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Purpose-Built Incentives: Benefitting Business and Regions

Sound incentive decision-making will make for a more perfect union between your company and the community in which it has chosen to locate.

April 2012
Precarious albeit improving economic conditions, constricted credit, a tsunami of business fees, competition from abroad, plus the garden-variety cost increases continue to conspire against companies. When pressures mount, demand for incentives grows. For years, communities found corporate incentive decisions unsettling. While their use today still falls short of enjoyable, to most communities, incentives are an acceptable and predictable rite of passage. No longer are incentives deemed a necessary evil. They are simply necessary.

Good Sense
Incentive exploration among corporate executives just makes good business sense, as does seeking affordable labor, reasonably priced real estate, dependable utilities, and efficient logistics. However, only the most myopic decision-makers consider incentives the penultimate location variable. Nevertheless, they are an indelible part of the location checklist that separate good from bad and right from wrong.

But what makes for sound incentive decision-making? How do you know the right incentives when you see them? Good incentives are like a fine marriage sans the infatuation. They are founded on mutual understanding, shared objectives, sanguine negotiations, and willingness to compromise. Both parties may give ground, but in exchange for a far greater, long-lasting relationship and return on their investment. Problems mostly arise when one fails to recognize and meet the needs of the other.

Historical Perspective

The incentives playing field was once controlled almost entirely by the business decision-maker. Communities were, of course, engaged in the process, but with the tone, tenor, and terms largely dictated by the company. Historic incentive preferences of business and conventional incentive theory went something like this:

Cash was king and, therefore, grants were most desirable. Then came free land followed by forgivable, no-interest loans; forgiveness was a virtual certainty. Next came tax abatement and credits with a long-term time horizon. On the heels of this was subsidized job training if properly customized or, even better, reimbursement of employer-led training. This was followed by deeply discounted roadway and infrastructure extension, and finally trailed by the litany of duty-free trade, fee-elimination, streamlined permitting, and the many other lesser, yet important, inducements.

Just as most lottery winners prefer a lump sum payment, CEOs and CFOs gravitated toward large, upfront packages guaranteed to hit the bottom line on their watch. This was the norm for decades, reaching its crescendo in the 1980s and 1990s during the highly publicized incentive bidding wars.

During this period, community benefits - largely in the form of jobs and investment - were merely aspirational. Business attraction success of the economic developer was based on the location selected, not the actual benefits derived. This was replaced by employment and investment metrics, and the investor's commitment to reach agreed upon milestones or risk incentives clawed back for lack of compliance.

But even at this stage, inconsistency reigned. Some communities brandished clawbacks as a public threat in order to satiate elected leadership but lacked the tracking tools and mechanisms to enforce them. Others overcompensated by penalizing companies for unforeseen conditions beyond their control. The well-intending company, blindsided by economic recession, was treated just as the one that never expected to reach its stated job and investment goals in the first place.

Balancing Corporate and Community Need
While underlying incentive preferences may not have appreciably changed for business decision-makers, the pendulum continues to swing toward a more balanced arrangement where community needs share the spotlight with corporate desires. Corporate accountability is today deemed paramount and mostly enforced, albeit in a reasoned fashion. Astute businesses expect this mandate for accountability because they see that many of the factors constraining corporate profitability are eroding government finances as well. In addition, they know incentive providers are answerable to their stakeholders, just as are the corporations who seek them.

Unlike in the European Union - where incentive controls are in place to tamp down bidding wars - no such safeguards exist in the United States at the state, local, or any other level. Still, a kinder, gentler arrangement is at play today, where most businesses view incentive decisions as a partnership between investor and location. Abuse or excess on either side can be the death knell to long-term success.

For most incentive providers, ROI remains defined as high-paying jobs and investment generated - the more the better. But today, far greater specificity is applied. Jobs that diversify the industrial base and add economic stability are paramount in importance, as are those that benefit the economically disadvantaged. New facilities that leverage local suppliers trump those with no local connection or local-buying intent.

Present day incentive recipients are not only expected to operate within the community, but to become an active part of it. Companies with a track record of public school sponsorship, entrepreneur mentoring, cultural advancement, and general philanthropy are warmly embraced. In short, those committed to doing good are valued more than those consumed by only doing well. However, the objective community knows that charitable giving, even among the most profitable corporations, is not an entitlement.

Sophisticated Tools
As incentive benefits to the community become more precisely defined, so do the modeling tools used to grant them. The rationale behind this emerging sophistication is also appreciated by corporate decision-makers. Two such tools coming into vogue are Predictive Modeling and Precision Cost Benchmarking.

Predictive Modeling identifies businesses that may be on the verge of a new investment, in need of a local market presence and, therefore, ripe for target marketing and incentivizing. Those already contemplating an expansion are more likely to view incentives as an enhancement rather than the motivating factor.

Precision Cost Benchmarking goes well beyond traditional competitive assessments and location SWOT (strengths, weaknesses/limitations, opportunities, and threats) analyses by modeling the costs a business is likely to incur in a given community versus in its competitor locales. Precision Cost Benchmarking begins by constructing a virtual, industry-specific proxy of a company based on realistic occupational, real estate, utility, logistics, investment, and other characteristics. It then calculates the local operating costs for that precise type of business versus competing locations. In addition to the location marketing applications, the results of this benchmarking are used to determine whether and/or how much incentive may be needed to close the cost gap or address other location limitations.

Purpose-Built Philosophy
Since the advent of incentives, governments have been preoccupied with the notion of structured programs delivered with rigidity rather than flexible solutions to address a particular business need. In many communities and states, these programs have been misdirected silos laden with Catch 22s. For instance, the desirable company in need of tax abatement could only procure the incentive if it were willing to locate in an area for which there was no suitable real estate; the cutting edge, tech-driven, efficient business could not receive financing because it created too few jobs, etc.

This too is changing. New incentive creation is shifting away from the generic and toward incentives that are purpose-built. This makes perfect sense because the sweet spot of incentive utilization is where one scratches the itch of both business and community. While these incentives may address a recognized corporate need, they are designed at least as much to satisfy a specific community objective.

For example, customized skill development programs may target a work force deficiency of the prospective investor, but they also raise the bar for community work force competency. If these skills are relevant to multiple industries rather than one specific job, then employment opportunities exist even if something happens to the job at hand. Industry or cluster-specific incentives commonplace in much of the country help diversify the economy and/or attract businesses that can leverage and benefit the existing supplier base. Beyond promoting economic stability, they attract businesses to locations where direct competition is minimal but suppliers and service providers plentiful. Property development assistance as well as infrastructure incentives can produce long-term, fully served inventory previously deficient, while addressing a site selection elimination factor.

Further, international incentives pique the interest of foreign nationals, unleash foreign direct investment, and forge other overseas linkages that may otherwise not materialize. The U.S. State Department's EB-5 program is a prime example where qualified foreign nationals receive a Green Card in exchange for modest investment and job creation in high unemployment or rural areas. For many, securing permanent U.S. residency status is priceless.

Forming a Better Union
Communities now have a much greater appreciation for business climate causality. A dearth of lifestyle amenities is not just a quality-of-life issue; it requires businesses to try harder, wait longer, and pay more to attract labor desirous of these amenities. Cumbersome, unpredictable permitting and regulatory processes can result in costly start-up delays. A glut of competing businesses in overlapping industries leads to premature defection of workers and the choice between hefty retention bonuses or lost productivity as replacement workers get up to speed. Public schools out of tune with the business community and emerging market trends fail to prime the work force pump with properly educated, technically astute youth. Incentives in remote, inhospitable locations that are ill suited for business investment are hardly incentives at all.

As understanding of location characteristics and their impact on business challenges and opportunity grows, so will the variety and mutual benefit of incentives crafted to address them. Finding the incentives sweet spot will make for a stronger relationship between communities and the companies they are intended to attract.

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