Friday, June 15, 2012

States Funding Companies: Always a Bad Idea

The annual BIO meeting will be in Boston next week, so the media is looking a little bit more at our sector.  Today's Globe has an Op-Ed from Geoff MacKay, the CEO of Organogenesis, titled "Keeping Mass in biotech race" (or, online, "Fueling the next wave of biotech growth" .  Reading it, I've been kicked out of my posting inertia, as it touts exactly the sort of strategies which I believe are mistakes, with recent events nearby providing evidence.

MacKay's lead-in is that Massachusetts has a thriving biotech industry and that this contributes in important ways to the economy of the state.  No argument there.  He goes on to describe how other states and countries are eagerly trying to lure companies away, which is certainly true.
When BIO Nebraska offers convention-goers Omaha steak tips at the end of a long day, or when BIOTECanada supplies Tim Horton’s doughnuts and coffee for thousands at breakfast, they are not just showcasing their hospitality. They are firing the opening salvo in an aggressive marketing campaign that may include strong financial incentives, tax breaks, lower labor costs, and, in some cases, a fairly convincing argument about quality of life benefits outside of our state.
MacKay knows this well, because as he continues his own company was heavily recruited a number of years ago, and only when Massachusetts laid out a package of financial incentives did Organogenesis commit to stay.

Now, I do not believe I'm a Mass biotech snob, and there are certainly many companies that do very well outside hub areas such as Boston, the Bay Area or the D.C. Metro area.  But, my suspicion is that many of those companies do well because they grew organically in their location, and I also believe there are many real costs to a business in operating outside of the hubs.  For some companies, the benefits outweigh the negatives, but that is even less likely if you move to such an environment.

A key advantage of being in a hub is a supply of experienced staff.  Biotech has its ups-and-downs, but because there are so many companies in the Boston area there are lots of folks who are looking for positions.  When you are the hiring manager, that means you can look carefully for the right fit yet find someone relatively quickly.  Big tech hubs like Boston also mean that there are more opportunities for spouses and life partners who are technically oriented, and while that doesn't describe my situation it does seem that an awful lot of senior biotech folks share their lives with other senior biotech folks.

I'm also suspicious that many CEO's know all this, and simply rationally play states against each other to their company's benefit.  However, there are plenty of examples of CEO's who aren't so sophisticated, with the former management of BiogenIdec serving as one data point.  A few years ago someone had the brilliant idea of moving the non-R&D folks outside the Cambridge headquarters to the tony town of Weston, which happened to be where the then-CEO lived.  Those who had to live with this decision rapidly discovered the sheer inefficiency of it, as while the organization chart might have shown a clean split the reality is that communication must flow throughout an organization, and communication is often most effective face-to-face.

As far as incentives, there is a danger that Massachusetts politicians will soon forget the recent blow-up of 38 Studios (indeed, I thought about titling this "38 Reasons States Shouldn't Bribe Companies to Stay", but who's going to read something that threatens you with 38 bullet points?).  Curt Schilling started and ended his major league baseball career in Boston, and played a key role in the 2004 drive to a World Series victory, most memorably while playing with a jury-rigged ankle repair that visibly bled during the playoffs.  At the tail end of his career, he became known both for loudly espousing a free-market approach to the economy (he was even mentioned as a possible candidate for political office) and for a deep interest in sophisticated video games.

Schilling founded a company which ended up being named for his uniform number, 38 Studios.  The goal was to produce a new generation of online multi-person video games.  After starting in Massachusetts, he successfully wangled a $75M loan guarantee from Rhode Island on the condition that the company move there and create a set number of jobs.  Amazingly, Massachusetts officials refused to make a sweeter offer.  38 Studios' first game arrived this past winter and was greeted with critical praise but relatively modest sales.  More importantly, in the meantime the governor's chair in Rhode Island switched from someone who had spearheaded the deal to someone who publicly opposed it.

This spring, it all blew up rather spectacularly.  Rhode Island realized that 38 Studios was in serious trouble, and was asking for an advance on some additional tax credits (which it could in turn sell).  Governor Lincoln Chafee, was clearly not in favor of further aid, though did consider it.  38 was also due to make a payment on one of the loans, and looked like it might miss and default on the loan.  To much fanfare, the company delivered a check for the amount -- but it soon came out that they had tried to quietly tell RI not to cash it immediately, because it would bounce!  Later, it would come out that the company hadn't been making payroll for several weeks.

The whole incident underscored multiple points of why governments should not be directly funding businesses.  Schilling had a passion for the business, but no experience.  A good VC (I'm not claiming these are universal or common, but this is my experience) would help guide the company; politicians are completely wrong in this goal.  Schilling would later complain that Chafee's dire pronouncements on the company had killed a potential financing deal, but one of the Business 101 lessons apparently never taught to #38 by his agent is that if you don't have contractual control over who says what, then anybody can say anything.  In any case, if public money is at risk then the governor is ethically obligated to speak up.

The state also had no business investing so much in a single risky company.  Just the financials looked ugly; 38's next game was at least a year from delivery and they were carrying hundreds of employees.  Given media reports, it seems not unlikely that 38 Studios was going to go $150M-$200M in the hole to develop the game, which could only be justified by absolutely chart-topping game sales.  RI was effectively also help fund economic activity in other states, as 38 Studios had acquired other companies along the way.

Massachusetts can't be smug about 38 Studios, as it bet a similar outsized amount in a green energy company called Evergreen Solar, which also went bust. Solyndra in California has been a national example.

If the pols really feel they must spend, there are good ways to spend that money.  Unfortunately, that spending is much more spread out and doesn't quickly generate a bunch of jobs which can be claimed to be the direct result of the legislation.  Of course, many such jobs really aren't -- many would have been created already.

One core area in need of investment is transportation.  The MBTA system is creaking along due to deferred maintenance and delayed rolling stock replacement, and probably needs billions of dollars.  A recent Globe front page graph showed clearly that MBTA ridership growth continues at a steady clip, but there hasn't been service growth to match.  Indeed, due to equipment shortages that spacing of trains on several lines is growing.  After the T, there is the expansion of the Hubway bicycle system beyond the small core region served now.  If you never use the T or Hubway, just remember that riders on these systems would probably be in cars competing with you on the roads.

Housing continues to be expensive in the Boston area for a variety of reasons.  While some of this is deliberate and chosen (such as towns wanting to manage their population densities), there are many opportunities for government to foster housing development in ways that will encounter little resistance.  Cleaning up brownfields and streamlining permitting processes are obvious ones.

There's also the local environment.  Workplaces are more appealing when they are near parks, restaurants and other amenities.  The Globe today also had an item on the conversion of individual parking spots to miniature parks, and idea that has a lot of merit as long as it isn't overdone.  Exploring ways to add more food and entertaining options, ranging from expanded night hours, additional liquor licenses for very small trendy bars and food truck zones, these are all the obvious purview of government.

Finally, there is that issue of training.  The area's premier universities and colleges play a key role in providing scientists, and many of the existing companies groom new executives.  Where the state should play a role is fostering training programs at the high school and community college level to prepare a healthy cadre of research technicians, which during the boom years at the end of the last century were in short supply.  Many of the skills that go into such training, such as keeping meticulous records, following procedures to the letter and learning how to capture and report data, all are valuable in non-biotech fields.

Perhaps that is my overall theme.  If government wishes to enhance the biotech industry, or the robotics industry, or the computer services industry or the myriad of other exciting sectors in the local economy, the wrong way is to try to throw money at individual industries or companies.  Targeted tax breaks and loan guarantees are rarely deployed well, are often timed badly, and benefit few outside those targeted.  Broad improvements to the transportation, park and educational infrastructures will pay dividends for every industry and all of the citizenry.  Let gullible states throw their money away luring a few gullible companies; invest instead in across-the-board improvements which will both boost the current crop of companies as well as enable new exciting industries that don't even exist yet.

No comments: