Looming Red

The first result of a moderate fire going through a forest with dry enough grass and green enough trees will be a complete burn off of the undergrowth while the trees are left standing. The trees might have some recovery and adjustment to do, but they are free from immediate future fire danger due to the lack of dry tinder recently burned off. The trees are free to continue to grow taller of wider and the undergrowth and saplings are gone. When a forest has been completely obliterated, trees and all, it is from a fire of greater intensity with greater kindling to fuel the larger destruction of the larger trees.

In a free society, government regulations are like these more moderate forest fires. The regulations burn through the small businesses and enterprises alik, but leave the enterprises standing and free to thrive in the new environment of devastation. This analogy is evident from the costs of compliance figures of new regulations and the profit margins a business has to survive the unknowns that the future brings.

All businesses have to plan for unknowns and accomodate them as quickly as possible and with the least losses possible when the unknowns become known. The future, to any entrepreneur is a source of hope and energy, but it is also a source of fear. When economies go south, costs for materials rise, and other surprises happen, the business owner or director has to adjust drawing on the built funds of formerly successful years. The business has to whether the storm with strength of former profits.

Regulations enter markets like moderate fires because of the costs that they force all to bare. Regulations are just like rising materials costs. If a business makes bean bag chairs and a new regulation regulates that fire retardants be added to the batting, what costs does that business now have to bare? They have to bare discovery of the new regulations, the cost of the retardants or the badding with the retardants added, the cost of risk of non-compliance, and the cost of not being able to maintain the customer’s desired price.

Discovery is expensive. The cost of discovering what the regulations even mean down to the level of the final product is the cost of attorneys, accountants, and fines resulting from the bad advice of  attorneys and accountants who proved to not be omnipotent. That discovery cost is not a cost that can be recovered on its own. It has to be rolled into the losses born by former profits or rolled into the cost of products or services.

For one section of the Sarbanes-Oxley legislation, FEI (Financial Executives International) found the average cost of compliance to be $1.7 million in 2007. Now, add that to the average cost of the rest of Sarbanes-Oxley. Of course that is cost born by evil bankers and speculators, so it’s alright, except for the fact that the cost is passed along in the form of lower investment gains and higher fees. When your 401K takes a dip it is not totally from a bad market, it also comes from the cost of regulations.

Once the regulations are discovered and the discovery is tacked on the end of the aggregate bill for the bean bag chair example, the business will have to find materials suppliers who have discovered as fast as they have and at a competitive price. Suppliers that meet that description will be fewer, making the supply of the badding lower driving up the price. So, the regulation had the same effect on the market that a devastating low crop yield of cotton would have. The scarcity of compliant badding is artificial scarcity.

The business may risk non-compliance because the cost of compliance is so great. This could cost more, however, since many regulatory fines are per-incidence, meaning exponentially high to a successful business. Some non-compliance can even bring prison time. In the case of regulation, it is not easier to ask for forgiveness.

The ultimate cost is the loss of customers, because the customers had no inside-baseball understanding of why you suddenly started raising the cost of your bean bag chairs. Costs cannot be born by the customers forever since customers will not buy at any price. Even if some knowledgeable customers knew why the bean bags jumped in price, the same customers may not have the money to buy at that price no matter how understanding they are.

If the bean bag company could not take the loss with previous year profits and could not pass the cost to customers, the business is burnt away. Where a larger business could whether the onslaught longer and more effectively, the smaller business is gone. The small business was the promising sapling growing from a single seed and seeking to grow to great heights or the lush grass satisfied with small stature and deep roots. The regulation forest fire burnt out the grass and saplings and left the mature trees to grow another year and root themselves ever deeper.

When a moderate fire goes through a forest, the smaller growth is reduced to carbon and other component fertilizers for the forest that often benefit the larger trees in the aftermath. Markets are no different in that the destruction of small businesses leaves gaps that can be filled by ever-growing enterprises with better lobbyists and larger teams of attorneys and accountants. Regulation helps big business, it doesn’t hurt it.