“Follow the money.”
It seems overly simplistic, but following the money is a basic rule economists follow. If you want to know people’s motivations for things, especially in the world of public policy, follow the money.
Before we get to why policy decisions are made, let me back up a step and talk about how national chains screw our local economies.
Market Data Flags Your Local Economy for Extraction
A standard practice in economic development for downtowns and main street organizations, is doing a market analysis. A big part of a market analysis is something called retail gap or leakage. This calculates how much people in a geographic area spend on products and services (demand) and compares it to the amount of those same products and services in the same geographic area (supply.) If there’s more demand than supply, then there’s leakage.
This means if people don’t have access to the goods and services they want, they likely go somewhere else farther away or online to get it, and money leaves the local economy. Chain retail looks for a large amount of retail leakage in their particular sector. If the amount of leakage reaches a certain point, they will consider locating in an area.
Every chain has slightly different criteria, but there is an entire sector of the real estate industry that calculates these leakage rates and criteria, and flags them for developers to plop in a nondescript (aka cheap) building on the cheapest land and markets the building to a chain.
I personally have sat through demos of these large database firms who brag how with one click, they can give you a list of every national chain who would consider locating on any site you choose. Most small independent businesses have no idea where to even get this data or that it even exists at all.
Chains are Gold Diggers
The most common defense of chain retail is “they employ people and pay taxes.” That’s true. They do. But even with hundreds of employees per store (most making minimum wage) and paying taxes, they are still extracting millions of dollars from your community.
Want to know how much? There are two numbers you need to understand. The first is Net Operating Margin. This number is basically the percentage of a store’s sales that are straight profit being shipped back to headquarters, whether its Bentonville, Minneapolis, or wherever. The other number is the average sales per store. If your community charges a local sales tax, you can probably find your specific location easily at City Hall. If not, you can use specific chain averages. These two numbers multiplied show you how much leaves your community every year. If you have several big boxes (which many communities do) then there are tens of millions of dollars leaving your community every year, which you can document like I did below.
|Chain Retailer||Operating Margin||Avg. Sales Per Store (National)||Avg. Annual Extraction|
Sources: The Motley Fool, Statista, Corporate Filings, 2019
This is a huge transfer of wealth from your local community to the corporate headquarters and shareholders of each of these companies. Assuming locally owned stores would carry the exact same products, this is the most defining difference between chains and locally owned businesses: where the profits end up. As a quick aside, the margin for online retail giant Amazon is only 3.5%, but they lack the overhead of brick-and-mortar stores. And unless you have an Amazon fulfillment center in your community, NONE of that money stays local or employs local residents. Whether its chains or online, money leaves your community making other people rich, but your community poorer.
Chain vs Franchise vs Locally Owned
It would be easy to just say your choices are national chains or locally owned. But there’s another option that muddies the water a bit. These are franchises. Franchises are often locally or regionally owned stores or restaurants, like McDonald’s, but are part of the national corporation. The benefit to local owners is buying into a proven business model and support in the form of suppliers, marketing, store design, and in some cases, financing. In these cases, the profit of the store (or stores) is kept locally or regionally. However, these franchises still must pay an annual franchise fee to the national corporation as well pay the suppliers the chain mandates (not from your community.) Remember the national marketing support? Yup, none of that is local either. That goes to firms in New York and other big advertising agencies. The main differences between national chains and franchises versus locally owned, boils down to local suppliers, support services like advertising and accounting, and most importantly the local owner who lives in your community. In the end, franchises are slightly better than national chains, but locally owned businesses still retain far more money in the local economy because they use other local businesses.
|Fees||None||Paid to Corporate HQ||None|
Why Don’t Local Leaders Care
I do think local leaders care…a little. I believe they see a successful small business and want more of those but have a fundamental disconnect between seeing that business and their policies and priorities. There are three main reasons local leaders pursue national chains over locally owned businesses. These are:
- Validation + Vanity
- Municipal Finance
- It’s Easier
Let’s take a closer look at these…
Validation + Vanity- The sad truth is, local leaders often see big national chains as a status symbol. That a big national company would want to come their town says something about their personal leadership. THEY made that happen. But it’s more like the sugar daddy or momma who believes the young, attractive gold digger is there because they see what a truly great person they are and not because they have millions of dollars they want.
I once had a local council member come up to me after a speaking engagement and attempt to brag that he and his council, “got together and gave Home Depot $100,000 to come to” their town. It was the first time I had to tell an elected leader they just wasted taxpayer money. He seemed confused at my response. But for them, the fact Home Depot was coming to their town meant more than the fact they were going to put the locally owned hardware stores out of business. He likely either didn’t know or care they were also helping facilitate the extraction of approximately $7 million is wealth transfer out of their community.
Municipal Finance- Municipal financing systems (and therefore motivations) are jacked up no matter where you go in the country. This is where we follow the money. There are two primary drivers from a taxing perspective that fund a lot of municipalities across the country: local sales taxes and property taxes. Local sales taxes are exactly like they sound. A small percentage of tax charged on the item sold. How does this promote chains? The simple math is the more retail sales that occur in a municipality, the more revenue they generate. Therefore, the motivation in this financing model is to help facilitate as many sales as possible.
Who is set up to generate a lot of sales? National chains. They do national advertising buys and have easily recognizable brands. The bigger the box, the more sales and sales taxes they generate. In this model, overbuilding big box retail to become a regional hub is rewarded and where the profit goes is of no consequence.
The other big taxing mechanism is through real property taxes, or taxes levied on real estate. In this model, the more real estate that is built, the more revenue. This results in a windfall of new cash every time a new building goes up. The fact infrastructure must be extended (and often initially paid for by developers) is largely ignored. The net result in the short-term is this windfall, regardless if the market data supports new construction. The long-term costs increase pressure for new revenue results in, you guessed it, the need for more development to pay for the last round of development. This creates a vicious cycle of growth and debt until the municipality either:
- runs out of land or;
- creates such a large blight problem from development leap frogging into new construction and leaving previous iterations behind.
It’s Easier- Recruiting big boxes stores is fairly easy. As I mentioned earlier, the market data is half the battle. Freeway access is the other. And there are huge associations like the International Council of Shopping Centers (ICSC) who act as a sort of a Tinder for chains and locations. After that, inertia takes over.
Helping start successful small businesses is hard work. Really hard. You have to find people who are motivated to be their own boss, quit their job, put their life savings on the line, find financing, and be able to function for at least the first year at a loss. The success rate isn’t terribly high either. So, it’s messy too. Lots of small businesses don’t make it past the first year.
As a former local economic development official, I will also tell you that people (especially economic development professionals) don’t want to be associated with failure. Small business development takes a ton of time and energy and doesn’t always pan out. Why spend all that time, frustration, and money when it’s easier to recruit big retailer. On top of that, your local elected leaders really like it when you bring them a retailer their constituents know and love, and they provide some of your funding.
If you’re a developer, you really want a national chain to fill your commercial space, even in a mixed-use and/or downtown project. Because of the high failure rate of small businesses, developers want to know they can count on the rent from those spaces. National retail chains are considered, “blue chip tenants.” This means they can sign long-term leases that make the developer and property managers life easier, can help them secure financing for their projects and provide revenue that makes the building more valuable.
Now that you know how and why the chips are stacked against small businesses, what do you do? Well, acknowledging you have a problem is the first step towards recovery. The first step is telling dad his 20-something year old girlfriend isn’t into him for his good looks. You will have to connect the dots for your local leaders on how much money leaves the community. Even then, the power of the existing municipal financing model will be hard to break.
The goal of economic development should be the creation of local wealth. If that’s the case, then a municipal funding model should follow suit. Shifting from local sales tax or property tax, to a local income tax makes the municipality vested in seeing its residents financially succeed. But this is difficult to do alone, because if a local government institutes a local income tax and the neighboring one doesn’t, the immediate reaction is high income residents will move to the taxing jurisdiction that doesn’t. They might. But if it’s coupled with lower property taxes or lowered sales tax, it becomes more palatable. Also, while some people might move, there will not be a mass exodus because of a local income tax. And if a local income tax isn’t sellable where you live, you at least know what the problem is and may be able to address it with more of a locally driven idea. I’m not here to handcuff your creativity.
As for addressing the vanity and economic development aspects of this, talking up the importance of locally-owned businesses (and finding great examples in other places) and putting an emphasis on how attractive they are to other locals, and even to visitors, if it helps make your argument. Creating unique places isn’t just about architecture and public space, but the impacts unique businesses have on the quality of life and ability to keep and attract residents is a growing factor in economic development as well.
To change the way our local governments value small businesses will not be an easy or fast process, and ultimately you may not even win. But it’s the fight that needs to happen if we want to fix our local governments and help local residents have ownership of communities.
Leave a Reply