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Boulton: Barriers to entry impact the free market

Boulton: Barriers to entry impact the free market

August 28, 2009
August 28, 2009

Barriers to entry are anything that gets in the way of starting a business or entering a trade. Most arise through a natural process, mainly the need to raise the necessary capital required to successfully conduct a business. For example, if one wanted manufacture steel, one first needs to build a steel plant, or buy one already in existence, and that requires a ton of money. Thus the average bear can probably scratch the idea of becoming a steel magnate. Conversely, to become a barber one only needs a chair, clippers, and a hairbrush. If any cash is left over, then the remaining bucks could be used to rent a storefront – no big deal.

For some industries, barriers to entry can become somewhat more sophisticated with some being the result of a natural process and others the product of a government mandate. Take the one that I spent a career in – retail stockbrokerage. First I had to find a way to get affiliated with a firm that was a member of the New York Stock Exchange, an entity that had developed naturally over the history of the United States to provide a centralized, organized, transparent vehicle through which stocks could be traded fairly for all concerned. All the rules and regulations governing exchange members and those individuals affiliated with them had emerged over time in response to attempts to solve specific problems that had occurred from time to time.

Since some level of knowledge was required to serve as an intermediary between the investing public and those executing orders on the exchange’s floor, I was required to pass the NYSE/ NASD broker’s examination (now called the Series 7 Examination) – another barrier to entry, but one based on achievement. However, because of the Glass–Stegall legislation of the 1930s, passing this exam meant that I was in an exclusive, albeit still sizeable, fraternity since commercial banks, savings and loans, plus insurance companies were legally barred from competing with me and my firm.

Still, in Redding, California there was a Dean Witter office to suck business away from us at Birr Wilson & Co and no matter where else I’d practiced my profession, Merrill Lynch was still the elephant in the neighborhood. The only way I could establish a barrier to entry in this restricted but very competitive world was to raise the quality of my services to levels others couldn’t meet and hope that the word got out that I was the most competent investment professional in town.

However, the SEC stepped in and eliminated the NYSE’s fixed commission structure in 1975 so that for the first time the brokerage industry had to compete on price and discount brokers began to appear to take business away from me and my associates (removing a barrier to entry) – a process that just about finished off traditional retail brokerage once the internet appeared, which those favoring full and open competition in providing investment products greatly approved of. Next the savings and loans were allowed to sell mutual funds, followed by the return of commercial banks to the industry as the last vestiges of the ‘Chinese Wall’ created by Glass–Stegall was torn down by the Congress in 1997.

Collectively, all the measures taken at the behest of non-investment bankers in the world of finance by both the SEC and the Congress succeeded in squelching my rice bowel. Of course investment banking probably should never have had its congressionally-mandated monopoly in the sale of investment products to start with, but FDR’s Administration and its congressional majorities at the time felt that protecting my rice bowel was important for the country following the Crash of ’29. Basically, over 70 years the Congress gave and then took away my “monopoly” – a legally imposed barrier to entry designed to keep commercial banks and insurance agents out of my industry.

Another group of entry barriers I faced were more practical. Early in my career I gave thought to being a floor broker trading for my own account, but that idea died when I realized that I couldn’t raise the $10 grand necessary for a seat on the Pacific Stock Exchange, let alone the more that $100k necessary to buy a seat on the NYSE. Then there was the issue of having enough money to meet the capital requirements laid on exchange members.

The same problem existed when I researched membership on one of the country’s commodity futures exchanges. So I did the next best thing: I formed my own commodity futures trading advisory firm and after developing a highly successful trading methodology, I discovered that we spent as much money marketing our services as we raised in investment advisory fees. The accompanying advisory publications we produced also ate money since they had to be prepared and printed in booklet form before we could sell them through direct mail marketing, which also meant feeding the postal service. Because I was always under-capitalized, thanks in part to the IRS and my 81 percent marginal tax bracket plus FICA, eventually the dream became impractical.

Yes, a shortage of working capital is a barrier to entry but one that was solved when it came time to open my own brokerage office. Originally, before the internet, all transaction orders and information came in and out of the office via a land line where Pacific Bell Telephone had a monopoly. Add on the fees paid to Dow Jones News Service, etc. and the office nut for telecommunications and information services quickly approached seven grand per month – a figure that meant it was best if Birr Wilson & Co paid the bill.

Fortunately satellite communications and financial news through the television set appeared on the scene (breaking down a barrier to entry). This cut the monthly nut down to manageable proportions so my dream of owning my independent brokerage office became economically viable. Unfortunately independence cut me off from most of the investment banking industry’s ‘initial public offerings’, the product lines which actually made retail stock brokerage profitable, and I voluntarily eschewed packaged products like mutual funds and limited partnership since they were generally a bad deal for my clients compared to the results I could get for them through individual stocks and bonds (a self imposed barrier keeping me from competing directly with ‘financial planners’).

Eventually the internet with its e-commerce component should have made my life easier had I stayed with it since it would have imploded the cost of office operations even further, plus eliminating the need to mess with individual stock certificates because issuing them seems to have gone by the boards. However e-commerce has plugged transaction commissions down to $7 per trade irrespective of transaction size.

Ergo, with just about all the barriers to entry eliminated sans the qualification exam, it’s no longer possible to make a living as a stockbroker providing quality investment advice to individual clients. So with virtually zero in the way of entry barriers, I finished the requirements to become a chartered financial analyst and become a content provider with my own investment advisory website – barriers to entry virtually zilch.

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