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Open Doors?

Entrepreneurs have pushed for deregulation as a way to get a foot in the door of old, entrenched industries. But is cutting through the red tape the solution you've been waiting for?
September 1, 2003
URL: http://www.entrepreneur.com/article/64002

LaLa Wang has fought the law. So far, the law has won. A Harvard Business School graduate, Wang, 40, thought she had a potential breakthrough idea when, in the mid-1990s, she founded Mlx.com, a Web site dedicated to connecting landlords, property owners, real estate brokers and apartment hunters in New York City. With Mlx.com, Wang wanted to streamline the real estate market, making it easier for apartment hunters to view many different places, by putting photos online and allowing brokers, owners and landlords to better tailor offerings to potential clients. "I thought we had the model: an open system that would bring everyone together," Wang says.

Mlx.com has proved popular with consumers, but Wang's life has only gotten harder. According to Wang, larger, established real estate brokerages in New York City have pushed state regulators to use a 1975 licensing law against her company. The law says all companies that provide real estate listings must first obtain a welter of paperwork about each property--hard copies of contracts, escrow agreements and other papers that would be impossible for an e-commerce firm to obtain about the hundreds or thousands of online listings. (Older listings sources, such as The Village Voice, do not have to obtain this paperwork before posting real estate ads.) State regulators chose to enforce the 1975 law, and when Wang tried to continue operating, the state suspended her real estate license. Fighting to keep her business and overturn the 1975 law, Wang says, "has already cost over $300,000 in legal bills and an enormous amount of stress."

Deregulation of New York's real estate industry, Wang believes, could help solve her problems, allowing her to compete with larger brokers. Many other entrepreneurs share Wang's belief. They are convinced that deregulation of industries ultimately benefits entrepreneurs. Yet despite several examples of deregulation boosting the fortune of entrepreneurs, in some cases deregulation backfires, primarily helping larger companies.

Removing the Barriers

Many free-market advocates argue that, in theory, deregulation--the reduction of statutes and oversight in an industry--usually helps small companies because regulating industries allows monopolies to develop, throwing up barriers to entry for start-ups. "Entrenched companies, which usually have more political power, can be very successful in using laws to prevent any opening in their industry [and] turn into monopolies," says Braden Cox, technology and policy counsel at the Competitive Enterprise Institute, a free-market think tank in Washington, DC. "When you remove red tape in an industry, you don't need to be as big to have a chance there, and when businesspeople see that there is opportunity, it encourages more entrepreneurs to enter the field and leads to risk-taking and creativity."

Wang and many other online real estate companies believe the theory. "If we can get New York to repeal the 1975 law, we can have a real market, where companies like mine can survive," says Wang. Similarly, small players in other e-commerce industries are pushing for deregulation of a series of statutes used by large companies to prevent competition from Web upstarts. Large wine wholesalers have used their influence to get laws passed that restrict Internet wine sales, while major contact lens companies have allegedly done the same to Web-based contact lens vendors. Indeed, in an October 2002 ruling, the FTC noted, "Regulations may be having significantly anticompetitive effects on e-commerce." In response, Web sellers have pushed for deregulation of Internet wine and contact lens sales.

"When you remove red tape in an industry, you don't need to be as big to have a chance. . . . It encourages more entrepreneurs to enter the field and leads to risk-taking and creativity."

The positive impact of deregulation can be seen in trucking, one of the first two industries to be deregulated by the federal government (the other one was aviation). "Before 1980, [when President Carter deregulated the industry], it was very hard to start a trucking company," says Charles Harrett, president of New Albany, Indiana-based Northern Continental Logistics, a seven-employee firm that he started in 1998, after working for a larger logistics firm. "All existing routes were held by large companies, and you had to prove to the Interstate Commerce Commission (ICC) there was a need for you to enter the industry. To convince the ICC, you'd have to get the support of many companies--have them say they wanted you in the market shipping their goods. Going through this process was time-consuming and expensive."

Now, Harrett notes, it's easy for entrepreneurs to get started in the trucking industry. He believes lowered barriers to entry have fostered competition, reduced prices for consumers, and encouraged innovative people to enter the business--people who have introduced satellite technology and other breakthrough technologies to the industry.

Other truckers agree. "In general, deregulation has been positive for small companies," says Gary Hanke, 49, president of Pegasus Transportation Inc., a shipping firm in Jeffersonville, Indiana, that has 275 employees and also started after the 1980 deregulation. Like Harrett, Hanke had worked for larger companies before deregulation but couldn't start his own business until the market opened up. "Today you can easily get a license for a few hundred bucks, so anyone can get into the business and quickly be able to ship to 48 states," he says.

The White House, many congressional representatives and some state legislators agree with Hanke and Harrett. President Bush has highlighted the need for deregulation in a range of industries, including energy and the military/defense sector, as a means of helping more entrepreneurs. The Bush administration has already begun privatizing and deregulating large segments of the federal government. Treasury Secretary John Snow has said that for the American economy to grow strongly again, "the requirement is for greater flexibility, for deregulation." And Michael Powell, head of the FCC, has turned out to be one of the most forceful proponents of deregulation in the media, telecommunications and communications industries in decades.

Meanwhile, last year the U.S. House of Representatives Small Business Committee proposed the Small Business Advocacy Improvement Act, which tried to strengthen the SBA's Office of Advocacy, tasked with highlighting regulations hindering small companies. At press time, the bill was in markup before the Small Business Committee. On the state level, several legislatures have proposed creating state commissions of deregulation to reduce statutes in certain industries.

Ahead of the Curve
Is your industry on a path to deregulation? Plan ahead with the following steps:

1. Recognize that larger companies will try to fight back. "Big companies are naturally going to do whatever they can to limit anything that hurts their monopoly power," says William Schuck, executive director of Competition Ohio, a Columbus-based nonprofit focused on telecommunications choice. He advises small companies in an industry being deregulated to band together to inform consumers about the upcoming deregulation and develop advocacy organizations to fight the larger firms.

2. Move into a niche before deregulation. Companies that don't find a way to compete on grounds other than slashing prices may not survive deregulation, experts say. "Once the trucking industry was deregulated, there were so many small companies starting up that many clients didn't know how to distinguish among them, and they just looked for the lowest price," says Gary Hanke of Pegasus Transportation Inc., a shipping firm in Jeffersonville, Indiana. "If you didn't have a name before deregulation, you could get lost."

3. Learn from previous examples. Deregulation processes have, in many cases, followed similar trajectories. Business analysts say entrepreneurs thinking of entering a field in the process of being deregulated--wastewater management or energy, for example--should study previous examples of deregulation of that particular industry, whether in other states or in other countries.

What's Wrong With Deregulation?

Yet despite the example of the trucking industry, in some cases, deregulation does not benefit entrepreneurs. At times, the government pays lip service to deregulation while favoring older, more entrenched companies. Deborah Avant, an associate professor of political science at George Washington University in Washington, DC, notes that while the Pentagon has said it's deregulating the military contracting industry, it continues to offer contracts--without taking a large number of bids--to the same large companies that have traditionally dominated the defense industry.

In other cases, deregulation without enforcement of the statutes kept on the books, or overly rapid deregulation, can wind up actually fostering consolidation and putting power in the hands of the old monopolists. "You can't have wholesale deregulation without keeping some of the necessary rules in place," says Harrett. In the radio industry, for example, relaxation of federal rules on the number of stations one company can own, combined with lax enforcement of still-existing regulations designed to guarantee competition in each radio market, has allowed the conglomerate Clear Channel to dominate the airwaves in many markets. As a result, Clear Channel has pushed many small stations out of business.

"You can't deregulate so quickly; you have to make sure big companies don't backslide into monopolistic behavior. Deregulation should ensure the marketplace works, not that the marketplace gets trampled."

Similarly, says Chris Edwards, fiscal policy director at the Cato Institute, a Washington, DC, think tank, the incomplete and rapid deregulation of California's energy industry in the late 1990s did not create a level playing field between older and newer companies. Older firms consolidated power and used their knowledge of the market to manipulate energy prices upward.

Perhaps the worst situation has been in the telecommunications industry, which was supposed to be deregulated by the Telecommunications Act of 1996. Though deregulation led to the founding of a few smaller phone and Internet companies since that act was passed seven years ago, the major local and long-distance companies have actually increased their share of the national and state markets. According to strategy and technology consulting firm Booz Allen Hamilton, based in McLean, Virginia, small, local phone companies earned nearly $15 billion in revenue last year. By comparison, the larger phone companies--the so-called "Baby Bells" that are descendents of the old AT&T national monopoly--earned nearly $120 billion.

Telecom deregulation failed for several reasons. "The deregulation happened so thoroughly and quickly that it wiped out the kinds of regulations we needed to keep--regulations that would prevent Baby Bells from using the advantages they enjoyed to keep their monopoly power," says William Schuck, a former Ohio state legislator and now executive director of Competition Ohio, a nonprofit group in Columbus that's focused on telecommunications choice.

For example, Schuck says, though the Baby Bells were required by the 1996 act to allow smaller companies to use their telephone lines and exchanges, the Bells allegedly have provided worse lines and exchanges to those smaller companies, preventing them from winning customers. "You can't deregulate so quickly; you have to make sure big companies don't backslide into monopolistic behavior," Schuck says. "Deregulation should ensure the marketplace works, not that the marketplace gets trampled."

Even when deregulation succeeds, it can have unexpected side effects for entrepreneurs. In the trucking industry, after the initial round of deregulation in the early 1980s, thousands of new, small logistics companies entered the field. With so many new firms, prices for trucking fell precipitously, wages dropped, companies had trouble retaining drivers (since few of the best truckers were willing to work for lower wages), and thousands of companies went out of business in the mid-1980s. Even today, Hanke says, "margins in the trucking business are only 2 or 3 percent; they're below what they should be."

An Uncertain Future

Because of problems with deregulation, some states and cities have recently delayed further deregulation. Atlanta and New Orleans, for example, are reconsidering plans to privatize and deregulate their water and wastewater systems. After its previous fiasco, California's legislature is considering re-regulating the state's power industry.

Still, entrepreneurs need to be prepared for further rounds of deregulation. Many entrepreneurial companies do not prepare effectively for deregulation, and once it occurs in their industries, they squander opportunities and allow larger firms to retain some of their monopoly powers. According to Schuck, smaller phone companies in Ohio missed a window of opportunity that opened after the 1996 act was passed, in which they could have informed consumers that they were now players in the market, offering cheaper service.

Schuck argues that once deregulation happens, small companies need to initially band together to educate consumers that they now have a wider range of choices. Other entrepreneurs believe the key to surviving in a deregulated market is to find niche services to provide, thereby avoiding competing on price in an industry that, once opened up, could be swamped by thousands of new companies.

Entrepreneurs will have opportunities to test these strategies. Though some people have begun to question deregulation, it retains significant support in Washington and in many statehouses. In June, Powell, the head of the FCC, won approval from his commission to enact wide-ranging deregulation of the nation's media industry, while Secretary of Defense Donald Rumsfeld has pushed for private sectors of the military. "The trend is not going to go away," Cox says. "Eventually, we will see deregulation across the board in most industries.

By the Numbers
Deregulation can lead to more competition:

The size of the truck driver work force: 1.1 million in 1978; 1.9 million in 1996. (Source: Economic-
Inquiry)

The number of truck carriers regulated by the Interstate Commerce Commission (ICC) in 1979: 13,337. The number of interstate truck carriers regulated by the ICC in 1994, 15 years after deregulation: 54,000. (Source: ICC)

And deregulation has been actively promoted by the federal government over the past two decades, as the government has slashed its work force:

The size of the federal government devoted to regulatory activities in 1980, at its high point: 122,000 employees. The size of the federal government devoted to regulatory activities in 1990, after the first wave of deregulation: 115,000 employees. (Source: Washington University in St. Louis, Missouri).

But sometimes, deregulation can lead to excessive consolidation, increasing prices for consumers and limiting small companies' ability to compete:

Residential prices for natural gas in 1984, before deregulation: 44 percent above the wellhead price. Residential prices for natural gas in 1999, 15 years after deregulation: 181 percent above wellhead price. (Source: Public Citizen).


Joshua Kurlantzick is a writer based in Washington, DC.