As a business owner, how can you use labor as a source of leverage to increase the impact of your own effort? And does this use of labor create value? The answer to this pair of questions depends on how labor is used and the relative efficiency of the market. To start, consider the relatively simple business model of door-to-door sales. Assume for a moment that you can generate $100 per day selling magazine subscriptions door-to-door.
X >>> $100 net
You then hire and train another salesperson to replicate your efforts in another neighborhood. You agree to pay this person $80 per day. Now you have combined sales of $200 per day, $80 of which you must pay the second salesperson.
2X >>> $200 – $80 = $120 net
By continuing to expand your sales force you can linearly increase your net earnings…
10X >>> $1,000 – $720 = $280 net
This model can work so long as there is some market imperfection (specific information, licensing agreement, etc.) that prohibits the other salespeople from simply directly selling themselves. Or, if they are willing to accept only 80% of the net take in exchange for you taking on their risk. Either way, the answer to both our questions is yes. You did find a way to both amplify the return on your own effort and in the process created market value by reallocating labor from a lowered valued use to a higher valued one.
ow let’s revisit the questions using a more complex business model, a restaurant. Assume, as before, that working alone you can generate $100 per day net. But this time you see that by adding additional labor you can more than proportionally increase your productivity. Hiring another worker, again for $80 per day, you can have them specialize in preparing the food while you specialize in interacting with the customers. The resulting synergy results in the ability to now generate $300 per day net.
X >>> $300 <<< Y so $220 net
In both examples, labor is successfully used to amplify your own effort. And in both examples, the reallocation of labor results in more valuable products and services being provided to the market, i.e. value is created. In the first example, value is created by addressing an existing market failure or more efficiently allocating risk. In the second example, value was created by recognizing the opportunity to combine resources synergistically to create something the same resources could not accomplish in isolation. The net gain in both cases is the market reward to you as the business owner for identifying and realizing this opportunity to better utilize resources.
As a final note, increasing your salesforce or kitchen staff tenfold doesn’t imply a tenfold increase in net return. Markets become saturated and kitchens crowded. Further, the wage isn’t the only incremental cost of adding labor. The cost of oversight also increases, sometimes more than proportionally. And so, for every business there is some level of labor usage where adding labor is no longer beneficial.