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the playing field
know what you’re up against
THE FUNDAMENTAL structure of the economy has been so radically altered over the past thirty years that everything has been turned upside down and inside out for the entrepreneur, the small business owner, and those entering the workforce. This change has occurred subtly but inexorably, aided and abetted by a national leadership that neither recognized nor understood the change. It has been lubricated by a financial system that has abandoned the direct borrower/lender relationship in favor of a complex geometric expansion of unsustainable credit through the use of derivatives, default swaps, collateralized mortgage obligations, and other exotic financial instruments that hurt the entrepreneur.
The root of this change was the drive to get big. Growth has been the mantra to be celebrated. It has become a conceptual obsession pursued by all participants in the economy and promoted by government agencies: the Federal Reserve, the Treasury, and GSEs (government-sponsored enterprises) like Freddie Mac and Fannie Mae. The natural controls of competition were cast aside in favor of central regulation as companies grew larger and larger until they became “too big to fail.”
American automobile companies—General Motors, Ford, and Chrysler—became known as the Big Three. The federal government turned a blind eye to the consolidation of Big Oil, where the largest eight companies became four. And the abandonment of the Glass-Steagall Act in 1999, which among other things separated commercial banks from investment banks, by an overlobbied and naïve Congress allowed major money center banks to expand their financial services into insurance, investment banking, underwriting, and the purchase and sale of derivatives. The otherwise sacrosanct commercial banking business shifted from a national resource to an enormous potential liability.
These fundamental changes have left a giant hole—aka companies that are “too big to fail”—to be filled by the taxes of the American people, and the end result has been a revision of economic life for everyone in the country. This has certainly torched the business landscape for any creative-minded entrepreneur.
If you are going to operate in today’s economy, you have to learn some of the rules of the road to success. You must first understand that the free-market economy is no longer so free. The intervention of regulation, the threat of concentration, and the constant and incessant encroachment of governmental agencies must be fully understood before you do anything in business. Your ability to comply with the blizzard of paperwork and reports required by various rules that come down from Washington, D.C., your state capital, or your local zoning board may mean the difference between success and failure.
Since you cannot change the system, you must ask yourself how you can survive all the forces against you: big government with all its regulation, big banks with all their money, and big corporations with all their political influence. How can you learn to compete in a monopolistic environment? For starters, you need to understand the economic environment from the top of the financial scale to the bottom. The only way an underdog in any sport ever wins is by studying its more powerful opponents. Only then can the underdog devise a game plan that will work. So, while describing today’s marketplace, I will lay out some solutions that have worked for me—and, I hope, provoke some thought as to what may help you.
bigger is not better
Size has become a major problem in every facet of American business, and every small businessman, from the guy who owns a neighborhood fruit stand to the technology whiz creating a new smart phone app, must deal with this. The notion of “big” is deeply ingrained in the American psyche, from the Big Gulp to the Super Bowl, and there does not seem to be any change on the horizon. As Samuel Bowles and Herbert Gintis, both emeritus professors of economics at the University of Massachusetts and now at the Santa Fe Institute, pointed out in their paper “Origins of Human Cooperation,” those conditions where self-regarding individuals might otherwise cooperate are not met in settings where large numbers interact. This concern with bigness in our society is pernicious. Why does everybody and everything have to be big?
As an example, a hypothetical item from tomorrow’s newspaper: A meeting of an international group of nations was convened. In order to create a level playing field, the nations agreed to write position papers that reflected their national identities in an economical way. First, they needed to select an absolutely neutral subject, something indisputably innocuous. After a long discussion, they finally agreed on a topic: the elephant! Then all went off to write their papers.
Six months later, they reconvened. The French were the first to present their work, which they titled “The Love Life of the Elephant.” The Italians were next and presented “The Gastro nomical Aspects of the Elephant.” The Russians discussed “The Psychology of the Elephant.” The Germans focused on “The Scientific Rami -fications of Being an Elephant.” The English detailed “The Tradi -tions of the Elephant.” Finally, it was the turn of the American representative. His paper was titled “Bigger and Better Elephants.”
As people focused on the desire to be bigger rather than better, those two concepts became equated at some point, and big is now believed to be better. Well, big is not better. Size is not efficient, and size in and of itself destroys free-market competition. History tells us as much. All we need to do is look back to the trust-busting days when President Teddy Roosevelt broke up the railroads and Standard Oil, using the legal powers of the Sherman Antitrust Act. Over the past twenty-five years, in contrast, the government has been promoting size by abandoning the antitrust laws and by allowing companies to make themselves bigger, while the Justice Department put the Sherman Act in a locked drawer.
Bigger certainly has not proved to be better in the automobile business. Not that long ago, there were several automobile manufacturers, including Nash, Kaiser, Hudson, Studebaker, and Packard. They had to compete with one another. Was it difficult? Yes, but it led to innovation. The market controlled their fates. Little by little, these companies either were absorbed or landed in the financial scrap yard of failed companies. Over time, we ended up with the Big Three—General Motors, Ford, and Chrysler. These three companies became so complacent with their products that foreign automakers overtook them and the biggest, General Motors, became a ward of the federal government after requiring some $50 billion in bailout money from the taxpayers because it was deemed too big to fail.
Size stifles innovation—and therefore stifles anybody who is an iconoclast. Size militates against the little entrepreneur running a business or carving out a niche because small companies like these cannot compete against size. Somebody who has a monopoly can crush you, not because of efficiency but because of size. Size implies more power: power to control the means of supply and production, power to control prices, and, most important, power to augment financing. And it is this financing power that ultimately influences the government, effectively bribing lawmakers because large companies have large sums of money to spend on lobbying.
In 2008, there were 15,150 registered lobbyists in Washington, D.C., who were paid $3.24 billion! That is practically its own economy and nearly the GDP of Fiji! As Dick Morris and Eileen McGann so clearly lay out in their book Catastrophe, the lobbyists and stealth lobbyists (please, call us “strategic advisers”) are practically running public policy. The stealth lobbyists are unregistered, and they are the most powerful. They include the likes of former Senate majority leaders Tom Daschle and Bob Dole, who are listed as part of the law firm Alston & Bird’s Legislative and Policy Group, yet are not “registered” lobbyists.
One of the primary arguments in favor of allowing the banking system to consolidate and create bigger banks was that it would be more efficient. The consumer would be able to have it all in one place, and one-stop shopping is assumed to be cheaper. But, as soon as that happened, the big banks began to raise their fees. They began to charge for your checks if you wrote more than ten a month and did not maintain a minimum balance. We—the little guys—were left with the short end of the stick.
The bottom line: You may not be hiring a lobbyist any time soon, but you need to be aware of how a lobbyist can influence lawmakers to change the rules against you in your particular game.
regulation instead of competition
The consolidation of major industries across the board has also resulted in making regulation a substitute for free-market competition, and this is suffocating people who have new ideas and want to bring them to fruition. If you are starting a business or transitioning from one trade to another, you must pay attention to how government regulations affect you. In some cases, these regulations can be helpful and can afford you advantages from unintended consequences.
More often than not, however, we have created a cycle that has become frightening to watch: An industry cries out that it cannot compete in a global economy unless it is allowed to get bigger. Slowly but surely, over time, the government allows that to happen and then becomes overwhelmed when it tries to control the monsters it has created.
We have come to the point in this country where regulation in and of itself is a burgeoning business. As my long-term real estate partner Lew Wolff often says, “The process has become the end product.” The regulatory system in the United States today hurts the small entrepreneur and works to the advantage of the big players, because the large corporations can spend money to lobby for their own self-interests.
Take, for example, the business corruption of the late 1990s: Dennis Kozlowski of Tyco, Jeffrey Skilling at Enron, and Bernard Ebbers at WorldCom, not to mention the illegal activity at Adelphia and Peregrine Systems. The massive fraud committed in these companies was addressed by Congress when it passed the Sarbanes-Oxley Act of 2002. This was a restrictive regulatory response to major acts of fraud. Whether Sarbanes-Oxley can contain corporate fraud is questionable and has been much debated.
In order to comply with the act, companies must follow dozens of rules implemented by the SEC that apply to all publicly held companies, large and small. As part of Sarbanes-Oxley, the chief financial officers and the CEOs of a publicly traded company must sign on the dotted line of the company’s financial statement, and under section 15(d) of the Securities Act of 1934, they are considered responsible for the accuracy of the filings. The cost of insurance to the company and to its auditor has skyrocketed. Complying with every minute regulation makes it almost impossible for smaller companies to exist. Where once small businesspeople were being encouraged, they are now being penalized, and it has come to the point where they must build these costs into their long-term business plans.
If a company is large, it can easily afford to comply with onerous regulations. I sit on the board of a NYSE company called Vishay Intertechnology, which represents a classic American-dream success story. The company was founded in 1962 by an immigrant engineer and Holocaust survivor named Felix Zandman, who held two patents for foil resistors. By 1985, it was the largest manufacturer of those electronic products in the world. Vishay now has more than twenty-two thousand employees and a market capitalization of roughly $1.5 billion. (Big, yes, but not in comparison with Exxon Mobil, with its market cap of more than $300 billion.) Vishay spends nearly $2 million a year complying with Sarbanes-Oxley. Does it change us? No. Are we doing anything differently? No. Are we any more efficient? No. We’re running the business the same way we always have. We’re just spending more time and more money to comply with regulations. Instead, these resources could be directed to creating new positions for recent college graduates or invested in new ideas.
Complying with the accounting provisions associated with the act can increase audit costs by 100 percent. That, in turn, increases cost to the consumer and penalizes small business. The real question should be: Does this stop fraud? Sarbanes-Oxley apparently had no meaning for Bernard Madoff, and I submit that no amount of regulation will deter crooks from cheating the system. If they are going to be thieves, they are going to steal because it is simply inherent in their character. All Congress has done by passing Sarbanes-Oxley is to punish the legitimate free market—and, in the process, to hamper creativity and reduce productivity.
Some big companies have argued that they must be allowed to grow larger because greater size will improve efficiency. This was the case when the oil companies went to Congress and said, “You need to let us combine.” The government responded by allowing Big Oil to grow out of control. Exxon merged with Mobil; Conoco merged with Phillips; Amoco and Arco were merged into BP; and Chevron merged with Texaco. There are now four dominant oil companies serving U.S. customers, and all are deemed too big to fail. Consequently, the government has become the only entity large enough to exert control over them, which has resulted in platoons of regulators whose salaries are paid with tax dollars. It is also squeezing out the small businessman who wants to run a local gas station, garage, or convenience store that opts to sell nonbranded product and does not want to be subject to the dictated prices of the big oil companies.
In a true free-market economy, competition is the regulator. In other words, if there are twelve companies in the oil and gas business, they are going to compete with one another. As the number of companies shrinks to four, what happens? There is less competition, and therefore the remaining companies must be regulated by the government. It becomes a centralized system that is controlled by regulation, not competition. The need to comply with massive regulation works against the small entrepreneur. Regulation works against individual innovation. Regulation works against individual creativity. And regulation restricts individual freedom.
close encounters with the joys of regulation
Many years ago, a group of partners and I built a condominium project on Huntington Harbour, an upscale beach community located just south of Long Beach, California. The Ford Foundation was my partner, and it had somehow ended up with a parcel of land with a water view.
We entered into a transaction to buy the land subject to our being able to develop a seventy-unit condominium project—and then we entered the regulatory funhouse.
To proceed, we needed the approval of twenty-seven different regulatory agencies. That’s right, twenty-seven! We had to deal with the local planning department, the pollution control agency, the State Tidelands Commission, the Coast Guard, the Department of Public Safety, the State Water Resources Board, the Environmental Protection Agency, the State Highway Patrol—and on and on it went. All of the federal regulatory agencies were duplicated at the county and local levels. We had to submit plans to each one of them, and each one had to be satisfied. The problem was that these bodies didn’t talk to one other, and many of their regulations were just different enough to create constant roadblocks. The process was a blizzard of paperwork, hearings, and filings—followed by long delays.
After months of frustration, we finally capitulated to the bureaucracy and retained an “expeditor.” That’s a euphemism for a lobbyist. We paid him a fee for his connections, and he got everyone’s attention. That is exactly the way things are done in Washington. The only difference was that our man wore sneakers instead of alligator shoes. Why, in our society, is the influence of money always required in order to get anything done? It’s an outrageous system. The public has been coopted. Once again, this system was not set up for the benefit of the small businessman; it benefits those who have enough power to influence the politicians, those who make up Big Business.
We spent five years sorting out the regulatory issues in the Hunt -ington Harbour project. And who benefited from all of this? The consumer? No. The ultimate purchasers of the condominiums? No. They were the people who suffered. There were carrying costs for the interest on the money spent to buy the land, the myriad engineering and related studies made to satisfy the regulators, and the fee for the expeditor, none of which was related to the bricks and mortar actually used to construct the building but all of which had to be factored into the final price to the buyer. So, in effect, buyers paid for something for which they received no value. The cost of regulation from which we as consumers derive little or, at best, limited value shows up at every level of government.
I faced a similar problem with a project I undertook in 1999 in Temecula, a small, charming southwestern California town whose motto is “Old Traditions, New Opportunities.” I can personally vouch for the “old traditions” part. We bought a parcel of land located between a group of shops and a residential housing area. Eight years passed between the start of the development process and the breaking of ground for the construction of a planned shopping center. Eight years! During most of the time, we devoted ourselves to satisfying the myriad government agencies whose sole responsibility was to regulate the process. The cost of money during the carrying time drove the price of the land up another 50 percent.
What I have encountered is an example of what happens every day, and any small businessman will inevitably encounter similar roadblocks regardless of his chosen business. Granted, some regulation is necessary and justified. For example, you cannot just let a developer run wild and build without any codes. But once the developer has complied with the code and has signed off, that should be it. Unfortunately, that is rarely the case.
knowing the rules can help you make your own
Regulation is part of the “system,” and you need to know how the system works before you can do things differently. As the old adage says, if you are going to play the game, you have to know the rules. In some cases, knowing the rules is the game. What-ever business you are in, you must seek out, study, and understand the rules.
There are government programs, such as 221(d)(3) and Section 8, that most people—including those who should—know little about. These programs give tax incentives to private developers who agree to construct government-sponsored, low-cost housing. Recently, I was the unintended beneficiary of a government program on a restaurant building I bought in Tuscaloosa, Alabama, with two friends, Mike Bodnar and Charles Morgan Jr.
The restaurant, Chuck’s Fish, is named after Charles Morgan Sr. I grew up with Charles Sr. in Birmingham. He was a legendary civil rights attorney who challenged the racist attitudes of the old South. He tried and won several landmark cases before the Supreme Court in the 1960s, including the “one man one vote” case that forced Alabama to create districts equal in population.
The idea behind the restaurant came from the fact that there is an abundance of wonderful seafood in the Gulf of Mexico and no great place to showcase it in Tuscaloosa. Charles, Mike, and I bought the restaurant building. It turned out that a couple of doctors had given a chef a blank check; he had massively overbuilt, and the restaurant had closed after a year, leaving the building vacant. Because of the circumstances, we were able to make a very favorable economic transaction. Charles then put together an operating group to run the restaurant. There are few businesses more difficult than operating a restaurant. It requires constant attention and long hours.
But we had two instant advantages. The first was management. Charles had a wealth of experience, having been an operator and owner of another restaurant for more than twenty years. Mike Bodnar was equally experienced. The second advantage was our location in downtown Tuscaloosa near the courthouse and the University of Alabama campus. The courthouse provided us with a lunch crowd. The university, which has grown from twenty thousand students to thirty thousand in the past few years, provided us with a weekend crowd. During football season, the town is flooded with people watching the mighty Crimson Tide in a stadium that has expanded from 78,000 seats to 92,000 and will soon have 101,000. So we were more focused on the BCS standings than government handouts.
We even got lucky when it came to regulations in that area. It turned out that, after Hurricane Katrina, Congress passed a law that said that if you made an investment in the Gulf region, called the Gulf Opportunity Zone or GO Zone for short, you could depreciate the asset by 50 percent in the first year if it was an active business. This meant that if you paid $1 million, you could deduct half of that on your tax return in the first year, regardless of how your business was performing. Therefore, if you financed the purchase of a business by putting $300,000 down and borrowing $700,000, you would have received back in tax savings most of your money in the first year. Even if you lost everything, you were made whole in tax savings. Just think, another well-conceived government program!
This was an ancillary occurrence. We did not buy the restaurant space for that reason. In fact, we did not even know that Tuscaloosa was in the GO Zone until after the fact. Tuscaloosa is two hundred miles from the Gulf of Mexico. Nevertheless, we took advantage of the tax savings on the real estate because it was one of the rules of the game. We have a very successful operating restaurant, and the tax savings became icing on the cake. In this case, we were just lucky. The regulation, which was passed to help the survivors of Hurricane Katrina, became a serendipitous asset. More often, regulations become a monstrous liability. In either case, you need to know how the regulators are going to affect your business.
It’s virtually impossible to know the ins and outs of all the congressional legislation that may have an impact on your business. Even the members of Congress who vote on these bills are rarely familiar with all the bills’ contents. (Do you really think your representative read the 2,300+−page health care bill?) Staff appointees and lobbyists who do not have to defend their policies to voters are the ones who actually write the legislation and then sell it to Congress.
Instead of being a solution, our elected officials are more often the major cause of problems. First, they impose the regulation; then they pass a tax to pay for it, penalizing small business. Alexis de Tocqueville, writing about the United States in 1831, said, “A democratic government is the only one in which those who vote for a tax can escape the obligation to pay it.” The federal government is too big and too remote. (Local representatives are more accountable. You can attend city council or county commission meetings, and you can actually speak to local officials and ask questions. And, because local campaigns are smaller, people can organize a bloc of like-minded voters to remove disagreeable council members.)
Remember my story about my first job in Hollywood? The same is true about Washington: You may not be able to change the government, but you sure don’t want it to change you. It’s best to be informed about the people who are making—and constantly changing—the rules. And if you happen to become influential in the business community and get the ear of one of our nation’s leaders, tell them what to do to help the entrepreneur.
People inside the Beltway don’t believe anything exists beyond Washington, D.C. Something happens the moment newly elected representatives or senators cross the Potomac River. A virus infects them. The same thing is true in Hollywood. Once people exit the Hollywood Freeway, that’s it. They’re hooked. By the way, there is a convention, confirmed by those who live there and supported by the press, that no one exists between the Hollywood Freeway and the Potomac River. People in these self-selecting towns are focused exclusively on themselves: what clothes they wear, what parties they attend, and what causes they collectively endorse.
Years ago, I met Jack Kemp when he was a congressman. I was having lunch at 21 in New York with Ira Harris, a managing partner at Salomon Brothers. Ira is a great people person, one of the best I have ever known. Ira introduced me to Jack. At the time, M*A*S*H was a big hit. Jack asked me where I was from. I told him that I lived in Los Angeles. He asked what I did. I said I was an actor. I don’t think he watched any television that was not about politicians, so he had no idea who I was.
In turn, I asked him, “Where do you live?”
“Washington,” he replied, somewhat surprised.
“And what do you do in Washington?” I asked.
He didn’t know quite how to respond. In fact, he was slightly stunned. But I couldn’t resist calling out the self-importance that comes with being part of the inside-the-Beltway world. I liked Jack Kemp very much. I thought Jack’s idea of encouraging housing ownership as opposed to renting or subsidizing ownership was a terrific idea. His Empowerment Zones could have really worked. But it tells you a lot that even an affable guy like Jack Kemp could not overcome the addictive poison of Washington power pills.
leveling the playing field
Clearly, the playing field in the business world is not level. So does the little guy really have any chance against Big Business and bad bureaucracy? Yes, but the only way for the individual entrepreneur to navigate the system we have in this country is not to be conventional. Again, convention stifles innovation. It stifles creativity. It stifles individuality.
Entrepreneurs who run small businesses are the real backbone of the American economy. Ninety-eight percent of U.S. businesses employ fewer than one hundred people. Their stories begin with an individual saying, “I’m going to open a business, and I’m going to do something different. If I don’t make a better product or produce some product and offer it at a lower price, then the best thing I can do differently is service—how I treat the people.” When a company gets larger and larger, the customer becomes anonymous, and that is part of what hurts Big Business.
There are some companies that have not fallen prey to this syndrome. Sheetz, an upscale convenience store chain, used to hire retired women to greet customers. They would stand by the door, invite you in, and offer you a fresh cup of coffee. That makes an impression, and people will go back because they are treated like, well, people. It is obvious but worth stating: No matter what your business, giving your customers personal attention is something you can do better as a small businessman.
With the playing field in the business world the way it is today, it is increasingly difficult to succeed as an individual entrepreneur if you do not think outside the box, if you do not look at things in a different way, if you do not make your own rules. Altering your approach is critical, not just what you are doing but how you are doing it. As Yogi Berra once quipped, “You’ve got to be very careful if you don’t know where you are going, because you might not get there.” Know where you are going.