptance of social responsibility, requirement of fraud detection and reporting, data privacy measures and so on. New regulations, like those against money laundering, deceptive advertisements and marketing, anti-competitive business, violation of consumer protection laws, prevention of sexual harassment etc., are being continuously introduced, thus adding to the compliance cost. Further, as a company grows, although it benefits from ‘economies of scale’ even with regard to compliance costs, certain costs like those associated with access to the capital market and the resultant compliance cost increases.
Cost of Non-Compliance
Although cost for compliance has been on the rise globally, a number of studies have revealed that it is even more costly not to comply with regulations. In others words, the cost of non-compliance is always higher than the cost of compliance. A study shows that the former is 2.7 times the latter. To put it simply, a company that avoids or fails to pay the compliance cost in time ends up paying a minimum of 2.7 times the amount of default as non-compliance cost. Thus, in a country like India, failing to meet regulatory compliance requirements in prescribed time and manner costs companies some thousands crore rupees.
The staggering amount is because of the fact that costs of non-compliance actually go far beyond simple fines. As they say, the fine a company pays for non-compliance, is only the tip of an iceberg. The actual financial burden of non-compliance would also include other hidden costs. Based on the severity of the non-compliance, one or more of the following costs may also be incurred:
- Cost of time and paperwork in replying to show cause notices
- Cost of disruption in business
- Cost of loss in reputation of the company
- Cost of loss of stakeholder’s trust
- Cost of loss of productivity
- Cost incurred in inspection and investigation
- Cost of products that have been seized from market due to con-compliance
- Cost of injunctions
- Cost of resultant litigation
- Cost of compensation
- Cost of compounding of offences
The above costs form part of cost of non-compliance and are over and above cost of fines, penalties and other fees. Further, repeated non-compliance may result in long term loss of reputation that may even harm the branding of a company, resulting in permanent threat to business. Certain things like customer trust, goodwill, brand image etc. once lost are difficult to win back.
Avoiding Cost of Non-Compliance
The cost of maintaining compliance is thus much lesser, and impliedly easier to manage, than the cost of dealing with non-compliances. By creating a robust compliance structure and having a good compliance team an organizations can not only avoid fines and penalty but also ensure that there is no reputation damage, slowdown in production and avoidable litigation in future. As they say, “Prevention is better than cure”, the best approach for all organisations to avoid high costs of non-compliance is to have a robust compliance planning and compliance officials.
Ineffective Compliance is as bad as Non-Compliance
If compliance is not done in time, and in the manner required, it is as bad as non-compliance. Hence, in this article, whenever we talk of compliance cost, we mean efficient and timely compliance cost only.
Compliance Cost as a Profit Centre
Compliance has always been treated as a Cost Centre. Ensuring high levels of compliance indeed involves some costs. It must be treated as a Profit Centre as, although not directly, but indirectly it does add to a company's bottom line profitability. A proper compliance management system in an organisation ensure the benefits of better efficiency, that leads to higher productivity, lowers chances of process and system failures, lower deviations from standards that reduces rejections, and the consequent cost of rework, enhances reputation leading to better market share and resultant increased revenue.
Need for more compliance professionals
With increased dedication to avoiding non-compliance, an organisation would ideally require more compliance personnel, in the senior, middle and junior levels. Initially this would seem to increase the cost of compliance, but in the long run, this actually reduces the cost of non-compliance, which is multiple times the cost of compliance incurred. Larger organizations have double the benefit resulting out of economies of scale.