City Buyer Beware: Not Even Amazon Is a Sure Bet

Amazon’s announcement of HQ2, a second headquarters, is about to set off an incentive arms race among state and local officials bidding for its economic promise. Elected leaders will leap at the chance to recruit Amazon, a widely admired technology company that has led development of some of the most powerful technologies of the 21st century, from cloud computing to smart speakers to drone delivery.  The company employs more than 350,000 people and has grown more than 40 percent in a year.

Amazon’s rapid job growth and strong market position suggest that the company’s promise of 50,000 jobs in HQ2 is as sure a bet as can be found in economic development. But technologies evolve unpredictably, and today’s market leader—even one as admired as Amazon— may take a tumble tomorrow. As state and local officials prepare to open public coffers to recruit HQ2, they should make sure taxpayers are protected if the company’s fortunes turn.

I learned this hard lesson myself when I was the director of business development in the Washington, D.C. mayor’s office five years ago.  At the time the hottest company in town was LivingSocial, a startup that offered daily deals to millions of email subscribers. LivingSocial was hiring several people every day in their Washington, D.C. offices, which the company seemed to outgrow every few months. The company was the flagbearer of DC’s tech sector with a value of $6 billion.

Recognizing its leverage, LivingSocial’s executives demanded that the city provide substantial financial incentives in exchange for the company remaining in Washington. After a lot of debate, my colleagues and I decided that, given the novelty of the daily deals market, we preferred an incentive package that the company would “earn” over time through continued hiring growth. The city ultimately gave LivingSocial a package along those lines, with a total value of up to $32 million.

As it turned out, the next few years were not kind to the daily deals space in general, and to LivingSocial in particular. The daily deals market lost retailers weary of bargain-hunting consumers who seldom became loyal customers. LivingSocial itself was hacked, with 50 million customers affected. Last year its competitor Groupon bought the company for a pittance.

LivingSocial’s demise was painful to Washington, resulting in hundreds of jobs and the loss of a top local tech brand. But taxpayers were unaffected because the city had negotiated an incentive package tied to performance. LivingSocial never hit its hiring goals, so the city never paid any money. It was that simple.

LivingSocial’s collapse may be an extreme case, but it’s hardly unusual that tech companies fail to meet their promises. In one notorious example, former Red Sox pitcher Curt Schilling received a $75 million loan guarantee from the state of Rhode Island for 38 Studios, his video game startup, in exchange for a commitment for 450 jobs. The company went bust in only two years, and the state recouped barely a third of its investment.

It makes sense for government to backload an incentive package to ensure that a company fulfills its commitments. But that seldom happens. Instead, state and local governments give inducements up front like tax cuts, relocation payments, and infrastructure upgrades, leaving them limited recourse to reclaim the money if the company fails to keep its part of the bargain, as happened with 38 Studios.

Corporations prefer to get the money earlier, and without strong clawback provisions that tie payments to performance, they have little reason to avoid making promises they may not fulfill. Motivations on the public side are also aligned against clawbacks or back-loaded incentives, since a governor eager to celebrate a new headquarters may care less about what happens if the deal sours once she is out of office. It’s not surprising, then, that over the last fifteen years state incentive packages have become increasingly front-loaded. Such packages are particularly ill-advised when given to technology companies that might easily beat growth projections (think Google in the last 15 years) or meet sudden headwinds (think Blackberry, or LivingSocial for that matter).

Could a new Amazon headquarters add jet fuel to the local economies of Chicago, Dallas, or Philadelphia? Amazon certainly wants city leaders to think so. Its initial announcement of HQ2 claims that Seattle, home to its current headquarters, gained $1.40 for every $1 that Amazon invested locally over the past two decades.

Even if Amazon’s numbers are true—a big if—it’s quite an assumption to presume that the next 20 years will be as kind to Amazon as the last 20, or that the city hosting HQ2 will benefit as much as Seattle has. Amazon itself, and not local taxpayers, should bear the risk if the company’s fortunes unexpectedly turn. The public officials scrambling to woo HQ2 would be wise to look past Amazon’s rosy growth projections and ensure their residents are protected no matter what the future brings.