Posts tagged ‘management’

Failing Government Managers Are Never Fired, They Are Just Moved (Or Even Promoted)

After the scandalous management practices in the Phoenix VA which were proved to sacrifice patient well-being, and even patient lives, in favor of artificially pumping up managers' metrics and bonuses, someone with experience in the private sector might have expected the agency to clean house.  Hah!

First, Congress rewarded the failing VA with more budget and headcount, the very things that motivate most government managers.

Now, the VA has assigned what appears to be their worst manager from a tiny, overseas branch of the agency to run the sensitive Phoenix office.

The Department of Veterans Affairs has named a new director to its beleaguered Phoenix VA Medical Center, and the decision instantly came under fire because the appointee left a previous hospital leadership post after it got the lowest satisfaction rating of any facility in the VA system.

RimaAnn Nelson, who most recently headed a tiny VA clinic in the Philippines, is expected to take charge of a Phoenix VA Health Care System that was the epicenter of a national crisis over its treatment of veterans. She is the seventh director during the past three years to enter a revolving leadership door at Carl T. Hayden VA Medical Center....

Nelson, who began her career as a nurse, was sent to the Philippines in 2013 after a series of incidents under her leadership at the VA St. Louis Health Care System. The Daily Caller, a non-profit, investigative news organization, said the incidents included two closures of the hospital due to medical safety issues, and potential exposure of HIV to hundreds of veterans.

How is this person even still employed, much less being rewarded with a larger, more responsible post?

In Defense of Profits -- Why They Are At Least As Moral as Wages

Quick background:  my company privately operates public parks, making our money solely from the entry fees voluntarily paid by visitors and campers.  We don't get paid a single dollar of tax money.

A major partner of ours is the US Forest Service (USFS), which actually operates more recreation sites than any other agency in the world (the National Park Service has a higher profile and the Corps of Engineers has more visitors, but the USFS is the most ubiquitous).  Despite the USFS being an early pioneer of using private companies to reduce the operating costs of parks and campgrounds, the USFS still has a large number of employees opposed to what we do.  The most typical statement I hear from USFS employees that summarizes this opposition -- and it is quite common to hear it -- is that "It is wrong to make a profit on public lands."

It would be hard to understate the passion with which certain USFS employees hold to this belief.   I discovered, entirely accidentally through a FOIA request my trade group had submitted to the USFS, that a Forest Supervisor in California (a fairly senior person in the USFS management structure) whom I have never met or even had a conversation with circulated emails through the agency about how evil he thought I was.

This general distaste for profit, which is seen as "dirty" in contrast to wages which are relatively "clean" (at least up to some number beyond which they are dirty again), is not limited to the USFS or even to government agencies in general, but permeates much of the public.  As a result, I thought I would describe a conversation I had with a USFS manager (actually this is the merger of two conversations).  The conversation below had been going on for a while discussing technical topics, and we will pick it up when the District Ranger makes the statement highlighted above (a District Ranger is the lowest level line officer in the USFS, responsible in some cases for the land management functions of an area the size of a county.  I have cleaned up the text (I am sure the sentences would not be as well-formed if I had a transcript) but I think this captures the gist of it:

Ranger:  I think it's wrong that you make a profit on public lands

Me:  So you work for free?

Ranger:  Huh?

Me:  If you think it's wrong to make money on public lands, I assume you must volunteer, else you too would be making money on public lands

Ranger:  No, of course I get paid.

Me:  Well, I know what I make for profit in your District, and I have a good guess what your salary probably is, and I can assure you that you make at least twice as much as me on these public lands.

Ranger:  But that is totally different.

Me:  How?

At this point I need to help the Ranger out.  He struggled to put his thoughts on this into words.  I will summarize it in the nicest possible way by saying he thought that while his wage was honorable, my profit was dishonorable, or perhaps more accurately, that his wage paid by the government was consistent with the spirit of the public lands whereas my profit was not consistent

Me:  I'm not sure why.  My profit is similar to your wage in that it is the way I get paid for my effort on this land -- efforts that are generally entirely in harmony with yours as we are both trying to serve visitors and protect the natural resources here.    But unlike your wage, my profit is also a return on the investment I have made.  Every truck, uniform, and tool we use comes out of my profit, whereas you get all the tools you need paid for by your employer above and beyond your salary.  Further, your salary is virtually guaranteed to you, short of some staggering malfeasance.  Even if you do a bad job you likely would just get shunted to a less interesting staff position at the same salary, rather than fired.   On the other hand if I do a bad job, or if one of my employees slips up, or even if some absolutely random occurrence entirely outside my control occurs (like, say, a flood that closes our operations) my profit can completely evaporate, or even turn into a loss.  So like you, I get paid for my efforts here on public lands, but I have to take risk and make investments that aren't required of you.  So what about that makes my profit less honorable than your wage?

Ranger:  Working on public lands should be a public service, not for profit

Me:  Well, I think you are starting to make the argument again that you should be volunteering and not taking a salary.  But leaving that aside, why is profit inconsistent with service to the public?  My company serves over 2 million visitors a year, and 99.9% give us the highest marks for our service.  And for the few that don't, and complain about a bad experience, every one of those complaints comes to my desk and I personally investigate them.  Do you do the same?

Why do I make such an effort?  Part of it is pride, but part is because I understand that my margins are so narrow, if even 5% of those visitors don't come back next year -- because they had a bad time or they saw a bad review online -- I will make no money.  Those 2 million people vote with their feet every year on whether they think I am adequately serving the public, and their votes directly affect how much money I make.  Do you have that sort of accountability for your public service?

Postscript:  Interestingly, though perhaps not surprisingly, the government ranger did not bring up what I would consider the most hard-hitting challenge:  How do we know your profits are not just the rents from a corrupt, cronyist government contracting process.  Two things let me sleep well at night on this question.  The first is that I know what lobbying I do and political connections I have (zero on both) so I am fully confident I can't be benefiting from cronyism in the competitive bid process for these concession contracts.  Of course, you don't know that and if our positions were reversed, I am pretty sure I would be skeptical of you.

So the other fact I have in my favor, which is provable to all, is that the recreation areas we operate are run with far lower costs and a demonstrably higher level of service than the vast majority of recreation areas run by the government itself.  So while I can't prove I didn't pull some insider connections to get the work, I can prove the public is far better off with the operation of these parks in private hands.

Perfect Example of Blaming the Free Market for Government Interventions

Hillary Clinton, along with many politicians and most of the media, is arguing that the recent large price increase in Epipens is some sort of market failure requiring government intervention to solve.

Democratic presidential nominee Hillary Clinton jumped into the fray over rapid price increases for the EpiPen, a life-saving injection for people who are having severe allergic reactions.

Mrs. Clinton called the recent price hikes of the EpiPen “outrageous, and just the latest example of a company taking advantage of its consumers.”

In a written statement calling for Mylan to scale back EpiPen prices, Clinton added, “It’s wrong when drug companies put profits ahead of patients, raising prices without justifying the value behind them.”

Why aren't similar government interventions required to curb greed in the pricing of paint, or tacos, or toilet paper?  Because the markets are allowed to operate and competitors know that if they raise prices too high, their existing competitors will take sales from them, and new competitors may enter the market.  The reason this is not happening with Epipens is that the Federal government blocks other companies from competing with Mylan for the Epipen business with a tortuous and expensive and pointless regulatory process (perhaps given even more teeth because Mylan's CEO has a lot of political pull).  The MSNBC article fails to even mention why Mylan has no competition, and in fact essentially assumes that Epipens are a natural monopoly and should be treated as such, despite the fact that there are 3 or 4 different companies that have tried (and failed) to clear the regulatory process over the last several years with competing products.  Perhaps these other companies would have been smarter to appoint a Senator's daughter to a senior management position.

Hillary Clinton is proposing a dumb government intervention to try to fix some of the symptoms of a previous dumb government intervention.  It would be far better to work the root cause instead.

Postscript:  Credit Vox with the stupid argument of the day:  

Other countries do this for drugs and medical care – but not other products, like phones or cars – because of something fundamentally unique about medication: If consumers can’t afford the product, they could have worse odds of living. In some cases, they face quite certain odds of dying. So most governments have decided that keeping these products affordable is a good reason to introduce more government regulation.

Hmm, let me pick a slightly different example -- food.  I will substitute that into the Vox comment.   I think it would be perfectly correct to say that there is not price regulation of food in the US, and that "If consumers can’t afford [food], they could have worse odds of living. In some cases, they face quite certain odds of dying."  In fact, the best place today to face high odds of dying due to lack of food is Venezuela, where the government heavily regulates food prices in the way Vox wished to regulate drugs prices.

Example of the Impact of Minimum Wages on Consumer Prices

I thought folks might be interested in a letter I just wrote to the US Forest Service.  I have left some of it out, but these are the guts of it.  As many of your know, we manage parks and campgrounds under concession contract for public entities.  As such, we typically must get changes to customer fees approved in advance by the agency.  This is a version of a letter we just wrote to a number of US Forest Service offices in California explaining the substantial increases to camping rates that must occur over the coming years to accommodate the new California minimum wage laws.

2017 Fee Proposal & Impact of California Minimum Wage Increases on Camping Rates

The purpose of this letter is to make you aware of the substantial effect that the recent increase in California minimum wages will have on use fees. I will get into details below, but in short the newly-legislated 50% increase in the state minimum wage is likely to increase our costs by about 22%, even ahead of inflation in other categories of expenses. Just to stay at parity and to avoid cuts in service, we (and other California concessionaires) are going to need substantial increases in fees over the next five years. Frankly, this does not make me very happy – our company will have to struggle with public resentment of the new fees without making an extra dollar in profit – but it is the reality we must face together. The only other alternative would be large cuts in service (e.g. bathroom cleaning frequency) which frankly I am not going to accept.

Background on the Minimum Wage Increase

California minimum wages have already risen over the last three years by 25% from $8 to $10 an hour. The new California law, which will apply to most concessionaires, demands the following timetable for minimum hourly wages (smaller companies with fewer employees than we have will have one extra year to comply):

2016: $10.00

2017: $10.50

2018: $11.00

2019: $12.00

2020: $13.00

2021: $14.00

2022: $15.00

Note that given the terms of other portions of labor law, these same sorts of percentage increases must trickle up to all managers and salaried employees in California as well.

Background on Concessionaire Cost Structures

Not surprisingly, as a labor-intensive service business, a substantial portion of concessionaire costs are directly tied to wage rates. The minimum wage increase will increase at least three categories of our costs:

  • Wages
  • Payroll taxes (which are calculated as a percentage of wages, so will go up by the same percentages as wages go up)
  • Workers compensation insurance premiums (which like payroll taxes are calculated as a percentage of wages and go up by the same percentage wages go up)

Looking at our financials for our California permits (we have three large permits in the Inyo NF and one in the Cleveland NF) these three categories make up 44% of our total costs.

Preliminary Estimated Fee Impacts

Let’s look, then, and how much our costs may rise between now and 2022.

For the labor and labor-related charges discussed above, we know that costs will rise 50% between now and 2022. A 50% price increase on 44% of our costs raises our total cost structure by 22% (0.5 * 0.44).

But all of our other costs will also continue to rise during this period by at least the national rate of inflation. It is very possible that these costs will increase faster in the future due to this minimum wage increase – for example, our waste disposal costs will almost certainly go up as the labor costs of waste disposal companies rise. For a starting point, we will assume 3% general inflation in 2016 and 2017 and 4% in the years after that. This would yield a 24% increase in the other 56% of our costs for an impact on our total costs of 13.4% (0.24*0.56). Combining these two effects, we can expect a total cost increase to operate campgrounds in California by 2022 of 35.4%.

Note that though we bid based on trying to earn a profit margin around 9%, our actual profit margin in the USFS campgrounds we operate in California has been between 3% and 7% of revenues (5% in 2013, 7% in 2014, 3% in 2015). There is simply no room in that margin to absorb a 35.4% cost increase. We are going to have to therefore seek fee increases over the next 6 years in the 35% range, or between $6 and $8 on the $18-$23 camping rates that currently obtain. This is about a dollar or year, or two dollars every other year.

Competitor Analysis

We understand that the USFS wants to justify fee increases based on market conditions. One problem we will have is that even though we don’t open until April or May at seasonal locations, we need to get fee approval the previous September or October. We fully expect private operators will have to pursue fee increases of a similar magnitude; however, they may not announce their new higher rates in time for our very early fee-setting process. This makes local competitive analysis misleading.

Fortunately, in California we have another large public campground provider, California State Parks (CSP), that has many of the same public service and land management goals as has the US Forest Service. They therefore make a very good comparison. While rates vary by park, CSP is typically charging $35 a night for a no-hook-up campsite in parks that are very comparable in their natural settings to USFS campgrounds.

We currently charge no more than $23 for a no-hook-up site in the USFS in California (both in the Inyo and Cleveland NF). Even with a $6 fee increase, we would still be offering no-hookup campsites at 17% lower cost than does the State of California today (and presumably even lower in 6 years given that CSP is likely to continue to increase its camping fees).

[Rest of the letter on exact fee recommendations and other contract issues omitted]

Living Atlas Shrugged in Venezuela

This sounds so much like the latter stages of Atlas Shrugged, when one by one Colorado businesses shut down, worsening shortages across he country.  The government tries to come in and restart each factory, but there is no confidence that the government can actually do the job and within months the whole thing has imploded forever.

Over the weekend, Kimberly-Clark said that the South American nation’s deteriorating economic situation had made “it impossible to continue our business at this time."  The company had made a number of hard-to-find staples in Venezuela such as diapers and face tissues.

As Bloomberg adds, the decision will likely to add to shortages that have gripped Venezuela for the past few years after the ruling socialists capped the price on many consumer basics below production costs." As we have documented repeatedly, desperate shoppers now routinely spend long hours in front of stores to purchase essential products ranging from toilet paper to rice. At the same time, companies face hefty losses on price-controlled goods, while the products are often flipped on the black market for many times their sticker price.

So in retaliation, Venezuela's government announced it had seized the factory.  Labor Minister Owaldo Vera said Monday that the socialist government took the action at the request of the 971 workers at the factory that the company decided to shutter. The seizure follows a similar takeover from 2014 when Clorox announced it was closing its doors.

"Kimberly-Clark will continue producing for all of the Venezuelans," Vera said in a televised statement from the factory surrounded by workers chanting pro-government slogans. That statement was not exactly true: former workers of the company would continue producing under the observation of government management. We doubt this "forced restructring" will survive more than a few months.

I have written this before, but I interpret Atlas Shrugged a bit differently than most.  There is much criticism of the one-dimensional characters and limited character development in the book.  But I have always thought this beside the point.  The main character in Atlas Shrugged is the world itself, and the main story arc is the decline and fall of the world under the increasing influence of socialism.  All the human characters are just props to this main drama.

In this interpretation, the climax of the book is when the hobo Jeff Allen tells the story of 20th Century Motors to Dagny on the train.  This story shows the final death throws of a group of people attempting to pursue socialism in its purest form.  It's a statement of the end towards which everything else is quickly heading.  After this point in the book, we immediately are in Galt's Gulch and end up with Rand's Utopian vision, which from a literary standpoint is awkward and boring.  That's because utopian novels are always dull as dirt.  Rand's triumph in that book was that she was absolutely prescient about how socialism plays out, which we are seeing today in Venezuela.

Hillary Clinton and "Intent" -- Can the Rest Of Us Get A Mens Rea Defense From Prosecution?

Yesterday, the FBI said that Hillary Clinton should not be prosecuted because, though she clearly violated laws about management of confidential information, she had no "intent" to do so.  Two thoughts

  • Even if she had no intent to violate secrecy laws, she did - beyond a reasonable doubt - have intent to violate public transparency and FOIA laws.  She wanted to make it hard, or impossible, for Conservative groups to see her communications, communications that the public has the right to see.  In violating this law with full intent, she also inadvertently violated secrecy laws.  I don't consider this any different than being charged for murder when your bank robbery inadvertently led to someone's death.
  • If politicians are going to grant each other a strong mens rea (guilty mind or criminal intent) requirements for criminal prosecution, then politicians need to give this to the rest of us as well.  Every year, individuals and companies are successfully prosecuted for accidentally falling afoul of some complex and arcane Federal law.   Someone needs to ask Hillary where she stands on Federal mens rea reform.

Tesla and SolarCity: Two Drunks Propping Each Other Up

This is honestly one of the weirdest acquisition proposals I have seen in a long time:  Elon Musk's Tesla offers to buy Elon Musk's Solar City.

This makes zero business sense to me.    This is from the press release:

We would be the world’s only vertically integrated energy company offering end-to-end clean energy products to our customers. This would start with the car that you drive and the energy that you use to charge it, and would extend to how everything else in your home or business is powered. With your Model S, Model X, or Model 3, your solar panel system, and your Powerwall all in place, you would be able to deploy and consume energy in the most efficient and sustainable way possible, lowering your costs and minimizing your dependence on fossil fuels and the grid.

I am sure there are probably some hippy-dippy green types that nod their head and say that this is an amazing idea, but any business person is going to say this is madness.  It makes no more sense than to say GM should buy an oil production company.  These companies reach customers through different channels, they have completely different sales models, and people buy their products at completely different times and have no need to integrate these two purchases.  It is possible there may be some overlap in customers (virtue-signalling rich people) but you could get at this by having some joint marketing agreements, you don't need an acquisition.  Besides, probably the last thing that people's solar panels will ever be used for is charging cars, since cars tend to charge in the garage at night when solar isn't producing.

One might argue that some of the technologies are the same, and I suppose some of the battery and electricity management tech overlaps.  But again, a simple sourcing agreement or a battery JV would likely be sufficient.

So what do these companies share?  I can think of three things.

The first is Elon Musk.   When one sees a deal like this, one is immediately suspicious that there is some kind of game going on where the owner combines holding A with holding B and somehow in the combination ends up with more wealth.  This is a game conglomerates played in the 1960's -- you could create a lot of (paper) value if you had a high PE (stock price to earnings ratio) company and went around buying low PE companies, instantly creating paper wealth if you could buy their earnings cheap and then have them suddenly valued at your higher PE.   Its hard to guess if this sort of game is going on here, as neither company has earnings (or rather both lose a lot of money).   Further, I have no read on Mr. Musk's personal ethics.  If this were Donald Trump, we would all immediately be suspicious such a game was at play.

The second thing these two companies share is that they have business models based on consuming massive amounts of government subsidies.  They get subsidies directly (each by selling various sorts of tax credits or fuel economy credits to power companies and auto makers), they have both gotten sweetheart deals from governments for production facilities, and their customers get subsidized as well in the purchase.  However, while there certainly are economies of scale for cronyism (large companies have the pull to get the loot), I shudder to think that there might be even more for these two companies to grab if they were larger.

The third thing these two companies share is that they both have huge financing needs, are losing lots of money, and are burning through tons of cash.   And here I think is the real heart of this deal, and if I am right, we may be able to answer the question on Elon Musk's ethics.  While both companies are burning through cash and are constantly going out to the market for more money, Tesla still has a (not totally justified in my mind) fabulous reputation with investors** and people seem to be falling over themselves to throw money at it.  With Apple languishing and Google old news, there is no hipper, trendier company out there.   On the other hand, SolarCity is starting to suck wind.  A few months back JP Morgan downgraded the stock:

SolarCity is having trouble attracting new investors, as the company has launched and canceled programs and altered its accounting methods, JPMorgan wrote in a note, according to MarketWatch.

Additionally, some of SolarCity's lower-income customers could be at risk of "slow-pay or default in the event of an economic downturn," the firm continued.

...SolarCity's weaknesses include its generally high debt management risk, weak operating cash flow, generally disappointing historical performance in the stock itself and poor profit margins.

They are also seeing more competition from local contractors and, perhaps most worrisome for their business model, various government subsidies are being scaled back and many states are changing their power metering rules to pay customers only the wholesale rate, rather than the retail rate, for power they put back in the grid.  They have said in most of their annual reports as a risk that their business model likely would not be viable (if it could be called that even today) without current or higher levels of government subsidies.

I have no inside information here, but this is the best hypothesis I can put together for this deal.  SolarCity has huge cash needs to continue to grow at the same time its operating margins are shrinking (or getting more negative).  They are having trouble finding investors to provide the cash.  But hey!  Our Chairman Elon Musk is also Chairman of this other company called Tesla whom investors line up to invest in.  Maybe Tesla can be our investor!

The reason I call this two drunks propping each other up is that Tesla also is also burning cash like crazy.  It is OK for now as long as it has access to the capital markets, but if it suddenly lost that, Tesla would survive less than 6 months on what it has on hand.  Remember, SolarCity was a golden child just 3 years ago, just like Tesla is today.  Or if you really don't believe that high-flying companies that depend on access to the capital markets can go belly up in the snap of a finger when they lose their luster with investors, I have one word for you:  Enron.

There is a substantial minority of the investment community that thinks that Tesla's headed for chapter 11, even before taking on the SolarCity albatross.  Here is one academic paper.  Here is another such opinion.  Non-GAAP reporting has proliferated like a cancer among public companies, with so many creative non-GAAP numbers that I am not sure the Enron folks would go to jail nowadays.  Tesla is a master of this game.    Even if Tesla is not headed for chapter 11, the absolute last thing Tesla needs to be doing is taking on a new acquisition that burns a lot of cash, while simultaneously diluting their management focus.

When I watch SpaceX launches, I so want to love Elon Musk.  But I am increasingly convinced that this is a terrible deal, an insider game he is playing to try to keep one of his investments alive.  I am seldom a fan of most minority shareholder lawsuits, but if I were a minority shareholder of Tesla I would be suing to block this acquisition.

By the way, many investors must be reading this the same way, because SolarCity stock prices are up and Tesla stock prices are down (at lot) today.

Disclosure:  I have been short Tesla for a while.  I shorted SolarCity this morning when the acquisition was announced, after its price popped up.  I consider this merger announcement as the moral equivalent of announcing that SolarCity is in financial distress.  These investments are tiny, the equivalent of a bar bet rather than any substantial investment on my part.

**Footnote:  I have to say this every time -- The Model S is a great car.  I would love to have one, if Santa put it under the tree for me.  But just because they have one great product does not mean that the company will be a success or is a great investment or that it is worth massive amounts of my tax money in subsidies.

Disney Wait Times Are Among The Most Transparent Service Numbers Anywhere

How often does Amazon fail to deliver Prime shipments in two days?  I have no idea -- I know it has happened to me sometimes, but they don't publish the metric.  What is the average wait time on the phone with the IRS?  We don't know.  What is the average wait time at a TSA checkpoint?  We don't know.

One thing we most certainly do know, and can know any time on any day, is the current wait time for any Disney ride.  I bring this up because some goofball in the Obama Administration made this absurd statement trying to justify the lack of transparency for VA wait times:

When you go to Disney, do they measure the number of hours you wait in line? Or what’s important? What’s important is, what’s your satisfaction with the experience?” McDonald said Monday during a Christian Science Monitor breakfast with reporters. “And what I would like to move to, eventually, is that kind of measure.”

Bruce McQuain rightly points out the downside of a longer wait for Space Mountain is just a tiny bit lower than the downside of waiting for heart surgery.

But I want to add that this statement is not even close to being factually correct on its face.  Here is an example of a site that has Disney ride wait times in real time, but there are dozens of apps and sites with this info because Disney makes the data public in an API most anyone can access.  (My favorite is Touring Plans, which has built a whole Disney trip planning business on top of Disney published wait time data -- as an aside, if you are a Disney fan or future visitor, you should join).

But I would go further.  I know for a fact that Disney spends a ton of time internally planning and improving ride throughput and capacity entirely with an eye to reducing wait times (and also, by the way, to making design changes that make ride waits more enjoyable with in-line activities).  They have a sophisticated operational research staff working on this all the time, and they are constantly tweaking their Fastpass system which would not even begin to work correctly if they did not understand ride wait times down to the second decimal place.  And by the way, if their management found out that some folks in their organization were fudging line wait time data, I am pretty sure the offenders would not be working there any more (as they are at the VA).

Postscript:  I am still amazed by the fail here.  Anyone who has been to Disney even once will know that all wait times are displayed all over the park on boards, and that at each ride, every few minutes a customer will get an electronic card at the beginning of the ride that precisely times their wait.   Seriously, where do they get folks like this who can blithely utter nonsense as if they know what they are talking about.  The whole premise is screwed up.  Yes, good service companies measure overall satisfaction. This is marginally useful data, but what does one do with it?  To really fix and improve the experience, one also has to measure many important bits of the experience.  Saying that one should pay attention to only one output metric and nothing else would get you laughed out of any quality course I have ever been to.

Update:  Also, I would add that there is a lot of market pressure on the wait time issue pushing Disney to improvement on lines, market pressure that does not exist on the VA (which is one reason they totally lack any accountability).  Disney has its FastPass system for helping guests manage ride waits, but both Universal and Six Flags have their own different systems (Universal has a higher level ticket you can buy that gets you preferred access to all rides, Six Flags Magic Mountain has a pager system where you tell it which ride you want to do next and they page you when your place is ready).

Minimum Wage Pits Employees vs. Customers, Not Employees vs. Management

This post earlier on the customer service downsides of the new salaried overtime rules got me thinking more broadly about the impact of minimum wage type laws.  Progressives justify such laws by saying that there is a power imbalance between management and employees, and that the government needs to have minimum wage laws to make up for the fact that employees lack power.

But from my experience in the service world, it is wrong to look at the situation as a power struggle between managers and employees.  It is much more correct to look at this as a power struggle between employees and customers.  Let me explain.

Service and retail firms tend to live on razor-thin margins.  Retailers typically live on single-digit profit margins, and those of companies like Wal-Mart are as low as 2% of revenues.  Our company in the service business has a similar experience, averaging profit margins of 3-5% of revenues over the last 10 years.

This is not an accident.  Most service and retail businesses depend on simple service-delivery models using relatively low-skilled workers.  There are many low-skilled workers in the world.  If a company were to start making huge profits with a service model using such workers, it would be easy for others to copy it and hire the same types of workers and undercut them on price.  Margins tend to get competed down to the bare minimum.

No matter how much progressives would like it to be so, when California raises its minimum wage, it probably is not going to come out of company margins, at least in the near term.  Over the 10 years from about 2013 to 2022, California will have raised its minimum wage over 87% from $8 an hour to $15.  Wages and costs like workers comp premiums that are tied to wages are about half my costs.  This means an 87% labor cost increase will increase my total costs 44%.  How is that going to come out of a 4% margin?  It is not.

There are really only two things we can do, individually or in combination.  First, we can raise prices 44%, just to try to stay even.  Of course, some customers will balk and stop buying, and then we will lose business and perhaps have to close (we have already closed over half our businesses in California for just this reason).  Or second, we could cut staff in half to keep wages under control.  Of course, this means customers get served much more poorly, which also may drive customers away.  Other companies like fast food restaurants have a third option of automation, replacing people with machines -- I wish we could do this but right now we have run out of ideas for automating bathroom cleaning and landscape work.

Hopefully, you can see what is going on here.  The real tension here is between employees and customers.  When the state mandates a minimum wage in low margin service businesses (such laws are largely irrelevant to high-margin technology companies and such), compliance is paid for by the customer, either in the form of higher prices or worse service or both.

Why Don't Progressives Use Their Power as Hedge Fund Customers to Challenge Hedge Fund Compensation?

Kevin Drum observes that the top 25 hedge fund managers earned $13 billion in total, including one hapless dude who made $250 million despite losing money and shutting down the fund.

I will say that I have always scratched my head over asset manager compensation.  The tradition is that they get paid as a percentage of assets managed, sometimes with a percentage of the profits as well but never taking a percentage of the losses.   Perhaps this made some sense with smaller pools of money, but today with huge pools of money, the same old percentages yield ludicrous compensation results.  I certainly understand why the managers would defend this compensation scheme, but why do customers accept it?

This reminds me of real estate broker compensation.  The tradition when I grew up is that the seller paid 6%, about half of which went to the seller's broker and half to the buyer's broker.  For years that 6% was etched in stone and no one broke ranks -- the agents were pretty good at maintaining the cartel, and the government helped by putting the force of law behind broker licensing that helped keep the agent supply down.  But as home prices kept increasing, people started noticing that while 6% of $100,000 may have made some sense as reasonable compensation, 6% of $2 million was absurd, especially since a $2 million home was not even close to 20x harder to sell.   So people, initially savvy high net worth folks, and later everyone, began negotiating the 6%.  I have negotiated this number on every home I have sold since the mid-1990s.

I am not really knowledgeable about the asset management business -- in some sense I have negotiated my commission by choosing to put all my money in low-fee Vanguard funds.  How does the asset management business hold the line on fees, particularly when they are in a business where it is so easy to measure their relative performance, and presumably pay them based on this performance?

Which got me to thinking about the customers of hedge funds.  Aren't many of these customers progressive or controlled by progressives?  Hedge funds have been very successful marketing to university endowments, non-profit foundations, and public pension funds -- aren't these institutions often controlled by progressives, or at least left-liberals?  Aren't a disproportionate share of the very high net worth Hollywood and billionaire types who invest in hedge funds also progressive or liberal?  Heck, Hillary Clinton's son-in-law ran a hedge fund until recently.  So why don't these folks get together and instead of worrying about whether their portfolios are invested in Israel or Exxon or some other progressive bette noir, why don't they agree to a set of principles as to how they are going to pay for their asset management services in the future, and stick to these?  I say that progressives should get together, because they are politically passionate about this, but I can't think of any good reason why good libertarians or conservatives wouldn't happily join in to reduce their fees.

I understand that to the extent that there are black swan hedge funds that beat the market year in and year out, these folks will be hard to challenge as they can probably write their own terms.  But for the other 99% of hedge funds, why not use the power progressives already have as customers before we start talking about various government hammers.

PS-  I will put my two cents in.  I think the new Mother Jones site design is awful.

So @tylercowen, You Want to Understand the Great Stagnation? Here It Is

Certainly the government's current permission-based approach to business regulation combined with an overt hostility of government (or at least those parties that influence it) to radically new business models (see: Uber) is a big part of the great stagnation story.

But insanity like this is also a big part:

Vague but expensive-if-not-correct rules on employee seating just got vaguer and harder to figure out

Weighing in on two California laws that require employers to provide suitable seating to workers when “the nature of the work” permits it, the California Supreme Court said the phrase refers to an employee's tasks performed at a given location for which the right to a suitable seat is asserted.

In response to questions certified by the U.S. Court of Appeals for the Ninth Circuit, the state high court said April 4 that the phrase “nature of the work” doesn't require a holistic evaluation of the full range of an employee's tasks completed during a shift.

An employer's business judgment and the layout of the workplace are relevant in determining whether sitting is permitted, but courts should apply an objective analysis based on the totality of the circumstances, the California Supreme Court said.

It held that “if an employer argues there is no suitable seat available, the burden is on the employer to prove unavailability.”

As a business owner in California, I am going to have to do a ton of research to figure out just how we can comply with all this, and even then I will likely be wrong because whether one is in compliance or not is never actually clear until it is tested in court.  I had to do the same thing with California meal break law (multiple times), California heat stress law, new California harassment rules, California sick leave rules, the California minimum wage, Obamacare rules, Obamacare reporting, the new upcoming DOL rules on salaried employees, etc.

Five or ten years ago, I spent most of my free time thinking about improving and growing the business.  Now, all my mental bandwidth is consumed by regulatory compliance.  I have not added a new business operation for years, but instead have spent most of my time exiting businesses in California.  Perhaps more important is what I am doing with my managers.  My managers are not Harvard MBAs, they are front-line blue collar folks who have been promoted to manager because they have proven themselves adept at our service process.  There are only a finite number of things I can teach them and new initiatives I can give them in a year.  And instead of using this limited bandwidth to teach some of the vital productivity enhancement tools we should be adopting, I spend all my training time on compliance management issues.

You Know It Is Time to Short the Economy When...

.... your paper prints headlines that say "Economists: Zero chance of Arizona recession."  I am sure Houston would have said the exact same thing, right up until oil prices dropped to $30 and suddenly there was like a 100% chance.  When the Arizona Republic makes a definitive economic prediction, bet the other side.

Anyway, I am considering this headline to be a flashing indicator of the top.  In 2005 I wrote about another such indicator that told me the housing market had peaked:

So, to date [May 31, 2005], I have been unconvinced about the housing bubble, at least as it applied to our community.  After all, demographics over the next 20-30 years are only going to support Scottsdale area real estate.

However, over the weekend I had a disturbing experience:   At a social function, I heard a dentist enthusiastically telling a doctor that he needs to be buying condos and raw land.  The dentist claimed to be flipping raw land parcels for 100% in less than 6 months.

For those who don't know, this is a big flashing red light.  When doctors and dentists start trying to sell you on a particular type of investment, run away like they have the plague.  At Harvard Business School, I had a great investment management class with a professor who has schooled many of the best in the business.  If an investment we were analyzing turned out to be a real dog, he would ask us "who do you sell this to?" and the class would shout "doctors!"  And, if the investment was really, really bad, to the point of being insane, the class would instead shout "dentists!"

Which reminds me that in the last 6 months I have started hearing radio commercials again urging folks to get into the house-flipping business and make their fortune.  Whenever institutions start selling investments to you, the average Joe, rather than just investing themselves, that should be taken as a signal that we are approaching a top**.  About 12-18 months before oil prices tanked, I started getting flooded with spam calls at work trying to sell me various sorts of oil exploration investments.

** Postscript:  In 2010, when house prices were low and some were going for a song in foreclosure, there were no house flipping commercials on radio.   That is because Blackstone and other major institutions were too busy buying them up.  Now that these companies see less value, you are hearing house flipping commercials.   You know that guy who has a book with his fool-proof method for making a fortune?  So why is he wasting his time selling books for $2 a copy in royalties rather than following his method?

Home Ownership and Labor Mobility

Alex Tabarrok discusses some academic work that shows a declining inter-regional mobility in the United States which is causing local economic declines to last much longer than they used to last.

In a new paper, also cited by Leubsdorf, Danny Yagan at Berkeley suggests that reduced migration is only part of the problem. What has made the aftermath to the 2008-2009 recession so bad is that migration is low at the same time that it has become more necessary than ever. The 2008-2009 recession was especially localized, it hit some places harder than others and in a way that appears to be permanent. But migration has been too slow to solve the problem.

The usual story is that in-and-out migration equalizes wage, unemployment and employment rates across the nation. Some places may be harder hit than others but movement quickly makes the US into one labor market. In the aftermath of this recession, however, that isn’t happening for employment rates. Using a clever research design that looks at workers with similar education and skills doing the same jobs at the same large firms but in different locations, Yagan finds that location continues to matter years after the recession has ended. Workers who worked in the places hardest hit in the 2007-2009 recession have employment rates today that are 1% lower than similar workers in regions that were less hard hit.

It is probably unfair for me to comment on this because I have been highly mobile in  my life, having lived and worked in about 10 places as diverse as Houston, Dallas, Boston, Boulder, Seattle, Phoenix, St. Louis.  However, I will take  a shot at this.  Some of my hypotheses:

  1. Government programs to encourage home ownership have reduced mobility.  It is simply harder to move if one has a house to sell, and this was worse in the last recession, which was driven in large part by falling home prices, which made it even harder to move when one has an underwater home to sell.
  2. Political/Cultural redlining reduces mobility.  As an example, certain millennials want to be nowhere else but San Francisco, despite how absurdly hard it is to live there.  They will starve in poverty there before going to, say, Houston, which is an easy place to live when one is young but which many consider to be a evil redneck backwater.
  3. Use of Communication technology causes people to think they can reduce mobility when they perhaps can't.  I think a lot of folks with modern communication technology assume that location is irrelevant and that they should be able to do X work anywhere they want.   I think they are overestimating where many industries and companies are right now (though they may be correct in the future).  Just from tax compliance and regulatory perspectives, it is pure hell for a company in, say, Texas to have an employee in, say, California.  Plus I think there are still real networking and management reasons for employees to be concentrated in facilities.


Why Exxon Provides a Good Analogy for the Central Banker's Dilemma

This article on Exxon stock seemed to be an allegory for the current problem central bankers face:

Earlier this month, Exxon Mobil (NYSE:XOM) reported Q4 2015 earningswhich, as expected, looked ugly considering the large decline in the price of oil over the last one and a half years. Exxon Mobil has long been one of the largest repurchasers of shares, spending a net of $89.74B on share buybacks during the 2010 through 2015 period. However, during the Q4 earnings release, management stated that share buybacks were being halted, presumably to preserve cash...

Contrast that with the strategy from 2008 when share buybacks were accelerated during the market fallout of the Lehman Brothers bankruptcy and the beginnings of what's now known as the Great Recession. Management reduced shares outstanding by 7.5% in 2008 alone...

Oil prices have sunk to lows not seen in more than a decade. The share price hit a low in the $60s in 2015 which hadn't been seen since late 2010. If you're of the belief that oil prices will rebound, eventually, then now should be the time that Exxon Mobil is ramping up the share buybacks not eliminating them.

This is the problem the author is highlighting:  Exxon ran up tens of billions in debt to stimulate the stock price in good times.  Now that times are bad, at least in the oil patch, the tank is empty (so to speak) and they have had to cease buybacks at the very time they would make the most sense (the same amount of money spent at lower stock prices would have higher impact on EPS).  The tank is empty enough that they might have to cut the dividend, an action with such negative consequences for stock value that it would likely undo all the effects of years of stock purchases.

I am not trying to beat up on Exxon -- I actually admire them as a well-managed company and pretty much every large corporation has gotten caught up in this unproductive Fed-inspired game of borrowing at close to zero and buying back stock (to my mind the financial equivalent of the Keynesian digging of holes and filling them back in).  But I hope you can see the analogy with the position of governments and central bankers.   For the last 5 years, when economic times have been good (alright, maybe just OK) governments have been deficit spending like crazy and central banks have been expanding their balance sheets with programs like QE to keep the economy stimulated.  But just as with the situation at Exxon, when the bad times come, bankers are going to find themselves with far fewer options than they had in 2008.

PS:  This is what Exxon really should have been doing the last 5 years -- hoarding their cash and borrowing reserves to be able to buy assets like crazy on the cheap in the next downturn.  They have always been able to do this in past downturns.  I suspect it may not be possible this time.

Local Media Still Trying to Save the Phoenix NHL Team

No one loves local sports teams more than the local media.  I think they know, but probably won't admit, that they would lose a huge chunk of their remaining readership / viewership for their news products if they did not have local sports to report on.  So you will almost never, ever, ever see local media reporting reporting on the true cost (in terms of handouts of taxpayer money) to retaining pro teams.

My coverage of the Phoenix/Arizona Coyotes hockey team goes way back, including even to a mention in a George Will column.  I won't repeat all of that.  I just want to point to this article entitled "Glendale selects AEG to manage Gila River Arena; Arizona Coyotes' future unclear."

Glendale selected facilities-management company AEG Facilities to operate Gila River Arena, likely hastening the city's split with the Arizona Coyotes hockey team.

The telling thing about the article is that it never once explains to readers why this bid award might hasten the split with the Coyotes.  They mention that the Coyotes chose not to bid on the contract.   So why is this award a problem for them?  Do they hate AEG for some reason?  If you really were new to the issues here, you would have to scratch your head and wonder why the two issues were connected.

Oddly enough, everyone knows the reason, but the local media really wants to avoid mentioning this reason.  Here is the elephant in the room no one will recognize:  The Coyotes struggle to make money in this market, a fact made worse by the terrible location of the stadium at the far end of town from most of the potential corporate ticket buyers and wealthy people.   As a result, the team languished in bankruptcy for years, in part because the NHL (who took over the team) refused to sell it at a reasonable market price.

They finally found a buyer who agreed to buy it for an above-market price, but did so only because there was an implicit promise by the town of Glendale to subsidize them the $100 million difference between the actual and market price of the team..  The Goldwater Institute called foul on this subsidy and got it stopped.  So the town found a way around it, promising to award the team the stadium management contract for a price  $8-$10 million a year above market rates for the service.   The present value of this above-market pricing over the life of the proposed contract nearly exactly matched the earlier subsidy proposal Goldwater killed.  Various folks cried foul again, seeing through this sham, and got that stopped.

So the reason this award of the stadium management contract to AEG is so devastating to the Coyotes is that this contract represented the last hope of exacting a hidden subsidy from the city.  With this contract awarded to an arms-length third party at market rates, the last chance of making the Coyote's business viable on the taxpayer's backs seems to have escaped.

Update:  I am hearing now that another reason the Coyotes are done in Glendale is that they think the city of Phoenix or Scottsdale will build them a new stadium.  ugh.  Will it never end.

When Julia Tried to Start a Business

I was doing a radio interview and was reminded of this article I wrote in response to the famous Obama "Life of Julia" piece extolling the virtues of government in our lives.  Since I spend so much of my time in the last few years finding ways to comply with ever more onerous regulations (rather than actually improving my business or customer service) I thought I would offer a different view.  When I argue that free market proponents need to talk about taxes less and regulation more, this is what I am thinking about.

Since it has been several years since this went up at Forbes, I want to reprint it here in full:

Last week, the Obama Administration released a campaign piece about the life of Julia, showing how Julia benefited from taxpayer largess and oversight by the state at many points in her life. But the campaign piece was incomplete, and missed the part where Julia attempted to start her own business. Long before she started a web business out of her home, she tried to start a retail business.

Julia always liked the outdoors — remember that taxpayers helped her retire from productive work so she could work in a community garden. Well, as she was growing up, Julia loved to camp outdoors. For years she camped at a lovely lakefront public campground until it was forced to close — unfortunately, the government agency that ran the campground had operating costs that were so much higher than the fees charged to visitors that they couldn’t afford to keep it open any longer.

But Julia had an idea. After forming a corporation (a surprisingly easy task with lots of private companies competing to help one complete the proper legal steps), Julia approached the public parks agency about the possibility of her leasing the campground and reopening it under private management. She was surprised, though, at the tremendous opposition she encountered in the agency. Despite the fact that she was willing to adhere to operating standards and restrictions set by the public agency, she initially encountered tremendous resistance. She had assumed a parks and recreation agency would welcome the opportunity to reopen a park to the public, be she had underestimated the near universal opposition to private enterprise she found among the agency’s employees.

Eventually, though, with a lot of hard work and some help from a local TV station that rallied park users to her cause, the public agency agreed to a one-year pilot of her idea.

So the hard part was behind her, right? Probably not. In fact, Julia expected entrepreneurship to be tough. She was worried about the challenges of hiring good employees, getting financing for new equipment, and marketing her new campground. As it turned out, though, she would have little time for any of these concerns.

Before she could even think about hiring employees, she had to get a federal tax ID number, or FEIN, for her company. This identification number allows her to collect and pay her employee’s Social Security and Medicare taxes, as well as withhold and submit the Federal income tax obligations of her employees. In addition to these reports, she also learned that she had to file a separate report each quarter on her employee’s earnings in order to file and pay Federal unemployment taxes.

But her state has its own income tax, so she had to register for a separate ID number to report and pay employee state tax withholding, and then had to fill out yet another registration for another ID number to file another regular report to pay state unemployment taxes. Her state also has a public rather than private workers compensation system, so she registered for another number so she could fill out another monthly report to pay state workers compensation premiums.

And of course, since Julia intends to make retail sales, she needed to register with the state (yet another number and report) to collect and pay sales tax — though her state calls it a “privilege” tax rather than a sales tax because, as the state’s web site explains, conducting commerce is a privilege that can only be exercised with the state’s permission. She is momentarily encouraged when she finds out her state sales tax does not apply to camping, only to eventually find out this is because the state has a completely separate system (yes, another registration number and monthly report) for collecting and paying lodging taxes. So sales in her campground store will be at one tax rate on one report while campsite rentals in the same park will pay a different tax rate on a different report. Which seems overly complicated until she finds out her county also has a separate sales and lodging tax that are added to the state’s, and must be reported separately under a different registration number to the County. Thank goodness she is not in a city, or she could easily have had to file and pay three separate sales taxes and three separate lodging taxes (city, county, state). If she ever decides to rent boats on the lake, she will have to get another state registration to pay a special state boat rental tax, the percentage of which varies based on whether a boat is motorized or human-powered.

Whew. Julia thought she had finally tracked down all her tax registrations, but she was wrong. Her corporation is an S-corporation, so she files and pays her corporate income taxes on her individual return. But it turns out her state also has a franchise tax on corporations she must pay separately, based on her total revenues. In addition, it turns out that each year she must produce a complete list of all her businesses personal property, from lawn mowers to computers to radios to chairs, and submit this list to the County so she can pay property taxes on all these items. Unfortunately, in her state the property tax bill does not end there. When the public agency was running the campground, the county was not allowed to charge another government agency property taxes on the assets. The agency still owns the property — it is just leasing it to Julia so she can operate it — but the county has a mechanism called the Leasehold Excise Tax to make Julia pay the property taxes the agency doesn’t have to pay.

So twelve registration numbers and 12 monthly/quarterly/yearly reports later, surely Julia has fulfilled all her obligations to the government. Unfortunately, no, because she has not even begun to address licensing issues. To begin, the County will require that she get an occupancy permit for her campground, which must be renewed annually. This seemed surprisingly easy, until someone from the County noticed she had removed an old rotting wooden deck from the back of her store that had been a safety issue and an eyesore. It turns out she was in violation of County law because she did not get a removal permit first. She was required to get a permit retroactively, which eventually required payments to seven different County agencies and at one point required, for a reason she never understood, the collection and testing of a soil sample.

Because she will be selling packaged foods in her store (e.g. chips and pop-tarts), she also has to get a health department license and inspection. She had originally intended to keep some fresh-brewed coffee for customers in the store, but it turned out that required a higher-level health license and eight hours training in food handling. She might have been willing to pursue it, but the inspector told her that to make coffee, she would need to install a three-basin stainless steel wash-up sink plus a separate mop sink in her store, and she decided that coffee would have to wait.

Once through the general health licensing process, she then needed to obtain licenses for individual products. She wanted to sell aspirin, so she had to get a state over-the counter drug sale license. She knew that customers would want cigarettes, so she had to obtain a tobacco sales license. One day as she was setting up, a state inspector noticed she had a carton of eggs in her cooler, and notified her she needed a state license to sell eggs (as Dave Barry would say, I am not making this up). And then there was the problem of beer.

She knew that selling beer would require an alcohol license. In addition to requiring a long, tedious application, getting such a license required that she be finger-printed at the local Sheriff’s office, that she measure the distance in feet to the nearest three stores that sold alcohol and the nearest school and church, and that she attend eight hours of special alcohol sales training. The whole application process took many months — at one point her application was kicked back to her because she included a computer CAD drawing of the store when the instructions require the drawing be made by hand (I repeat, I am not making this up). She finally thought she was home-free, when she found her state requires a public hearing as a final step to determine if the market really needs another liquor retailer. At that hearing, several large, powerful local liquor businesses testified that the market was already saturated and that they already had plenty of competition, thank you very much, and her application was denied.

By the time Julia called it quits, she still had multiple applications pending. She hadn’t yet figured out how to create the stormwater runnoff management plan needed for her stormwater permit. She hadn’t been able to satisfy the state air resources board in permitting her small above-ground fuel tank. And she was still going back and forth with the state department of water resources for her drinking water sampling and testing plan.

Julia gave up her dream of working outdoors, and spent the rest of her life closeted in a room staring at a computer screen. It wasn’t what she really wanted to do, but web design does not require a license (yet) and she could avoid the hassles involved with having employees. The public never got its park back, and the campground still sits closed, the facilities falling apart from neglect. But a few months after Julia gave up, a park agency employee wrote a scathing editorial in the local paper, citing Julia’s failure as a great example of how private enterprise has failed and the need for public agencies to do more.

Julia’s experience is a composite, but is based entirely on my personal, real experiences. Every tax, registration, report, inspection, and license mentioned is a real one my company has had to obtain at some point in our expansion to new states. The only difference is in the story of the liquor license, where after my local competitors initially blocked the license I had the wherewithal to fight and eventually get it issued.

Looking at the Business Cycle as an MBA Rather Than an Economist: The Effect of Organizational Dynamics on Recessions

I will confess that there is much about advanced economics that I have trouble following, because I just don't have the background.  I suspect I am more comfortable with a mal-investment model of recessions because it is something I can see and understand as a business guy, whereas when talk gets into monetary policy I can quickly get lost.

For example, in this Arnold Kling review of Scott Sumner's book on the Great Depression, I totally get this:

Sumner's theoretical framework starts with a straightforward explanation for fluctuations in employment and output. Large shortfalls in output and employment occur when relatively flexible prices fall in relation to relatively sticky wages. When firms face high wages and low prices, they have to cut back on employment and output.

A business guy (outside of a commodity business) would probably say he sees a fall in demand for his product rather than a fall in prices, but I understand enough economics to know that these are essentially interchangeable -- the business is seeing a fall in demand at the old price but would likely see the same old demand if the price were lowered.

However, when I read stuff like this, I start to get lost.

If investors believe that the future path of monetary policy is expansionary, then they will immediately start to bid up prices for sensitive commodities. This means that if the central bank sends a credible signal today that it will maintain an expansionary stance going forward, this can quickly raise prices relative to wages, leading to a rapid expansion of employment and output.

I understand it intellectually, but I certainly don't go on a buying spree the moment the Fed announces more QE (though in retrospect looking a the rise in financial asset prices over the last few years, I should have).

But where I was going with all this is there are real-world effects that I am positive contribute to the depth of recessions that I seldom see in these economic theories.  For example, economic theories tend to assume firms are properly staffed heading into the downturn, such that layoffs are driven by the fall in prices/demand.

But that is not ever the case.  In my experience, it is an iron law of organizations that their staffing grows fat in the good times.  No matter how tough or attentive the management, firms will put on too much staff.

My personal theory is that organizations have a life of their own.  Almost literally.   In many ways the organization acts as a living entity with a mind of its own, trying to grow and feed itself.  It does not consider what size it should be, any more than a deer heard is concerned about its size vs. the available food supply.  It will keep growing until it is culled by an outside  force (lack of food or a predator).

I think of organizations the same way, and the only way to check its growth is with active management from the top.  Managers have to constantly stay on top of the organization's size and be pruning or culling it constantly (depending on the metaphor you want to latch on to).  However, because of scale economies, profits tend to grow faster than revenues at the top of the business cycle.  This creates a certain comfort level among management, and since pruning the organization is emotionally difficult -- at the least saying no to people's resource requests and at the most demanding layoffs --managers don't keep up with their job in this area in the good times.  No one notices that a 15% profit growth could have been 20% if they organization had properly been kept in check.

Then comes the downturn.  Demand and/or prices are falling, and profits are falling faster than revenues, and the crisis is now at hand.   Now that we have overcome whatever emotional starting friction there is to have layoffs, we might as well do the job right and cut not only what is required to keep up with falling prices, but we might as well take a look at the bloat we accumulated in the good times and right-size that away as well.  In fact, many businesses I have worked for or with as a consultant like to overshoot what they might have previously thought of as the right-size point, and cut even deeper, hoping that the limited resources will push the organization into finding new inefficiencies in how it does things.

And thus, in my view, the degree of layoffs in a recession will tend to be larger than that one might predict solely from sticky wages and declining  prices/demand.

By the way, for those of us who are skeptical about the government's ability ever mange a task efficiently, this organizational theory is one explanation.  Often commenters make the mistake of assuming that when I criticize tendencies in government organizations to look after themselves (rather than their mission) that I am singling government out as somehow operating differently from the private world.  That is not true.  Government is made up of the same human beings as businesses (though perhaps there is some negative self-selection) and government organizations are going to have the same tendencies as private organizations.

The difference is one of correction mechanisms and incentives.  Eventually, the private organization must clean out the bloat or else it will fail and go out of business entirely (unless of course the government bails it out, see: GM).  There is no such accountability with government organizations.   They just deficit spend or demand more taxes when they get bloated.   Making this worse are the incentives of  government agency leaders.   Lacking a profit metric or even a customer service metric, government agency managers typically get their pay and prestige set based on the budget and headcount of the organization they run, so cost and headcount cutting run directly counter to their incentives.  Combine this with higher barriers in government organizations to cleaning house (e.g. public union power and politicization of what should be efficiency decisions) and we get the dysfunctionality of government.  But again note, this is an issue of accountability mechanisms and incentives, not of having better or worse or smarter people.

China as a Test of Keynes vs. Hayek

Let's start by saying that I have an imperfect layman's view of Keynes and Hayek.  This is my understanding and over-simplification of how these camps deal with economic downturns.

  • Keynes:  Economic downturns result from some sort of failure of aggregate demand.  There are positive feedbacks in the system such that a small downturn can lead to a larger downturn if left unchecked (but on the flip side mean that a small stimulus can have a disproportionately large effect on demand).  The proper government response to a downturn is to create demand through government deficit spending.   Failure to emerge in a timely manner from a recession likely is the result of the government not being aggressive enough in its spending.
  • Hayek:  Economic downturns result from mis-allocation of savings and investment capital, often due to government policy by not necessarily so (one can argue the housing bubble was driven by government policy, but the first Internet bubble likely was not).  The proper government response to a recession is to stop any distorting government policy that drove it and let the economy sort itself out by restructuring.  Failure to emerge in a timely manner from a recession is likely due to interventions that slow this necessary restructuring (e.g. bailouts, government-directed investment programs).

I will say that if my Hayek description is not correct for the Austrians, it is correct for me -- this is what I believe happens.

That said, I have long thought the Japanese lost decade(s) were pretty much final proof of the Hayek vs. Keynes explanation, and I am sort of amazed people still argue about it.  I remember in the 80's people in the US admired the Japanese MITI system of industrial management that carefully directed investment into government-preferred industries and, by the way, stomped on the Japanese consumer (including laws that kept both the retail and agricultural sectors backwards) in favor of promoting the export market.

In the 20+ years since Japan slid into a downturn, they have been the poster child for Keynesian stimulation.  They have deficit spent like crazy and have driven up -- by a longshot -- the largest government debt as a percent of GDP of any of the industrialized nations.  Yet still they flounder -- I would argue precisely because they had an Austrian recession, based on years and years of government-enforced mal-investment, but have refused the Austrian solution.  Watching it evolve over the years, I have thought it impossible to miss the point, but it appears that Krugman-Keynesians can always argue, not matter how much government debt was run up, that the problem was that they just didn't spend enough.

Well, in my view we have another such test coming, perhaps even more stark -- in China.  China, perhaps more than Japan, has filled their economy with investment distortions -- the huge empty cities that get shown on the Internet seem to be one example.

China empty city

And over the past year or two, China has been deficit spending and stimulating like hell -- both at the central government level as well as with policies that have encouraged the accumulation of debt both locally and in industry.

This is why I think the crash is coming in China, and the longer they manage to delay it by artificial means, the worse and longer the crash will be.  There is probably a bet that could be had here, but I am not sure how it would be structured.

Looking for Advice: Ethics of Prisoner Labor

This is sort of an odd topic to have on my mind, but I was thinking about it today in the context of a bid package I have in my hands for concession management of a park in Georgia.

The RFP kept referring to "community workers" who do 60% of the labor in the park, and part of our responsibilities included managing these workers.  In my naivete, I thought these were volunteers, and sent a note telling them that while the government could legally use volunteers, it was very problematic under labor laws for a private company to benefit in any way from volunteer labor.

I was quickly informed that I had it all wrong, that this was a euphemism for "prisoners," and that I could take advantage of their close to fee labor to do much of the heavy lifting in the park maintenance.

I must confess this is a new one for me but my initial reaction is queasiness about it.  On the one hand, we are talking about unpaid labor from men in involuntary servitude -- do I really feel good about benefiting economically from this work?  On the other hand, I do understand that work programs can be beneficial for prisoners, though I am not sure the work we need is really going to be teaching many skills.  On the gripping hand, there is "Cool Hand Luke", which is impossible to get out of my head when considering prison labor in the deep south.

One other aspect of the RFP that struck me cold was the pages and pages of requirements, including an actual oath I have to take, that I will do everything possible not to hire an illegal immigrant.  Now, that sort of thing is likely required of them by state law, and is not that unusual (Arizona has similar provisions, I believe).  But juxtaposed with the prison labor, it leaves me cold.  Essentially, they won't allow me to accept the voluntary labor of a Mexican man paid at minimum wage, but they are encouraging me to accept the involuntary labor for free from a group of prisoners.

I just encountered this about 10 minutes ago so I am still thinking on it -- the basic opportunity is attractive.  But I have walked away from opportunities before over these sorts of ethical issues -- most recently, over a refusal to drug test employees when that was a state requirement.

I welcome thoughts in the comments (I know I mentioned immigration, but in this one post I would be thrilled if we could lay off my supposed naivete on immigration and focus on the ethics of profiting from free prison labor).

A Fundamental Shift in the Economy, At Least for Entrepreneurs and Small Business

When politicians argue about small business growth, they argue about stuff like taxes and access to capital and, god help me, completely irreverent (to small business) stuff like the ExIm Bank.

I would argue that there has been a fundamental shift in the economy relative to small business over the last four years, but it has nothing to do with any of that stuff.  I would summarize this shift as follows:

Ten years ago, most of my company's free capacity was used to pursue growth opportunities and refine operations.  Over the last four years or so, all of our free capacity has been spent solely on compliance.

Let me step back and define some terms.  What do I mean by "free capacity?"  In a small, privately-held company, almost all the improvement initiatives spring from the head of, or must heavily involve, the owner.  That would be me.  I have some very capable staff, but when we do something new, it generally starts with me.

So OK, our free capacity is somewhat limited by my personal capacity as owner and President.   But actually, I have a head full of ideas for improving the company.  I'd like to do some new things with training that takes advantage of streaming video.  I'd like to add some customer service screening to our application process.  But my time turns out not to be the only limit -- and this is one of those things that HBS definitely did not teach me.

In the real world, there are only so many new things I can introduce and train my line managers to do, and that they can then pass down to their folks.  An organization can only accept a limited amount of new things (while still doing the old things well).  This is what I mean by "free capacity"  -- the ability to digest new things.

Over the last four years or so we have spent all of this capacity on complying with government rules.  No capacity has been left over to do other new things.  Here are just a few of the things we have been spending time on:

  • Because no insurance company has been willing to write coverage for our employees (older people working seasonally) we were forced to try to shift scores of employees from full-time to part-time work to avoid Obamacare penalties that would have been larger than our annual profits.  This took a lot of new processes and retraining and new hiring to make work.  And we are still not done, because we have to get down another 30 or so full-time workers for next year
  • The local minimum wage movement has forced us to rethink our whole labor system to deal with rising minimum wages.  Also, since we must go through a time-consuming process to get the government agencies we work with to approve pricing and fee changes, we have had to spend an inordinate amount of time justifying price increases to cover these mandated increases in our labor costs.  This will just accelerate in the future, as the President's contractor minimum wage order is, in some places, forcing us to raise camping prices by an astounding 20%.
  • Several states have mandated we use e-Verify on all new employees, which is an incredibly time-consuming addition to our hiring process
  • In fact, the proliferation of employee hiring documentation requirements has forced us through two separate iterations of a hiring document tracking and management system
  • The California legislature can be thought of as an incredibly efficient machine for creating huge masses of compliance work.    We have to have a whole system to make sure our employees don't work over their meal breaks.  We have to have detailed processes in place for hot days.  We have to have exactly the right kinds of chairs for our employees.  We have to put together complicated shifts to meet California's much tougher overtime rules.  Just this past year, we had to put in a system for keeping track of paid sick days earned by employees.  We have two employee manuals:  one for most of the country and one just for California and all its requirements (it has something like 27 flavors of mandatory leave employers must grant).  The list goes on and on.  So much so that in addition to all the compliance work, we also spent a lot of work shutting down every operation of ours in California, narrowing down to just 3 contracts today.  There has been one time savings though -- we never look at any new business opportunities in CA because we have no desire to add exposure to that state.

Does any of this add value?  Well, I suppose if you are one who considers it more important that companies make absolutely sure they offer time off to stalking victims in California than focus on productivity, you are going to be very happy with what we have been working on.  Otherwise....

I fully understand the dangers of extrapolating from one data point**, but for folks who are scratching their head over recent plateauing of productivity gains and reduced small business origination numbers, you might look in this direction.

By the way, it strikes me that regulatory compliance issues set a minimum size for business viability.  You have to be large enough to cover those compliance issues and still make money.  What I see happening is that as new compliance issues are layered on, that minimum size rises, like a rising tide slowly drowning companies not large enough to keep their head above water.  We are keeping up, but at times it feels like the water is lapping at our chin.


**Unrelated Postscript:  I have found that in the current media/political world, people love to have only one data point.  Why?  Well, with two data points you are are stuck with the line those points define.  With just one, you can draw any line you want in any direction with any slope.

I Have This Argument All The Time With The US Forest Service

I operate recreation areas in the US Forest Service and from time to time get criticized that my profit adds cost to the management of the facilities, and that the government would clearly be better off with a non-profit running the parks since they don't take a profit.  What they miss is that non-profits historically do a terrible job at what I do.  They begin in a burst of enthusiasm but then taper off into disorder.    Think about any non-profit you have ever been a part of.  Could they consistently run a 24/7/365 service operation to high standards?

Don Boudreaux has a great quote today that touches on this very issue

from page 114 of the 5th edition (2015) of Thomas Sowell’s Basic Economics:

While capitalism has a visible cost – profit – that does not exist under socialism, socialism has an invisible cost – inefficiency – that gets weeded out by losses and bankruptcy under capitalism.  The fact that most goods are more widely affordable in a capitalist economy implies that profit is less costly than inefficiency.  Put differently, profit is a price paid for efficiency.

It is also the "price" paid for innovation.

Excellent Slate Article on GMO Safety

It is a long article, covering a lot of ground, and is full of links to literature on both sides of the debate.  But its conclusions are pretty definite

I’ve spent much of the past year digging into the evidence. Here’s what I’ve learned. First, it’s true that the issue is complicated. But the deeper you dig, the more fraud you find in the case against GMOs. It’s full of errors, fallacies, misconceptions, misrepresentations, and lies. The people who tell you that Monsanto is hiding the truth are themselves hiding evidence that their own allegations about GMOs are false. They’re counting on you to feel overwhelmed by the science and to accept, as a gut presumption, their message of distrust.

Second, the central argument of the anti-GMO movement—that prudence and caution are reasons to avoid genetically engineered, or GE, food—is a sham. Activists who tell you to play it safe around GMOs take no such care in evaluating the alternatives. They denounce proteins in GE crops as toxic, even as they defend drugs, pesticides, and non-GMO crops that are loaded with the same proteins. They portray genetic engineering as chaotic and unpredictable, even when studies indicate that other crop improvement methods, including those favored by the same activists, are more disruptive to plant genomes.

Third, there are valid concerns about some aspects of GE agriculture, such as herbicides, monocultures, and patents. But none of these concerns is fundamentally about genetic engineering. Genetic engineering isn’t a thing. It’s a process that can be used in different ways to create different things. To think clearly about GMOs, you have to distinguish among the applications and focus on the substance of each case. If you’re concerned about pesticides and transparency, you need to know about the toxins to which your food has been exposed. A GMO label won’t tell you that. And it can lull you into buying a non-GMO product even when the GE alternative is safer.

This is just the management summary, the article goes into great depth on all of these.


The DOL is Admitting That New Overtime Rules Won't Lead to Much Extra Pay

Here are some numbers from the DOL draft rule.

They think there are 21.4 million salaried workers subject to the wage test.  Since the new number was set at the 40th percentile of these workers, presumably about 8.6 million will fall below the new number.  But of these, only 4.6 million would be have to be shifted to hourly/overtime rules (not sure why the difference, I guess other tests must still apply as well).

Those 4.6 million are expected to cost employers an additional $1.2 billion in wages, which seems like a lot but equates to an additional $261 per person per year extra.   In other words, a pittance for all this disruption.

The Left is already saying that companies won't adjust and all these folks will get raises.  But the DOL obviously thinks differently.  Either it thinks these folks are only working maybe an hour each of overtime per week, such that the overtime rules will only cost a few bucks a week, or the DOL thinks that a lot of work and wage rates are going to be pared back leaving folks about where they are today, except now as timeclock punchers rather than trusted salaried professionals.

I am still going through all the tables in the back where they generate this stuff, but there are a couple of admissions there you WILL NOT find on liberal blogs today

  1. The DOL expects that base wage rate for regular work hours to fall for the affected workers with this new law.  You heard that right.   See table 21.  The fall from $18.38 to $18.21 after this rule in DOL projections
  2. You will see folks (like Kevin Drum linked above) saying that this ends 60 hour work weeks.  In fact, in table 22 the DOL says the average work week of those affected by the rule is 41.6 hours, which will go down to 41.5 hours by this rule.  In fact, the 60 hour folks are a minority of go-getters who are trying to prove themselves out for upper management.  These are the folks hamstrung by this law, hammering precisely the upwardly mobile folks one would hope to encourage.

France Arrests Entrepreneurs for Crime of Innovation. Is it Any Wonder the Economy Sucks?

CEO of Uber France has been arrested because, uh, his competitors have resorted to violence to defend their inferior product.  The fact that the victim rather than the perpetrators of violence is getting arrested speaks volumes to how far governments will go to block innovation that hurts politically-connected incumbents.

After days of violent protests and defiance on the part of Uber's French management, two of the company's employees were taken into custody for "illicit activity" today. Uber France CEO Thibaut Simphal and Uber European GM Pierre-Dimitri Gore-Coty were arrested for running the company's ride-sharing service illegally. TechCrunch reports the pair is also being held under suspicion of "concealing digital documents." Last week, French Interior Minister Bernard Cazeneuve took legal action to shut down UberPOP, the service that employs non-professional drivers to provide rides, in response to protests that blocked key transportation hubs.

... While UberPOP was banned in France earlier this year, an appeals court said it could continue to operate until the final decision was handed down in September.

Obama's New Wage and Hour Laws Worse For Our Company Than Rising Minimum Wages

Rising minimum wages are bad enough, but generally we can offset them with price increases (remember that, though, next time you get ticked off about your camping fees going up).  As an aside, not every business is in a competitive position that they can do this.

But the new Obama Administration rules greatly scaling back on our ability to have our managers be exempt employees is far, far worse.  Because its not just money, but it changes the entire relationship between me and my managers.  Most of my managers don't want to be hourly employees (you should see the complaint emails I am getting since I announced that this is likely coming) and have pride they have moved beyond timeclock punching.  Also, I think a lot understand they are not going to make more from this, and they may even make less.  To the extent they are working overtime today (and they all are) they will not be allowed to work overtime in the future.  So I will have to hire someone else to do those extra tasks, and that person's salary is likely to come in part from what the managers are making now.

These next few months I am having all of my salaried managers fill out time sheets just for analytical purposes.  I need to know how bad this is going to be.  If you run a business, you shouldn't be waiting for next year to do something, you need to be thinking and analyzing right now how you are going to handle these rules.

I wrote a long article on this here.  Stephen Miller has more in the same vein (via Overlawyered great wage and hour news roundup).  Here is a taste:

In McCutchen's view, the administration fails to understand that "it's still the same pot of money that's available to compensate the employee," whether a worker is classified as exempt or nonexempt. So if overtime pay is required, a likely result will be to strictly limit overtime hours worked, despite the adverse effect on productivity, rather than—as the administration expects—to increase the employee's annual compensation.

While many non-executive employees view themselves as professionals and react negatively when shifted to hourly compensation, "the DOL wants nearly everyone to be nonexempt, and to sign in and clock out as do unionized workers," McCutchen contended. "They don't believe that some employees prefer to be salaried, with guaranteed pay and the flexibility to adjust when they do their work."

Postscript:  I guess I just don't understand the vision that is in the head of Progressives.  How does it help their stated goal of empowering the average Joe to convert him from a valued, up-and-coming junior manager to a 40 hour a week timeclock puncher?  How will people ever be able to migrate from lower end jobs to management positions if there are not junior manager positions in which they can demonstrate their energy and dedication?  I suppose they must believe that junior managers will still be doing the same things and working the same hours, but just earning lots of extra overtime with these new rules.  If that is really what they think, they are completely divorced from reality.