Archive for May, 2009

Local Power

Congratulations on the recent approval of Farm Power to sell stock to non-accredited investors in Washington State! This is an exciting thing because lots of people I know are interested in the idea of how can local folks invest locally but there are very few options. I got to invest in the first round. SEC regulations designed to protect people from being defrauded mean that either you have to be wealthy enough that the SEC isn’t worried about you (an “accredited investor”: anyone with a net worth of 1 million or more) or there can’t be much money at stake (Reg D places a limit of 35 non-accredited investors in any company.) So “friends and family” investments usually fall under Reg D, and folks are usually raising less than 100K, or they’re using their own money by mortgaging their house, tapping their retirement, got an inheritance.

Farm Power used a state regulation called the Small Corporate Offering Registration (SCOR). Under SCOR you can only raise one million dollars per offering , so the going theory is that you might as well just deal with accredited investors, especially I think now that there are all these organized angel groups. Otherwise you have to do the hard work of selling your stock through advertisements and meetings. Though honestly, the angel-group route might not be that different in terms of effort-to-reward. There’s no broker distribution network for this kind of stock, it’s too small-potatoes, not enough room for middleman cuts. I think a regional broker who would focus on SCOR offerings would make a good meeting place for investors like me who are looking for something more interesting than a Shorebank Pacific CD (though that’s not a bad place to start) that is local and green.

NET: While SCOR has been around for a decade, very few offerings have been made. When I last looked into it the primary users were churches issuing construction bonds to sell to their members. So let’s hope Kevin and Daryl SCOR with this offering and demonstrate that with a real, meaningful and local project it can work. They were inspired by the MinWind projects in Minnesota where local investors have successfully invested in local wind turbines. They’re also Skagit county natives and wanted to stay focused on their community, though raising that much money inevitably means including the whole Puget Sound. Still we’re all one watershed, so that’s local in my book.

In general, in community & local finance I keep running up against the challenge that it’s tough to pay any intermediaries for due diligence or market-making on smaller investments and not eat up all the return in fees, which is a structural barrier to the local economy. The internet should be a good opportunity to do things at low cost, but that business model also generally assumes scale, which if we’re focused on local, we lose. The other tradeoff is that direct and local pulls against diversified, but I think that’s solvable too, we just have to keep it in the puzzle.

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I had a great visit with two managers of the housekeeping cooperative recently. Their second unit is struggling to build business and we went over the likely problems. They had a good handle on it and seemed to just need some validation, but we did get into a discussion about how we could have ensured more customers right from the beginning by pre-advertising. It got interesting fast and I felt we were starting to document the gap between communal ethics and capitalist ethics and learn to articulate it. Obviously this organization will never get to a point of choosing between a legal decision and a business decision (IE go ahead and break the law and pay the fine because it’s still an economic gain) but I have, during my MBA, come to believe that it would be ethical to post a website advertising service in multiple service areas the group is not yet serving to test market demand and wait for it to reach a certain level before we actually launch a team.

The managers weren’t so sure, they felt that wasn’t wholly ethical. I argued that when a customer calls, you can honestly say you’re not yet fully operational but you’re coming and you’ll add them to your list for the launch announcement. Given the turnover in the market, 6 months later when there’s now a list of 150 at-one-time-interested customers to notify that a new provider is now in business, odds are some of them will bite. And what did that actually cost them: a single inquiry, likely one of many?

I see business models like that all the time, so I’m feeling like a pro passing this on to the cooperativists. But what are the ethics? A dead-end phone or email inquiry for service doesn’t cost the inquirer much. As I think about it I wonder if at some point it leads into a larger, well-used business model that I do find unethical. I haven’t seen anyone name it so I’ll call it “collective nibbling”, in disdainful honor of the Karass School of (Dubious) Negotiation’s “nibbler” technique, combined with the logic of collective action.

“Nibbling” is the practice of pushing for lots of small concessions. When I suffered through the negotiation seminar myself I remember Karass in the video suggesting to ask a seller to throw in a tie while you’re buying a suit. The online version of “Kennedy on Negotiation” by Gavin Kennedy (1998) emphasizes that accomplished nibbling is about a series of small concessions which gradually add up to a big concession. Ever had a moment when you felt like you were being sociable and you suddenly felt terribly taken advantage of? Gavin also calls this practice unethical. I’m actually quite proud that at the time I had the clarity of mind and conviction of conscience to state to the entire class that we were being taught to violate social norms. (Though now I know some biz schools teach that violating implicit agreements makes legal profit!) Anyway, Kennedy also says at one point “Most [individual nibbles] may be too trivial to provoke a response”. That’s where we get into the logic of collective action.

I’m currently reading Capitalism 3.0 by Peter Barnes (great book) and he brings up Mancur Olson and the logic of collective action to talk about why corporate interests dominate government. Olson pointed out that collective action is much easier for small groups than large groups, and much more rewarding as well. For Barnes, this explains why 5 airlines will spend millions to lobby for a $500 million dollar subsidy, because it’s a huge windfall for them, and citizens let it happen because in the end it costs us $5 each and it’s not worth the trouble to resist.

I see these two techniques often combined in business: it seems everybody charges a bonus “shipping and handling” fee beyond the actual costs of shipping, to the outrageous point where a photo printing site charged me $2.56 shipping and handling on an order of postage-included postcards that they were going to mail directly. They shipped nothing to me!! Maybe there are legitimate costs and it’s about gaming the initial pricing and surprising me at the end which is still an irritating nibble. My spouse goes batty about the way telecom companies break out a zillion fees as separate add-on taxes so they can advertise a low initial price; airlines do the same thing now too. Low-wage employers do it to employees all the time according to the housekeepers – hire them and then only at the first paycheck do they find out there was a uniform fee, or a training fee.

I’m sure we could all come up with a dozen examples. In the end, much as any of these things gall us, fighting them is batting at mosquitoes (and even some horseflies!) and so businesses get away with it. I don’t know how to draw the line, but the accumulation of these small bites is beginning to bleed the consumer economy dry. There are valid reasons for communal values folks to feel real concern about what they ask the public for.

Unfortunately, now we’re in business, and the alternative to asking potential customers to pay a negligible cost (of a potentially unproductive phone call) is starting a business with no customers. Somebody has to do that initial marketing with no revenue. As a cooperative it’s very difficult to raise starting capital – there’s no J-curve here on profits to attract private funders and public-minded funders are wary of for-profit models. Bhide in his classic text on business says that getting a business started requires spreading risk out among customers and employees and anywhere else you can. Having customers call you with the risk that you can’t actually serve them is doing exactly that. Otherwise we hire an employee with the risk we can’t actually give them work, or we take a loan with the risk that we can’t pay it back. There’s a conservation of risk: we can’t make it go away, we can only shift it around. If we insist on taking it all (or giving it all to one party) then we’re more likely to fail, so the question should be about a fair distribution of risk. The risk that our customer will have a wasted phone call, the risk that our housekeeper won’t get enough hours, the risk that the lender won’t get paid back, the risk that a truly worthy business model will flinch and fade.

I’m going to draw a line between the startup that needs to spread risk to survive and the ongoing concern that pushes for concessions to increase margin. I’ve also heard tell of a fast-growing high-capital startup that has abused some smaller suppliers by failing to pay bills until cut off. I know this startup is not yet cashflow positive so we can’t make a needs-based criticism because they are in danger of failing. Yet they’re not just violating implicit agreements, they’re violating explicit agreements. As any small company knows this is also a standard business practice. You don’t have to be in business very long to learn that a contract is only as good as your ability to enforce it.

So in becoming capitalist, I do see important distinctions among asking folks to take risks, asking folks to bear costs, and then what’s really going on in too much in business, setting up to lead folks into situations where by the time they recognize they’re being asked to bear a cost, the cost of not doing so (in lost time, committed resources) is greater. This is the curse I’ll name collective nibbling. The ultimate cost of that is a growing loss of trust and increasing business transaction costs; it is absolutely appropriate to decry that behavior. Just asking customers to take some risk, however, seems to be a necessary part of business thinking.

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