On the Control of Labor

Abstract

A veterinary service organization (the "Hospital") leverages, or controls, labor to produce revenue. In restrictive labor markets, where demand for labor is in excess of supply, the costs, availability, and quality of labor becomes more volatile and places downward pressure on revenues and profits. Hospitals need a strategic framework if they hope to sustain growth and return capital to their shareholders. The Control-of-Labor Strategy proposes prioritizing treatment of labor to gain competitive advantages in the labor market, build more effective teams, and capture market share during restrictive labor market conditions.

Introduction

Changing perceptions of work schedule, demographics of veterinary staff, and disruptions from COVID 19 have constrained the supply of veterinary labor. Simultaneously, the humanization of pets has kept demand for veterinary services strong. The cumulative effect has created a restrictive veterinary labor market. During restrictive labor markets, hospital growth is limited by its ability to attract, retain, and leverage labor. Hospital operators that do not remain competitive for labor expose themselves to downside risks that can have devastating financial consequences. The control-of-labor strategy is a strategic framework to hedge against downside risks and promote sustainable growth during restrictive labor market conditions.

The control-of-labor strategy seeks to maximize its retention, cooperation, and recruitment of labor through increased expenditures. As control of labor increases, operators leverage the improved competitive position to improve pricing power, preserve revenues, and deteriorate competitors. Labor control is differentiated into two types: intra-market and intra-organizational.

Intra-market control is an organization's relative competitiveness within the labor market. High intra-market control allows a hospital to hire faster and from higher quality candidates. Low intra-market control leads to longer durations of open positions and lower quality candidates. Hospitals must increase expenditures on labor to gain intra-market control. Achieving intra-market control puts downward pressure on competitors.

Intra-organizational control is an operator's ability to dictate the behavior of employed labor. Hospitals with high intra-organizational control have quicker employee buy-in of new strategies, disciplinary actions result in productive behavior change, and termination of labor is initiated by the hospital. Hospitals with low intra-organizational control see greater levels of pushback on new strategies, disciplinary action is less effective, and employees are more likely to terminate their contracts. As this paper will discuss, high intra-organizational control builds goodwill. Increases to goodwill create pricing power that is used to recoup the costs to implement the control-of-labor strategy.

Using the control-of-labor framework, veterinary services organizations can mitigate risk and continue to increase in value during restrictive labor markets. This paper will discuss the basic framework to control of labor. It will explore the two types of control and how they work together to create goodwill. Last, it will discuss the three outcomes that drive value creation at the hospital.

Framework

A fundamental assumption of the control-of-labor framework is that revenue and labor capacity are inextricably linked. Labor is a necessary input for all revenue generating events in a veterinary hospital. If labor capacity were to suddenly be cut in half, one could reasonably expect revenues to see a proportional decline. Therefore, during restrictive labor markets labor and revenues are referred to interchangeably. To control revenue growth, a hospital needs to control labor.

To gain control of labor, a hospital must seek to be the employer of choice in its labor market. Compensation and culture must be maximized in relation to all possible competitors for labor. For lack of doubt, compensation refers to all quantitative components and culture refers to all qualitative components of a given job. An employee must not be compelled to seek better compensation or culture at a competitor. From this foundation, a hospital begins to exert its control on labor.

Intra-market control and intra-organizational control develop simultaneously because they are largely dependent on the same factors. However, intra-market control typically lags intra-organizational control as reputation awareness in the labor market has slower penetration than within an organization. To develop intra-organizational control a practice must convince employees, through genuine action, that there is no better alternative job. Hospitals must keep wages above competitors through regular, aggressive, and unprompted wage increases. They must offer benefits that address the practical needs of labor force and exceed those of competitor's. They must set sustainable workloads and expectations. Management must be responsible, fair, and foster a healthy work culture. Existing employees wish to remain in good standing, so they simply do a better job and work hard to retain their jobs. Labor capacity is retained, therefore sudden declines to revenue are less likely. Preservation of existing revenues ensures that the control of labor hospital can continue to invest in its labor.

Consumers recognize the improved experience, this generates goodwill. The higher quality employees at control-of-labor hospitals generate higher quality interactions with clients. The greater labor capacity allows control-of-labor hospitals to offer more flexible scheduling. Simultaneously, competitor hospitals will face downward pressure on their labor, which leads to deteriorating experiences for the consumer. As goodwill increases at the control-of-labor hospital and decreases at competitors, the spread on goodwill becomes enormous. This spread generates the pricing power the control-of-labor hospital uses to generate greater revenues and returns to shareholders.

For the remainder of this essay, we explore how to generate control of labor and the outcomes that justify the strategy. We will discuss intra-market and intra-organizational control. Afterwards, we will discuss the three ends that justify the means and how each produces competitive and economic advantages. To begin, let's discuss intra-market control.

Intra-Market Control

To understand the advantages of intra-market control, consider the converse of control-of-labor: the cost-optimized labor strategy. Cost-optimization gives priority to minimizing the expense of labor to protect a hospital's profit margin. This strategy performs best when supply of skilled labor exceeds the demand, but it will never gain intra-market labor control.

A cost-optimized hospital will always have lower compensation than a control-of-labor hospital. This leaves a cost-optimized hospital's existing labor pool susceptible to competitive pressure from control-of-labor hospitals. Worse, a cost-optimized hospital turnover is susceptible to self-reinforcing pressures. Consider the perceptions created when an employee leaves a cost-optimized hospital and tells the remaining employees how they found a better opportunity elsewhere. The remaining employees will be compelled to explore better opportunities, which creates the opportunity for them to leave. This migration of labor reduces the cost-optimized hospital's labor capacity, thus revenue capacity. The consequent perceptions it creates generates increased pressure on the remaining labor. Through controlling the perceptions of a competitor's labor pool, a control-of-labor hospital uses intra-market forces to influence the behavior of its competitor's labor, while adding labor capacity to itself.

Example 1

Dr. Bayer leaves Cost-Optimizing Hospital due to disagreement with management over compensation. She enters the labor pool and gets a higher offer to work at Control-of-Labor (C-o-L) Hospital. Dr. Bayer is paid better, management is respectful and effective, and the team works well together because they tend to stay in their roles longer. Dr. Bayer shares her positive experience with a few previous coworkers from Cost-Optimizing Hospital over drinks and the forces of intra-market control go to work. Katie, a CVT who was particularly bonded with Dr. Bayer, decides to switch to C-o-L Hospital after hearing how much better it was. Michelle sees Dr. Bayer and Katie leave Cost-Optimizing Hospital for C-o-L Hospital and gets the perception that C-o-L Hospital must be a better opportunity, so she applies to C-o-L Hospital and is hired as well. As a result, C-o-L Hospital's actions dictate when Cost-Optimizing Hospital will need to recruit labor, and Cost-Optimizing Hospital loses labor capacity placing downward pressure on revenues. This is a real example, with different names, of how the author added 3 new staff members to one of his portfolio hospitals, C-o-L Hospital.

As this example shows, loss of intra-market control places downward pressure on labor capacity, therefore revenues; moreover, it creates a self-reinforcing socially validated pressure on the remaining workforce to seek opportunities at the control-of-labor hospital. Perceptions shift slowly and reversing a negative perception in the labor pool is expensive and difficult. Although Intra-market control has costs, not having intra-market control comes with greater implied losses and a loss of control. Uncontrollable losses are the types of events that put hospitals out of business permanently. Under the control-of-labor framework, preservation of existing revenues and expansion of labor capacity are given priority over profit margin preservation if economic factors do not allow for both. The conditions that produce intra-market control simultaneously develop intra-organizational control; in time, intra-organizational control builds goodwill with veterinary consumers. Control-of-labor hospitals leverage this goodwill to re-establish their profit margins.

Intra-Organizational Control

Intra-organizational control refers to an operator's ability to influence the existing workforce behaviors. It is derived from the same conditions that create intra-market control. Providing employees with the best compensation and best culture leaves no better alternative position. When no better alternative position exists, the employee will feel pressure to provide satisfactory work to maintain good standing within their company. This pressure will lead to more cooperation on new strategies, more productive responses to feedback, and lower chances of terminating their employment. Intra-organizational control creates hospitals that are easier to manage and more efficient to improve.

Intra-market control allows a hospital to start from a foundation of high quality employees, and intra-organizational control allows the operator to most efficiently leverage their labor to produce goodwill and economic returns. Hiring better candidates increases maturity levels, which promotes cooperative work styles, and more positive interactions with clients. The time and expense of dealing with turnover, recruiting, and training is reduced and frees those resources to be spent on improving other areas of the hospital. Employees are more responsive to feedback and less likely to become disruptive if they wish to remain in good standing. With intra-organizational control, hospitals can terminate employees when the hospital decides and plans to reduce its labor. In hospitals with low intra-organizational control, employees decide when to resign, which is less predictable and may not align with the needs of the hospital. Intra-organizational control of labor creates more effective teams and builds goodwill with consumers.

Effect on Consumers

Goodwill is the established reputation of a business regarded as a quantifiable asset, and is the largest asset on all veterinary service platform's balance sheets. The control of labor strategy has distinct advantages in generating goodwill. Clients begin to recognize, either consciously or subconsciously, the differences in a control-of-labor hospital: The higher quality of labor, the improved capacity to be seen, and the tenure/familiarity of staff. Each of these play an important role in developing goodwill, or trust, with the consumer.

The consumer learns through repeated experiences with a control-of-labor team that they are more likely to have positive interactions with the team recruited from the high-quality labor pool than from the low-quality labor pool. This improves retention of these clients, increases word of mouth recommendations, and encourages more frequent visits. Clients learn that the control-of-labor hospital is easier to schedule because it has been able to maintain or expand its labor capacity, often constraining its competitor's labor capacity at the same time. Clients are more likely to trust and comply with the recommendations of the healthcare team at a control-of-labor hospital because the higher retention leads to longer average tenure. Repeated interactions with the same doctors increase familiarity and builds trust. Goodwill increases drive value creation on the balance sheet.

Competitor hospitals, left with fewer and lower quality hires and deteriorating client experiences, face pressure on their goodwill within the consumer base. This exacerbates the gap in goodwill with the control-of-labor hospital. At a theoretical end, the control-of-labor hospital is the only place a professional would want to work and a client would want to bring their patient because the divide on goodwill, or more plainly reputation, is so great. Control-of-labor hospitals use this gap to regain any lost profit margin and generate outsized returns.

Margin Offsetting Strategies

Implicit in the control of labor strategy is that labor costs will increase. However, control-of-labor exists on a spectrum and changes can be implemented stepwise. Hospitals can scale up to a full control of labor strategy and leverage incremental growth to fuel the next round of improvements.

The control-of-labor strategy favors preservation of revenues even if profit margins must decline to do so. The future pricing power outlined works better the larger the clientele is. Increases and efficiency gains from high quality labor offset some of these costs, though these strategies may not always fully offset the costs. This is tolerable in the short and medium term for two primary reasons: lower volatility and future pricing power.

As discussed earlier, more predictable revenues and expenses carry lower risk. A control of labor strategy prioritizes maximizing revenues in both the short and long term. Profits are optimized in the long term, and have variable outcomes in the short term. Control of labor hospitals seek to continue strong revenue growth during tight labor markets with the assumption that revenues are sticky—meaning clients that switch to a hospital tend to stay with a hospital the following year.

Profit is a function of revenues (revenues – expense = profit; Revenues × profit margin = profit). If revenues are flat or declining, it is very difficult to produce positive profit growth. A control of labor hospital prioritizes revenue growth and accepts that profit margin may decline. However, this does not guarantee reduced earnings. Revenue growth may exceed margin compression and the hospital's earnings will grow. The stickiness of clients allows a hospital to achieve margin expansion on future visits as competitive advantages increase. Future margin expansion is driven by the second cost offsetting advantage of future pricing power.

Three Strategies That Control-of-Labor Hospitals Use to Offset Increased Labor Costs

1. Pricing Power

Goodwill, or rather the difference in goodwill with competitors, dictates how much pricing power a control-of-labor hospital achieves. If clients appreciate a marginally improved experience, they are willing to pay a small premium over the next best hospital. However, if perceived experience is substantially better than competitors, consumers show a willingness to pay a premium that exceeds what rationally may be predicted. Consider this example:

Example 2

Joan calls a veterinary office concerned her dog may have an ear infection and would like to be seen as soon as possible. This office implemented a control of labor strategy two years ago and has scaled its labor capacity to be able to accommodate clients like Joan the same day they call in 70% of circumstances. Joan's experience with her own healthcare providers and other veterinary offices has conditioned her to expect at least a week or more before an appointment is available. In fact, because veterinary labor is so short her primary office wasn't available for 3 weeks and the local emergency office declined to see her due to the non-life threatening nature of the condition. Joan is not only thankful to hear the reception at the control of labor hospital ask if she can come right down, but is impressed with how quickly they were able to prioritize her concerns relative to what other practices had told her.

Upon arrival, she is met by the team of mature staff that work cooperatively to get her concerns addressed. She is treated respectfully and transparently. She doesn't realize this, but she feels at ease to see a full parking lot when she pulls in and bustling lobby of activity because it is a social cue that other people trust this hospital. Joan's price sensitivity drops substantially with each interaction she has with a control-of-labor hospital. For its part, the hospital is going to charge Joan a same day work in exam fee which is 50% more than a standard sick exam and prices its catalog of services above competitor hospital due to existing pricing power. Joan complies with all the doctor's recommendations rationalizing that she doesn't know when she may be able to get an appointment again and would rather spend a bit more now than gamble that she may find a same day appointment next time. Upon checkout, Joan inquires about transferring her other pets records to the hospital because she is concerned if something else were to happen that she can't rely on her current primary office to see her when she needs them. The hospital hands her the email address to forward the records to and schedules her recheck ear exam.

Consider all of the ways the hospital in the above example was able to improve its pricing power. The exam had a 50% premium applied to it. The rest of the services that the hospital provided were priced at a premium to competitors. The client was willing to do more of the recommended services, which increased the services intensity of the invoice. After paying a premium for the appointment, the client sought to give all their future business to the practice. This is how control-of-labor wins.

Pricing power can generate above market returns by creating unique experiences for the consumer. In the above example, the consumer sought to have a same day or nearly same day experience. The control-of-labor hospital won her business by providing the same day experience that the competitors could not. Pricing power improved throughout the experience because the control-of-labor hospital had recruited the best employees who gave her the best experience. She was willing to pay more and wished to come back in the future; thus, the hospital grew future revenues and placed downward pressure on competitors revenues.

2. Preservation of Revenues

Revenue serves two roles in the control-of-labor strategy: as the upper limit that can be spent to gain control-of-labor and the basis for future pricing power.

Revenue as the upper limit that can be spent to gain control of labor simply means that a hospital can spend up to the amount of money it takes in to improve its intra-market and intra-organizational control. The more a hospital makes the more it can get control. Preserving current revenues, or not losing clients, allows hospitals to maintain their level of investment in their labor and maintain their relative control-of-labor. Losing revenues forces a hospital to scale back investments made to gain further control and constrains its ability to compete.

Revenues as the basis for future pricing power recognizes that profits are a function of revenues. A hospital with large gross revenue can have large net profit. A hospital with small gross revenues will not be able to generate large net profits. Hospitals must preserve their revenue, or client base, so once intra-organizational control builds goodwill the pricing power discussed above has a large enough absolute economic return to justify the cost of the control of labor strategy.

Practically, if a hospital implementing a control-of-labor strategy begins to see labor turnover for reasons that are preventable through increased expense and profit margin compression, the hospital should seek to prevent this turnover and loss of labor capacity and accept the greater expense in order to preserve its revenues. As goodwill develops, this hospital can recoup those costs through increased pricing power. However, once labor leaves it is expensive to get back and less labor capacity reduces the revenue a hospital can generate. If this hospital does achieve control of labor and pricing power, but has a smaller revenue basis to charge a premium on, then the returns generated are less significant than if they had retained the labor capacity to continue seeing their clients and preserve their revenues. Always seek to preserve revenues.

3. Deterioration of Competitors

This dynamic has been discussed throughout this paper. Restrictive labor markets are a zero sum game. To increase one hospital's labor capacity, another must decrease theirs. The one that decreases generally is not in control, and the decision is made by an employee. Remaining employees rationally assume that better opportunities exist and explore their options. If the opportunity cost is great enough, they will seek those opportunities. Deterioration of competitors stems from the propensity for a turnover event to trigger further turnover events based on threshold models of collective behavior.

Popularly used to explain collective behaviors of people in riot scenarios, threshold models of collective behaviors are used to predict behaviors of groups of actors (the "Employee") given two alternative choices: look for a new job or do not look for a new job. The model assigns every actor a threshold, which is the number or proportion of others who must make one decision before a given actor does so. In the context of a hospital, there will be employees who seek new jobs without prompt, there will be employees who seek new jobs if they see only one coworker leave, and there will be employees who do not seek a new job even if every employee has left. Deterioration of competitors occurs because turnover makes future turnover more likely and each event of turnover makes more of the remaining labor more likely to seek new jobs. For lack of doubt, cost-optimized hospitals are particularly susceptible to this. This single mechanism destroys more value than anything else in a veterinary enterprise.

As competitor's labor capacity deteriorates, so does its goodwill with clients. They become less able to provide the unique experiences that clients demand. They are forced to hire lower quality candidates or not replace open positions. Client perception and trust falls and the spread between client's perception of the control-of-labor hospital and its deteriorating competitors widens. The wider the spread, the greater the pricing power premium a control-of-labor hospital gets.

Hospitals with the greatest control-of-labor shield themselves from the effects of turnover on collective behavior and are positioned to reap the benefits of the competitor's deterioration.

Strategies to Maximize Intra-market Control

The control-of-labor strategy recommends investing an outsized proportion of revenues on recruiting new labor and retaining existing labor. Compensation mechanisms, any wage, benefit, or perk, that are most visible and easily relatable should be maximized and advertised. Visible compensations are the mechanisms that most labor participants will look at to determine their potential or current earnings; they can be both positive contributors or negative contributors. Visible mechanisms include hourly wage, salary, bonus structures, equity grants, cost of health insurance, employee discounting, paid vacation days, and retirement matching.

Large, one-time payments to new recruits is a very effective measure for incentivizing employees to leave competitor hospitals. Increased vacation days and substantial pet care benefits are also effective. In cost-optimized strategies, compensation is constrained, staffing levels are constrained, and control of labor is lost. Cost-optimized hospitals will feel competitive pressures from control-of-labor hospitals in many market conditions, but tight labor market conditions are when the pressure will be the highest.

Technology has increased transparency and awareness around compensation and culture. Employees can glean greater visibility into what a hospital is offering for a given position and trends in technology and government policy suggest that transparency will only increase with time. Employees at cost-optimized hospitals will eventually become aware of their opportunity cost of staying in their role when compared to moving to a control-of-labor hospital. As such, the model predicts that cost-optimized hospitals will incur greater turnover, greater difficulty recruiting new labor, and deteriorating cultures. They will take longer to fill open positions and must hire from lower quality candidates. Slower recruiting of lower quality candidates produces downward pressures on the hospital culture that increases the likelihood of further turnover, and this cycle becomes self-reinforcing. This self-reinforcing dynamic erodes the hospital's control of labor and can become terminal.

In contrast to cost-optimized hospitals, hospitals with control of labor will have increased intra-market control. Intra-market control allows hospitals to recruit and retain higher quality labor, and shorten the time required to fill open positions. This improves the hospital's ability to meet market demands, which are high as a precondition for this strategy. Having intra-market control also limits the quality of labor competitor hospitals have access to. As high-quality candidates are hired, fewer remain for the hospitals with lower intra-market control. This places downward pressures on competitor hospitals, especially those utilizing a cost-optimized labor strategy.

The end result is a hospital of high quality labor competing with hospitals of lower quality labor. This leads to intra-organizational control, which generates the economic return for the costs associated with controlling the labor market.

Barriers to Exit

An example of creating a barrier to exit through benefits is using discounts on veterinary services and inventory to drive employee retention. Discounts on veterinary services create an incentive for employees to take medical responsibility for more animals, which increases their personal expenditure on veterinary care. As a result, they must factor in the opportunity cost of leaving this role and losing the subsidies on the medical care. The extent to which this works is determined by how attractive the discounts are relative to the next best alternative. Simply offering a discount may be of little value if it is no more favorable than a competitor. To gain control of labor, the treatment of labor must be the best.

Summary

Veterinary hospitals leverage labor to produce revenues. In restrictive labor markets, access to labor constrains the growth and profitability of hospitals. Hospitals must compete in zero sum games to recruit and retain labor. Hospitals can use increased expenditure on labor to gain intra-market and intra-organizational control. Through control, hospitals can place pressure on their competitors and create pricing power premiums dictated by goodwill spreads. Hospitals prioritizing cost of labor over the control of labor risk self-reinforcing deterioration of their performance predicted by models of collective behavior. Hospitals succeed in this environment by recognizing these labor market dynamics and positioning themselves intentionally to be the benefactors. The Control-of-Labor strategy is a framework for veterinary service organizations to succeed in restrictive labor markets.