Wednesday, December 10, 2008

End of Work, End of Affluence III: The Rise of Informal Businesses

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As the Depression slashes sales, the high fixed costs of operating a business in the U.S. will till under thousands of firms large and small. As a result, millions will lose their jobs. Informal businesses with few or no fixed costs will arise to take the place of high-cost businesses and old-style permanent jobs.

The costs of doing business and paying employees and their overhead are insanely high in the U.S. As a result, any slackening in sales requires immediate cuts in payroll. As the recession turns into a Depression in 2009, thousands of businesses will find their fixed costs are simply too high to survive.

Correspondents Richard Metzger and Craig McCarty sent in this story which states the obvious: Company crashes set to hit record next year :

"Record numbers of companies will go bankrupt next year with 200,000 insolvencies in Europe alone and "an explosion" of failed businesses in the US, according to the world's largest credit insurer. "

For context, here's what it takes to keep the doors open for business in the U.S.:
1. in a major city, rent of $3,000+ a month for a modest space; property taxes paid by the landlord run at least $10,000 a year or about a fourth of rental income.
2. high "junk fees" levied by local government: business license fees (often a percentage of gross income, so you pay even when losing money), permits, special district fees, etc. etc.
3. high overhead costs for formal employees.
4. high taxes on net income and high overhead costs to comply with complex regulations and tax accounting. These high fixed costs are the reason a business can't cut employees fast enough to match dropping revenues; soon enough, revenues fall below fixed costs, meaning even firing all employees and working for free can't save the business.

Ironically, the absurdly high rents are set by the absurdly high value placed on commercial buildings--values based on the absurdly high rents some poor fool agreed to pay. Like a dog chasing its tail, commercial real estate skyrocketed in value as the boom led many doomed entrepreneurs into believing they could pay the stupendous rents and taxes and still make money.

The recession/Depression will cut down every business paying high rent and other fixed costs like a razor-sharp scythe hitting dry corn stalks. Let's check in with how many typical small-town or neighborhood businesses will bring in enough revenues in the Depression to support skyhigh rents and other high costs, and actually leave a livelihood for the owners:
bookstores: 0
dry cleaners: 0
ice cream /snack shops: 0
coffee shops/cafes: 0
corner grocery stores: 0
music stores: 0
high-end restaurants: 1 (the one the politicos frequent)
shoe stores: 0

You get the idea: high fixed costs will take down every business which can't remake itself into a low-fixed-cost firm. Unfortunately, the only businesses which can do so are those which own their own buildings and fixed plant outright.

Sure, the burgs around the headquarters of global companies like Apple, Chevron, Philip Morris, ADM, Proctor & Gamble, etc. will do OK, but as cities like San Francisco, Chicago and New York start squeezing the remaining corporate tenants for more tax revenue, even the global giants will pull up stakes and move to cheaper climes.

All those glitzy office towers are nice when the profits are flowing, but once losses start piling up the prestige value of an address goes to near-zero. And check out how "global headquarters" can shrink down to a few hundred employees as work is shifted to other cheaper global cities. One-person outfits and corporations alike may choose to maintain a tiny presence in New York for prestige purposes, but the core of the business will be moved elsewhere--it's either reduce fixed costs or go under.

The perniciousness of high fixed costs stems from wildly inflated real estate values and greedy governments which have long seen businesses as corralled cows to milk 24/7. As rents rise, valuations for buildings rise, too. But in recessions, the landlords' mortgage costs don't decline a single dime; so they are loathe to lower the rents, preferring to hope for better times next year.

That hope has another name: bankruptcy. Meanwhile, the cities, counties and states drawing off the businesses are loathe to trim taxes as revenues shrivel; they're more inclined to actually raise "junk fees" on business as a way to offset their declining tax revenues.

Even as they mouth "business-friendly" slogans and propaganda, the politicos smugly raise taxes, confident that (insert place--California, New York, San Francisco, Atlanta, etc. etc.) is "special." Note to Oklahoma, Mississippi, Kentucky, et al.--cut the fat from your state budgets and invest in your roads, railroads, electrical generation system and Internet trunk lines, and you will be able to cherry-pick global HQs from bloated, arrogant California and New York at will.

Oh, and don't forget to improve your schools; corporate HQ people look very closely at the quality of your public education.

So here is a recipe for destruction of enterprises large and small: landlords who cannot or will not lower rents by 2/3, and local governments who are in denial that their own high taxes are destroying or driving away their "cash cows."

Tourist destination cities like Honolulu, Los Angeles, New York and San Francisco have been able to rip off tourists for decades during the global boom; but as tourism falls in half (or more), the cash cows both domestic and foreign will be too few to support the bloated bureaucracies which have expanded on that fat tax base.

For the former employees, the landscape is bleak: there are no jobs anywhere, at any wage. If you happen to be a skilled machinist who lives near the plant making F-22 fighter aircraft, you're one of the lottery winners, along with the crew hired to repave I-999 (Obama's infrastructure spending). So out of 135 million jobs, how many are in highway/bridge rebuilding and defense industries? A couple million?

So how can anyone earn a living in The End of Work? Look to Asia for the answer. The MSM snapshot of Asia is always of glitzy office towers in Shanghai or a Japanese factory or the docks loaded with containers: the export machine.

But if you actually wander around Shanghai (or any city in Japan, Korea, southeast Asia, etc.) then you find the number of people working in the glitzy office tower is dwarfed by the number of people making a living operating informal businesses.

Even in high-tech, wealthy Japan, tiny businesses abound. Wander around a residential neighborhood and you'll find a small stall fronting a house staffed by a retired person selling cigarettes, candy and soft drinks. Maybe they only sell a few dollars' worth of goods a day, but it's something, and in the meantime the proprietor is reading a magazine or watching TV.
In old Shanghai, entire streets are lined with informal vendors. Some are the essence of enterprise: a guy buys a melon for 40 cents, cuts it into 8 slices and then sells the slices for 10 cents each. Gross profit, 40 cents.

In Bangkok, such areas actually have two shifts of street vendors: one for the morning traffic, the other for the afternoon/evening trade. The morning vendors are up early, selling coffee, breakfasts, rice soup, etc. to workers and school kids. By 10 o'clock or so, they've folded up and gone home.

That clears the way for the lunch vendors, who have prepared their food at home and brought it to sell. In some avenues, a third shift comes in later to sell cold drinks, fruit and meat sticks as kids get out of school and workers head home.

Fixed costs of these thriving enterprises: a small fee to some authority, an old cart and umbrella--and maybe a battered wok or ice chest.

So this is what I envision happening as the Depression drives standard-issue high-fixed cost "formal" enterprises out of business in the U.S.:

1. The mechanic who used to tune your (used) vehicle for $300 at the dealership (now gone) tunes it up in his home garage for $120--parts included.
2. The gal who cut your hair for $40 at the salon now cuts it at your house for $10.
3. The chef who used to cook at the restaurant that charged $60 per meal now delivers a gourmet plate to your door for $10 each.
4. The neighbor kids' lemonade stand is now a permanent feature; you pay 50 cents for a lemonade or soft drink instead of $3 at Starbucks.
5. Used book sellers spread their wares on the sidewalk, or in fold-up booths; for reasons unknown, one street becomes the "place to go buy used books."
6. The neighborhood jazz guy/gal sets up and plays with his/her pals in the backyard; donations welcome.
7. The neighborhood chips in a few bucks each to make it worth a local Iraqi War vet's time to keep an eye on things.
8. When your piece-of-crap Ikea desk busts, you call a guy who can fix it for $10 (glue, clamps, a few ledger strips and screws) rather than go blow $50 on another particle board P.O.C. which will bust anyway. (oh, and you don't have the $50 anyway.)
9. The guy with a Dish runs cables to the other apartments in his building for a few bucks each. 10. One person has an "unlimited" Netflix account, and everyone pays him/her a buck a week to get as many movies as they want (he/she burns a copy of course).
11. The couple with the carefully tended peach or apple tree bakes 30 pies and trades them for vegtables, babysitting, etc.

OK, here is today's "Depression business idea giveaway". Deploying the Pareto Principle, we can estimate that only 20% at most of the populace will be able to afford $10 to see a first-run film on the big screen.

So how to serve the other 80%?

Find a long-empty warehouse with an owner happy for a one-night rental (or a warehouse with no known owner at all), borrow/scrounge a decent screen (lots of multiplexes will have closed by then) and some folding chairs, old sofas from the dump, etc., get a DVD or print of a popular film and then charge $1 a person, maybe $2 if you actually get a real projector and a real print. Post the movies and dates on the Internet, spread the word on local campus websites, etc. (See Weblogs & New Media: Marketing in Crisis for more web-based marketing ideas.)

Have some homemade goodies to sell (no booze, you don't want it to get ugly) and a cozy atmosphere. People who want to see a film on a screen larger than a TV will pay $1, as will people who miss the "experience" of a theater.

I happen to know this model works because I've seen it work in 1986, even when there was no recession/Depression. People will flock to a super-cheap "theater" in a crummy warehouse as long as the picture quality is good and they feel safe doing so. Art films and foreign films might do OK, as will comedies and "dumb" movies which allow people to get together and mock something/have a few laughs.

All of this fits in with my suggestions for valuable trades posted in The Art of Survival, Taoism and the Warring States: making beer (in legal quantities only, which is still alot); saw sharpening, growing something to eat.

These ideas are all obvious, and they appear to be catching on; correspondent Azvitt recommended this story on empty urban lots in Detroit being turned into garden plots: GM's Bust Turns Detroit Into Urban Prairie of Vacant-Lot Farms.

Cities will have three choices in this environment, and those which choose badly will go bankrupt themselves as the new informal economy moves beyond their reach. Cities can try to suppress informal vendors and enterprises with heavy-handed tickets and court orders issued by police, but this will fail for the simple reason no informal enterprise can afford to pay even the "Business license fee," not to mention rent and all the other taxes. The informal economy will simply shift to beyond city boundaries, and the city will have lost its last best hope for survival.

Or, the city can look away, and tolerate a two-tier economy in which a dwindling number of old-style businesses pay full freight and taxes and the informal enterprises make enough for residents to support the few old-line "formal economy" firms that cling on.

Or the city actually embraces the informal economy, and sets up a venue for tiny enterprises to do business and perhaps prosper. If a stall is $10 a day, then maybe the city will get some takers--if they provide a clean, fun atmosphere for the $10/day. If not, why bother?

If a city license is $10 a year, then they might sign some folks up--especially if your service is then listed in the city directory, where it just might generate some new business.

Note to cities: you are now an enterprise, too. The cows you once milked are either wandering off or dying. Either get the entrepreneural spirit and help your residents make a living or prepare your bankruptcy filing. That goes for counties and states, too.

And so what will my informal business be? Just show me your crappy broken Ikea furniture and I'll demonstrate. As an old hippie carpenter, waste has always bothered me, so I've fixed quite a few busted particle board shelving units, desks, etc. I have my bag of tricks, nothing fancy, but nonetheless unknown to most "consumers." I'll trade for eggplants, homemade beer (not too fizzy or flat, please) or German-style black bread or melons or homemade noodles--go ahead and make me an offer.

Oh, and we made over 30 pies off our peach tree crop last season; what do you have to trade for a still-warm homemade peach pie? Can you swap out the back derailleur on my 15-year old Mongoose mountain bike? I just turned another 1,000 miles on it (in 7 months) and it's getting worn.

15 new provocative Readers' commentaries--check them out!

Here is Part II of Chris Sullins' strategic action thriller, Operation SERF: Operation SERF, Part II(Chris Sullins, December 6, 2008) It was a half hour after dawn and the early morning light provided enough illumination to the living room via the large broken picture window and open doorway to Eduard Morgan’s home. Mark had regretted allowing his aunt Maria to come back to the home with him to check things out. She was now knees down on the carpet next to Eduard’s body sobbing with her face buried in her hands. Operation SERF, Part I

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