Today, we take a brief pause from our normal economic and financial market commentary with this tale of common sense economic calculation and action. And no, we do not believe that the world is any more complex than we present it here. If you want to understand economics, you need first understand two things: That the human condition is one of scarcity and uncertainty; and that absent rational economic calculation and a certain degree of passionate risk-taking, nothing good can ever come of it.
Yeoville was a small Midwestern town of farmers, a few shops and cottage industries. It had grown slowly through the years and had not changed much. Once in a while there was a good year, less frequently a bad one. On occasion these were related to poor weather or other reasons for a poor harvest. There was also the difficult time when a large portion of the young men went off to fight in a war. Fortunately, most returned, although their absence put a huge strain on the remaining residents to make ends meet. But on the whole the townsfolk thought well of their position and went about their business with a healthy mix of realism for today and optimism for the future.
Mr. André Prenner was one of the more successful small businessmen in Yeoville. He was now in his 60s. His father had been a baker and manager of the town bakery, Yeoville Bakers. He was descended from immigrants from France, or so he was told by his parents, hence his first name.
André learned the baker’s profession from a young age, at first informally, assisting his father outside school hours and, after graduating the local high school, working part-time while taking a degree course in business at the local community college in the larger town a few miles downriver. As time would tell, André was not only given to work, but to greater ambition.
Taking advantage of youth, some savings from his part-time work, and a strong dollar, André celebrated completion of his business degree by taking an extensive trip to France – back to where, supposedly, his family was from – and also around various other countries in Europe. What he found astonished him: Unlike at home, where bread was simple, white and cheap, in France and in Europe generally, there was an endless variety of breads, in all shapes, sizes and even colors. It was as if the bread changed village to village. Even breads that looked the same tasted somehow different.
André returned to Yeoville some months later with a passion and a plan. He was going to turn Yeoville Bakers into something far greater than just a typical, small-town Midwestern bakery. He was going to introduce a range of European breads for distribution all over the state!
Now this was easier said than done. Anyone could, with enough searching around in a large city library, find a book with recipes for various types of European breads. But where to source the ingredients? And just because he loved the variety, would a range of pricey European breads sell well to a customer base which had lived its entire life chewing on the basic, cheap white stuff?
André promptly answered each such question with his passion. He was just going to have to give it a go. He was young; he knew the trade; he had learned to love European breads in short order; he had the support of his father even, who had a soft spot for his presumed French heritage. The worst that could happen is that he would go bankrupt and, as an experienced young baker, would then seek an assistant manager’s job at one of the many small-town bakeries in the state. In other words, his worst case was really quite similar to what he would do if he didn’t even give it a try. So give it a try he did.
It didn’t take long to discover that, if you knew where to look, ingredients for European breads were not difficult to come by. Indeed, the bigger US cities, in particular on the mid-Atlantic coast, were home to some well-established bakeries producing European-style breads. He soon found how to get access to those same ingredients, transported to Yeoville for what he believed reasonable cost. He also researched the cost of distributing his breads to other towns in the region and how to partner with local shopkeepers to sell his product. That was the easy part. More difficult was that he was going to need to expand the existing bakery by adding new equipment. If he simply stopped producing basic white bread, the bakery would generate no income at all during an uncertain transition period and risk losing its client base. No, he would need to develop the new range of breads in parallel.
As the bakery had not generated enough retained earnings to cover the purchase of the required new equipment, André was going to have to go to the local bank for a loan. Business plan in hand, he took his years of experience, good local reputation and enthusiasm into the bank. When he departed that day, he had secured a business loan, itself secured on the new equipment he was about to acquire.
Once he had arranged for the purchase of the new equipment – which would be delivered, installed and operational within just two months – he set out looking for the three new employees that would be required to run it. Only one needed experience, as he had that himself in spades. The other two could just be hard-working, reliable and willing to learn. He found the experienced employee at a bakery in a nearby town who was keen on a new challenge. The other two he found locally, both of whom had been doing odd jobs since graduating high school a year before, but according to their references they did quality work when they could get it and were quick to learn new skills.
For the first few months André didn’t give a thought to making a profit from the new operation. He wanted to sample customers’ tastes and make the decision regarding on which breads to focus for the first year so that he could secure the needed ingredients in affordable bulk rates. He travelled to many towns and even some small villages in his bakery truck, giving away free, fresh samples everywhere he went. Once it became clear what people liked and were willing to pay a bit more for, he contacted his suppliers, ordered the necessary ingredients for regular, weekly deliveries over the coming year, arranged for the printing and distribution of promotional material, finalized agreements with shopkeepers all over the state, and sent the new baking operation into high gear.
Already in the first year the new breads were contributing a substantial portion of the overall Yeoville Bakers’ profit and André repaid one-third of the bank loan. The business was growing rapidly, but now all costs were variable, internally-generated cash was substantial and, as such, the loan was no longer required. He paid it down fully within three years, two years ahead of schedule. This freed up additional cash which was used the following year to finance the lease for a new bakery, in another town about 50 miles away, which would make full statewide distribution a reality.
André was pleased with his success as a businessman but nothing pleased him more than when he entered the bakery at 5am each morning – bakers are notoriously early risers due to their need to prepare for everyone else’s breakfast – and smelled those European breads that he had first encountered several years prior on that auspicious trip to Europe. Bread was his business but remained his passion.
Many years later André was the most prominent baker in the state. He even distributed some to neighboring states. He employed nearly 100 bakers and a handful of young apprentices. But then came hard times: A major national recession. Budget cutting was the norm and, when it came to bread, customers were buying far less of his gourmet European breads. The operation was losing money rapidly and something had to be done.
Setting his passion aside for expediency, André took immediate action to protect his business. Having learned his trade by baking the simplest, cheapest bread possible, he went back to his roots. He cancelled his contracts with his suppliers for the gourmet ingredients and, once existing supplies were depleted, reoriented his entire operation toward making basic bread again. A dozen employees focused on the gourmet breads business were let go on the understanding that they would be re-hired once business turned for the better again. Other staff was expected to take a temporary pay cut. A few resisted but, once it was clear most of their fellow employees were willing to accept it, they went along.
At least there was still plenty of demand for basic bread, which provided for a reliable if less profitable business. This period lasted nearly two years. Yeoville Bakers was never at serious risk of bankruptcy, in large part due to Andrés swift reaction to the downturn. But it had been a hard time nonetheless and taught André some important lessons. When he felt the time was right and sensed rising demand once again, he returned to his passion of baking gourmet European breads and re-hired most of his former employees, several of whom had made do with odd jobs in the interim. Business began to grow again, but André was a bit more of a businessman now and a bit less of a passionate visionary. Yes, he had now managed to save a good deal of money, but he told himself he would always be cautious, never expand too quickly and always make certain he had the flexibility to change and/or reduce operations as required to face challenging circumstances.
It was three decades later when things got really bad. Not only was the nation in recession; tax and regulatory policies had made André’s business considerably more costly to run. Although he had not expanded the business by much in recent years, he now had to employ three accountants to handle Yeoville Bakers’ more complicated affairs. The US Department of Agriculture (USDA) was now quite active in screening foreign grain and flour imports for bad quality or what they sometimes referred to as “irregularities”, as if André or his more experienced staff would be unable to determine quality for themselves. The Commerce Department occasionally imposed foreign duties because of what they called “dumping” which to André seemed rather arbitrary. And the regular or, on rare occasion, surprise inspections of his own facilities, imposed a cost unseen by anyone but André and his core team, who always needed to be prepared just in case, with any and all requested documents, tours of facilities, product samples, etc.
As such, running the business had become more complex, with supplies harder to secure, prices more volatile and higher overhead costs. Adding to the challenges, it was now difficult to hire new employees, not because of a shortage of those able or willing to do quality work; rather, because payroll taxes and required healthcare and other benefits were much higher than before. Also, he had had some difficulty reducing staff during the most recent downturn, with one employee accusing Yeoville Bakers of unfair dismissal, including claims of workplace discrimination. The ensuing legal tangle was resolved in favor of Yeoville Bakers but cost André much valuable management time and taught him an important lesson about how careful he needed to be when hiring new staff. Unless he was absolutely certain that they were qualified, reliable and unlikely to complain if let go, he wouldn’t hire anyone, no matter how rosy future business prospects.
So now, André found himself facing the familiar situation of slack demand he had faced several times before in his long career, but he lacked the flexibility to respond as effectively. It was one morning when he was contemplating what, exactly, he should do in the current instance, when he received an email from the Small Business Administration (SBA) offering him a loan.
Now this had never happened before. André knew of many businesses that had received government subsidized loans through the years. Most of those businesses had grown and thrived, at least for a time. But he could not recall the SBA offering loans pro-actively in this way. It was the businesses that normally did the asking. So why was this happening? Could it have something to do with what he had heard about many banks turning small businesses down for new loans? Or cutting existing lines of credit? Everyone knew that banks had lost a huge pile on residential and commercial lending. Although André had no use for a loan at present, he was intrigued by the very existence of the program and inquired anyway, picking up the phone.
“Small Business Administration, new loans division, may I help you?”
“Yes, I’m calling to inquire about an email I received offering me a low-interest loan. Please could you let me know some of the terms and conditions, as well as the purpose of the program?”
“Of course. We are offering subsidized loans to small businesses that can demonstrate that their access to credit has been reduced, or that have viable expansion plans yet cannot get access to new credit. Specific terms and conditions vary with the size and proposed use of the loan. Those uses pertaining to environmental or green technologies receive the most favorable terms. The overall purpose of the program, other than supporting small businesses generally, is to ensure that credit is available, in particular for investment related to environmental or green technologies.”
“Have you recently been denied credit?”
“Do you have plans to expand your business?”
“What then is the reason for your inquiry?”
“Just curious, thank you.”
“Well if your circumstances change, please don’t hesitate to give us a call.”
“Thank you. I will do so. Goodbye.”
André hung up the phone and thought to himself. “So this is the way the government goes about trying to restore economic growth: First, they cut interest rates to near zero, following the residential and subsequent commercial real estate bust. But apparently that isn’t enough to stabilize the big banks, several of which are at risk of failure, so the central bank bails them out, assuming some illiquid, toxic debt that André knows will never be sold back into the market. Then the government enacts a massive stimulus plan, which seems primarily to funnel money to a bunch of big businesses with strong connections to government, most of which probably have little difficulty accessing credit. But none of this seems to help smaller businesses, which is where most hiring in the economy normally takes place and where worker productivity tends to be highest. So now it appears they’ve got some fancy new program to extend credit to small businesses, but the favored terms are reserved for those that are keen to invest in the sorts of projects that the government wants, for whatever reason, and which are already being done in some shape or form by the large, government-connected businesses that received most of the stimulus money in the first place.”
“In the meantime, they have raised payroll taxes, in part to pay for increasing healthcare costs. The state has also raised sales taxes to cover an unprecedented revenue shortfall. They are threatening now to raise income and corporate taxes. The regulatory regime was already uncertain and is likely to become more so as Congress seems unable to resist the temptation to respond to each new lobbying effort by this industry group or that. Workplace discrimination suits are now so commonplace that I need to do full background checks on potential employees to make certain that, in the case I need to let one of them go, they are unlikely to take legal action. Customer demand remains weak as unemployment remains high. Now my input costs are soaring because of the weak dollar – which I understand is the result of so-called “quantitative easing” – which pushes up global grains prices. These costs I can only partially, if at all, pass on to my customers, implying lower margins and profitability ahead.”
“And these guys think that I, a small-town baker, might be interested in a loan? In expanding my business? In hiring new workers? Business is risky enough in good times. It is riskier in bad times. But even in the bad times – and I’ve had a few – there have been occasional opportunities to hire a good employee; acquire some good equipment at a low price from another bakery closing its doors; adjust the product line to better suit changing consumer attitudes. Yet now, not only are times bad; the uncertainty is higher than ever and the priority of the government is really not about getting the economy going again with sensible, sustainable, predictable tax and regulatory policy but rather about subsiding their pet programs and government-connected firms, which in the end is only going to raise the overall economic debt burden, implying even higher tax rates in future. No thanks.”
He went for a long walk and thought. The next day he went for another long walk and thought some more. He spoke to a few other small businessmen he knew who were getting by but not doing particularly well. He shared a few thoughts with his wife and with the two oldest of his three children. And he made a decision, perhaps the most difficult of his life.
The next day, after he arrived at work, he assembled all of his senior employees in his office. He let them know that he was going to put the business up for sale. If they wanted, they could buy him out over time, financing the purchase with a loan that he would provide at a low interest rate. He was retiring, he said.
“This seems rather sudden,” said one of his assistant managers.
“No, actually, it’s not. It is the result of trends that have been in place for a long time. It’s just that I think about things differently than I used to. I’m getting older. And as you get older you begin to realize that some things may change for the better, some for the worse, but some things don’t change at all. I’m tired of waiting for some things to change. I’ve had enough. It’s your turn now. Good luck.”
His employees were stunned. They respected the man, who had a fine reputation. He had kept his business profitable and, more often than not, growing, for over 40 years. And now it was their turn. They were going to need good luck all right. Lots of it.
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