May 25, 2016, 11:44 am

This post earlier on the customer service downsides of the new salaried overtime rules got me thinking more broadly about the impact of minimum wage type laws. Progressives justify such laws by saying that there is a power imbalance between management and employees, and that the government needs to have minimum wage laws to make up for the fact that employees lack power.

But from my experience in the service world, it is wrong to look at the situation as a power struggle between managers and employees. It is much more correct to look at this as a power struggle between employees and customers. Let me explain.

Service and retail firms tend to live on razor-thin margins. Retailers typically live on single-digit profit margins, and those of companies like Wal-Mart are as low as 2% of revenues. Our company in the service business has a similar experience, averaging profit margins of 3-5% of revenues over the last 10 years.

This is not an accident. Most service and retail businesses depend on simple service-delivery models using relatively low-skilled workers. There are many low-skilled workers in the world. If a company were to start making huge profits with a service model using such workers, it would be easy for others to copy it and hire the same types of workers and undercut them on price. Margins tend to get competed down to the bare minimum.

No matter how much progressives would like it to be so, when California raises its minimum wage, it probably is not going to come out of company margins, at least in the near term. Over the 10 years from about 2013 to 2022, California will have raised its minimum wage over 87% from $8 an hour to $15. Wages and costs like workers comp premiums that are tied to wages are about half my costs. This means an 87% labor cost increase will increase my total costs 44%. How is that going to come out of a 4% margin? It is not.

There are really only two things we can do, individually or in combination. First, we can raise prices 44%, just to try to stay even. Of course, some customers will balk and stop buying, and then we will lose business and perhaps have to close (we have already closed over half our businesses in California for just this reason). Or second, we could cut staff in half to keep wages under control. Of course, this means customers get served much more poorly, which also may drive customers away. Other companies like fast food restaurants have a third option of automation, replacing people with machines -- I wish we could do this but right now we have run out of ideas for automating bathroom cleaning and landscape work.

Hopefully, you can see what is going on here. The real tension here is between employees and customers. When the state mandates a minimum wage in low margin service businesses (such laws are largely irrelevant to high-margin technology companies and such), compliance is paid for by the customer, either in the form of higher prices or worse service or both.