DRI-269 for week of 11-10-13: How Business Views Competition

An Access Advertising EconBrief:

How Business Views Competition

Every profession must endure the distortions resulting from the misshapen lens of public perception. Veteran economists know the specialized meaning of terms like “competition” and “efficiency.” They know the attitudes and mental habits formed by businessmen. And they know what happens when the mind of the businessman is forced to coexist with the vocabulary of economics. What happens is that the businessman perceives economics through the subjective prism of his own wants and expectations. This produces a view that is wrong in predictable ways.

By appreciating how intelligent, single-minded businessmen go wrong, we can better calibrate our own understanding with the truth. Recent published examples provide excellent case studies in the pathology of business misunderstanding of economics.

iK9 – Establishing “Standards” for the Detection-Dog Market

The current (11/4/2013) issue of Bloomberg Business Week tells the story of iK9, a detection-dog business started by a man named Tim Dunnigan. In the article “The Bomb Squad: Building an Empire on a Dog’s Nose,” author Josh Dean explains Dunnigan’s attempt to build a security firm around the olfactory talents of bomb-sniffing dogs.

Detection-dogs use their highly advanced sense of smell to locate everything from explosives to drugs to malignant tumors in humans. Their talent is inborn but requires extensive training and direction. Most of this training is done by individuals working alone or within small businesses, but one of the largest institutions devoted to this purpose is Auburn University’s Canine Detection Research Institute. This subsidiary of the university’s veterinary research school trains some 200 teams of dog and handler every year for corporate and government clients. Associate Director Paul Waggoner has perhaps the best view of the dog-detection market.

“Detection-dog training has been a vocation where most of the knowledge has been handed down in master-apprentice manner. That’s led to a lot of unproven ideas and ways of doing things,” Waggoner observes. “It’s still a young field,” a “trust-me” kind of business.

It’s no wonder, then, that “the detection-dog marketplace is fragmented, and no one knows for sure how large it is,” according to Josh Dean. Estimates range from $400 million to $700 million. So far, the big-ticket buyers have been government and the military, with private security a distant third. In principle, though, “any high-traffic location or corporate headquarters is vulnerable” to the threat of terrorism or criminal activity, so “the potential market is immense.” On the other hand, the service is quite expensive. Effective security requires round-the-clock surveillance and dogs need constant care and supervision. Demand has fluctuated wildly, skyrocketing after the 9/11 attacks and the Boston Marathon bombing but nosediving in between.

Tim Dunnigan’s business plan calls for reaching $200 million in revenue as quickly as possible. He projects about $300,000 in annual revenue from each dog-and-handler team, so his game plan requires employing hundreds of dogs and trainers. Competing in the marketplace poses special problems because the scope for cost-cutting is minimal; any reduction in quality could be fatal to the firm’s competitive position.

What is Dunnigan’s strategy for rising to this competitive challenge? According to author Dean, it would seem that Dunnigan is instead planning on cutting competitors down to his size. “As much as anything, Dunnigan’s strategy seems to be to raise the industry’s profile anddemand that anyone offering canine detection adhere to standards that have yet to be formalized [emphasis added]. One challenge, he says, is that ‘everybody thinks his technique is the best.'”

It is worthwhile noting that even the federal government – thus far the leading purchaser of detection-dog services – has so far feared to tread the line of standardization. “Detection dogs are such a freewheeling business that a U.S. government training standard does not exist among the many departments deploying them in the field,” Dean admits. The watchword of government is coercion and compulsion, so at first glance Dunnigan seems foolish for rushing in.

In a free market, Dunnigan is at liberty to promulgate whatever standards he chooses – for his own firm. He can advertise them in accordance with his inclinations and financial resources. He can contrast them with those of his competitors – or with those they lack.

But the phrase “demand that anyone offering canine detection adhere to standards” has a sound that is both familiar and worrisome to the veteran market watcher. It smacks of the classic American business strategy: get the government to suppress your competition. In this case, it would mean that Dunnigan is lobbying for passage of industry regulations that a fragmented industry of smaller operators would find costly and cumbersome. After all, they don’t have the resources of a CDRI or Auburn University to call upon. These regulations would raise costs in a highly competitive, low-margin industry. (“You wouldn’t believe how thin our margins are,” complains Paul Stapleton, son of the founder of MSA Security, pioneering private-security dog-detection firm and New York-market leader.) In turn, that would drive some firms out of business and reduce the supply of services, raising price for the remaining firms.

To the average person – the man or woman on the street, untrained in economics – a call for standards sounds innocuous and even praiseworthy. All of us have grown up hearing the phrase “the XYZ industry is not regulated by the government” used synonymously for “this industry is inhabited by dishonest, unscrupulous bastards who will take your money and your life without a second’s hesitation.” But to an economist, the “demand for standards” is seen in its true light – as a demand for regulation that will restrict competition at the consumer’s expense and for the benefit of one or a few firms in the industry.

Were we to summarize this rhetorical pathology, it would read as follows: “In order to protect buyers from being exploited by sellers, who may or may not possess mysterious means of providing this new and valuable service, standards of performance must be set. Obviously, these must be set by government because…because…well, because that’s just the way things are done. As a would-be leader in this field, I demand that government step in and set standards to save all of us sellers from succumbing to our own shortcomings.”

Evil Street Vendors

The great economist and multi-disciplinary theorist Thomas Sowell has specialized in exposing the logical shortcomings of conventional rhetoric. One of his most incisive exposes has been of the “powerful powerless” – groups of the lowly and disenfranchised whose economic prospects are customarily suppressed on the contradictory grounds that they somehow possess unfair advantages over ordinary people. Street vendors are charter members of this unfortunate fraternity.

The conventional case against street vendors was argued in a recent letter to The Wall Street Journal (11/11/2013). The author, one Jerome Barth, represents a New York business group called the 34th Street Partnership.

“The Journal has steadfastly defended street vendors in the past…It should follow from common free-market rules that this position is sound. However, in the case of street vending, it isn’t.” This stance is a backbone of the rhetorical practice known as “special pleading.” Free markets and competition, it grants, are wonderful things. They work beautifully – except in my particular case/industry/country/state/city/neighborhood. My case is special, exceptional. Why? Well…er…uh…because it’s mine.

“Street vendors are not necessarily the sign of a good economy or a good downtown. They are messy actors who usually have very poor aesthetics and offer a very uniform product of relatively low quality – when it isn’t counterfeit.” No doubt Mr. Barth would take strong exception if somebody referred to his colleagues in collective terms – “the 34th Street Partnership are sloppy businessmen with questionable ethics.” But he does not hesitate to herd all or most street vendors into one corral and brand them with the same iron. They don’t merely offer a uniform product; they offer a very uniform product! (In political rhetoric, nothing succeeds like excess.)

Of course, we all know that you just can’t trust vendors who sell uniform products of relatively low quality, like McDonald’s, White Castle, Wal Mart and Dollar Store. But it isn’t enough that the street vendors be pigeonholed as specialists in inexpensive, homogeneous goods – no, they must be stigmatized as crooks, counterfeiters. This is just another way of saying: “The customers of street vendors are complete idiots, since they cannot detect forgeries of the simplest, least complex goods; instead, they not only fall for the fakes but apparently keep coming back for more!” And since the customers of street vendors are the same people who patronize the downtown shops of the 34th Street Partners, Mr. Barth is stigmatizing his own customers and those of his colleagues.

“Further, they [street vendors] seldom follow rules, often don’t pay taxes, often exploit workers and leave messes behind.” Throughout the world, street vendors are the lowest of the low among businessmen. Often their net worth travels with them in the cart or wagon that dispenses their wares. The working capital with which they purchase tomorrow’s inputs is gained from today’s sales. But in Mr. Barth’s telling, these powerful powerless wield powers unknown to mortal businesses. They ignore laws, evade taxes, exploit workers – does this mean that a one-man hot dog vendor acting as entrepreneur exploits himself acting as laborer? Meanwhile, Mr. Barth would have us believe that police are the powerless ones. In reality, the police typically act in concert with Mr. Barth and colleagues to roust street vendors on the slightest pretext. Of course, nobody disputes that street vendors should pay taxes and respect property rights, and they possess no special rights or immunities that would prevent this.

“…The great retail places of the world…don’t have street vending or…limit it to products that enhance the street experience and have difficulty paying for storefronts (flowers, newsstands, shoeshine).” The criterion “products that enhance the street experience” is utterly subjective; it allows would-be cartels like the 34th Street Partnership to restrain trade and restrict competition while holding up a fig leaf of pretense by allowing vendors as long as they don’t compete with incumbent merchants. Any downtown habitué knows that flower stands, newsstands and shoeshine parlors do sometimes operate behind storefronts; this is merely the pretext under which the cartels grant them the special privilege denied to competing street vendors.

If there is even a tiny grain of truth in Jerome Barth’s case against street vendors, it would have to crystallize around the issue of spillover costs resulting from a transient vendor who cannot be traced and braced for costs of cleanup. Presumably, this was the rationale for Atlanta’s awarding a franchise rather than allowing open competition among street vendors (“…in the case of Atlanta’s concession of street vending to a single group. namely General Growth Properties”). However dubious this example and this practice may be, it serves to demolish whatever remains of Mr. Barth’s argument against street vending.

The outlines of this second anti-competitive rhetorical pathology are as follows: “Free markets are wonderful for everybody else, but not for me because my case is special. I am the helpless victim of invidious, evil forces beyond the reach of normal market competition. The law must suppress these competitive forces or they will destroy me. (The fact that these powerful evil forces consist of people who are otherwise the most powerless people in society is a paradox that I do not choose to address or even recognize.)”

It’s the Gypsy (Cab) in My Soul

Although both of the first two examples are recent, the attitudes displayed therein have been around for many years. A classic case amalgamating the two rhetorical stances involves the “gypsy” cab business. Gypsy (illegal) cabs operate throughout the world. Taxicabs are heavily regulated around the globe and gypsy cabs are linked to regulation the way pilot fish are attached to whales.

In its paradigmatic form, taxi regulation limits the number of taxis allowed to operate within a political jurisdiction and also prescribes the specific fare structure the taxis are allowed to charge. In effect, the governmental body regulating taxis functions as a cartel that blocks entry of new firms into the market. This limitation places an upward bound on the amount of taxi service that taxi consumers can receive, thereby bolstering the high price set by the regulators. In turn, this allows monopoly profits to be earned on the supply side of the market. Whether the beneficiaries of those profits are taxi firm owners or drivers or somebody else depends on various factors, some of which we will elaborate below.

New York City is the classic case of taxicab regulation resulting in monopoly profits and the proliferation of gypsy cabs. Beginning with the Haas Act in 1937, operators of New York City taxicabs were required to purchase medallions as emblems of licensure. During World War II, 1,794 of the original 13,566 medallions were returned to the city by entering servicemen. That left 11,772 outstanding medallions – a total that has not increased since then.

Meanwhile, the demand for taxicab service in perhaps the most tightly concentrated population in America continued to increase. There was no way to legally increase the size of the taxicab fleet and no way to legally raise the price of service. Thus, waits for service became intolerably long. Service to poorer neighborhoods deteriorated disproportionately, especially to ghetto communities where the risk of robbery and injury to drivers was thought to be higher. Eventually, local residents responded by reallocating private passenger vehicles to the service of commercial passenger transportation; they installed meters, top lights and lettering identifying the vehicle as a taxicab. These gypsy cabs found a plentiful market for their services inside the ghetto and even ventured into the larger community in search of business.

Sometimes private vehicles were conscripted to serve as livery vehicles or jitneys. In principle, livery vehicles are defined as for-hire transportation vehicles engaged via telephone or appointment only and not responsive to street hails. In practice, though, this distinction gradually blurred and the unmarked livery vehicles became de facto taxis. Individuals who contracted with grocery stores to provide exclusive “car service” for shoppers became the modern-day prototype for jitneys. With very few exceptions, these too have traditionally been illegal in America but have been tolerated by authorities beset by complaints about poor taxi service.

Why not simply open up the taxi business for competition? In New York City, the monopoly profits available in the taxi market have been reaped by owners of the medallions. Although it is the drivers who pocket the money derived from the high taxi fares, the value of those monopoly profits is capitalized into the price paid for the medallion. (The medallion is legally transferable, so a retiring driver can cash in his or her investment by selling the medallion to a prospective entrant into the business. The price of medallions fluctuates; it has often reached six figures over the years.) If the city were to suddenly allow free entry into the taxi business, the market value of those 11,772 medallions would suddenly fall to zero – and 11,772 medallion-holders would raise hell when their capital asset suddenly evaporated in their hands. Obviously, New York City politicians fear the volume of this outrage more than they welcome the more moderate gratitude that would flow in from taxicab consumers.

The official rationale for taxicab regulation dates back roughly a century, when the automobile was young and taxis competed with buses and streetcars. City government wanted to protect buses and streetcars from the competition of taxis. But they couldn’t very well say that they wanted to deny taxicab consumers the transportation services vital to their well-being. Instead, they used the same sorts of arguments that survive to this day in the official pamphlets and websites that warn against gypsy cabs.

A famous 1969 New York Times piece warned its readers that, by riding in a gypsy cab, “…you may be putting yourself in the care of a murderer, a thief, or even a rapist [!]. The gypsy driver, by the very fact that he solicits on the street, is at least a crook, but he may have big ideas which include you.” Of course, the inherent contradiction implied by this characterization is never broached. The very thing that makes the gypsy cab attractive is the possibility of earning money by transporting passengers. In order to do this, the vehicle must be made both conspicuous and distinguishable. But driving a big yellow vehicle marked with a number is not conducive to the successful commission of a crime, since it makes its driver both highly visible and easy to trace.

One would suppose that the prospect of traveling with crooks, rapists and murderers would deter prospective passengers of gypsy cabs, but evidence supports the conjecture that gypsy cab operations were and are “flourishing,” to borrow the characterization of black economist Walter Williams. Various estimates have been made of the gypsy cab influx within New York City. One Taxi and Limousine Commission chairman put forward the figure of 15,000, which would have made the gypsy cab business larger than the licit medallioned fleet.

This suggests that gypsy cabs are, in the aggregate, more beneficial than legal cabs. Throughout New York City, but especially in the ghettos and low-income areas, people dependent on commercial transportation are willing to use unauthorized means of transport rather than wait for hours on authorized transport that may never arrive. More pithily put by Wikipedia: “Passengers sometimes find illegal cabs to be more available, convenient or economical than licensed cabs.” Gypsy cabs are often cheaper than licensed cabs in absolute terms. If one thinks of a time delay in obtaining a cab as a form of higher price – foregoing time otherwise available for work or leisure, just as paying a money price entails foregoing alternative consumption goods or saving that could be enjoyed – gypsy cabs are clearly the lower-priced alternative to licensed taxicabs. Consequently, it is the legal taxicab industry that most assiduously demonizes gypsy cabs through propaganda such as that in the quoted New York Times piece above.

Seldom has reality been so at odds with rhetorical pretense as in the taxicab business, where the conventional thinking is bereft of any economic content. Expressing the conventional view compactly would yield something like this: “Crooks are people who violate the law. Gypsy cab drivers violate the law. Therefore, gypsy cab drivers are crooks. Crooks rob, rape and kill people. Therefore, gypsy cab drivers also rob, rape and kill people. You should be happy to wait hours for a licensed cab and pay its sky-high fare rather than risk robbery, rape and death in a gypsy cab.” As with the other rhetorical pathologies we exposed, this one is utterly without redeeming social value. It serves the interest of the taxi cartels and bureaucrats and nobody else.

Business and Competition

These few examples point to a great American truth. American business is devoted to the principles of free enterprise – but not to their practice. American business loves competition – for its rivals. The best way for a business to avoid facing competition is by removing competitors. The best way to remove competitors is by making them illegal or, alternatively, passing laws and regulations making it too costly for them to operate.

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