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Barriers to Entry

Wednesday, October 5, 2016 7:44
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Barriers to entry is a phrase you hear in business a lot.  It’s a wrote phrase from business school.  What it really means is what is the secret sauce that allows your business to be better than your competitors?  Sometimes, it is about brand.  This is why you see consumer products companies spend millions of dollars on advertising.  Most of the advertising is designed to create an aura around a brand, and then reinforce confirmation biases among customers.

In B2B business, it’s slightly different.  But, there are still confirmation biases in customers that companies can exploit.  There is still branding.  I am reminded of what my friend Richard Duchossois told me.  He said, “With this one company we owned, we never had to do any marketing.  Our customers brought us new customers.”

That word of mouth marketing is the best kind of marketing.

Many companies do have proprietary intellectual property that is a secret sauce which separates them from the pack.  At early stages the key for investors is figuring out if the secret sauce is scalable.  Often, the secret sauce is personal and it is hard to scale a person.

One of the most interesting things to watch with social media companies is how they use network effects to build a barrier to entry.  Does it make sense to try and compete with Facebook?  It’s an awfully hard, expensive mountain to climb.

But there are other barriers to entry as well beyond network effects, branding and secret sauces inside companies.  Regulatory.  Over the past 20 years, we have seen a massive increase in the federal and state government regulatory registers.  That creates an artificial barrier to entry.  Since Dodd-Frank was passed, it has become awfully hard to startup a bank.  By awfully hard, I mean impossible.

The regulatory state has caused consolidation.  Banks are buying up banks.  Insurance companies are buying up insurance companies.  Hospitals are buying up hospitals.  When the corporates get big enough, the next step is to find a way to do a foreign merger and move outside the US.  The tax arbitrage is good for shareholders and profits.

It occurred to me while watching and listening the discourse in this presidential cycle that politicians are no different than companies.  They brand.  They try and create network effects to build power bases and create advantage.  They also use artificial constructs to limit competition.

One of them is tax returns.  Let’s face it, there isn’t one single person in the US that can understand the US tax code.  It’s over 70,000 pages.  If I gave the same exact data to 10 different accountants I am highly likely to get 10 different returns.  So, since the US tax code is so messy with all kinds of built in loopholes for people that can qualify, why is a tax return a requirement for being a politician.

One thing that I detest about both political parties is career politicians.  Both parties have them.  Career politicians have incentives to keep independent businesspeople from entering.  If I look at the roster of politicians in Washington, a very large percentage from both parties have turned elections into a career.  That creates bad incentives.

You might hate Trump.  I can understand that and appreciate your point of view.  But, one thing the Trump tax issue should bring up is the tax code is severely unfair to many US citizens.  No matter what, when you raise taxes at the top of the curve, the middle class and poor get hit too.  We need a really honest, transparent conversation on the US tax code.  Unfortunately, it’s going to be impossible to have.  Taxes are economic incentives, not revenue generators.   He certainly isn’t a career politician and that’s one reason a lot of politicians hate him.

If the US went to a simple flat tax system of around 15% with very few write offs against income, there would be plenty of revenue to operate the government-and a helluva lot more economic activity.


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