Exclusive Markets & Economics of Density

Landline telecommunications […] involve significant fixed costs within each regional market, which are a requirement for economies of scale. These economies have created barriers to entry, protecting the incumbents. Potential entrants would have to seize sufficient local market share to become viable competitors, and the incumbents’ existing degree of customer captivity has made this difficult to achieve.

By contrast, global markets for long-distance telecommunications, film production, recorded music, and books are so large that they will support many entrants, each with a relatively limited market share.

– Bruce Greenwald, All Strategy Is Local.

This essay is one of the intermediate level steps to understand the waste industry as outlined in our primer on the waste industry.  Of the many peculiarities in the waste industry, economics of density & exclusive markets are the most important industry dynamics to comprehend for competent analysis of the waste space.

This essay aims to explain the distinction in market types that waste operators participate in. There have been a multitude of studies on “how waste markets function”, but geographical areas differ widely in trash collection. Context is king when it comes to analysis.

Classification: Natural Monopoly

The waste industry is defined as a natural monopoly by the United Nations Environmental committee.  Below is an excerpt from the 19th page of a UN committee discussing the waste industry:



So what is a natural monopoly? A natural monopoly is when economies of density combined with high asset depreciation ensure that full volume with one operator provides the most efficient solution for stakeholders.

Let me unpack that sentence in layman terms:

  • Economics of density is when a business can provide the same services with the resources by having more customers in one specific geography. Imagine that a neighborhood of 5000 people need to employ guards to patrol their street at night to dissuade criminals. Here are two scenarios that illustrate how economics of density work.

    Scenario 1: Each household uses a different residential guard company. In front of each house, a guard is stationed (5000 guards). Criminals are extremely dissuaded.
    Scenario 2: The entire neighborhood employs a single guard company. The guard company sends out 50 people on patrol each night. Criminals are extremely dissuaded.

    Scenario 3: The entire neighborhood employs a single guard company. The guard company sends out 4 people on patrol each night. Criminals are moderately dissuaded.

    Sending out 50 people to patrol a tiny neighborhood is still extremely excessive, but I wanted to emulate the effect of scenario 1 at a 1/100th of the cost. It should be clear when comparing all examples that a single provider uses the least amount of resources to achieve the desired effect.

  • Asset depreciation is when a business needs to replace expensive equipment to continue operating. If you run a personal taxi service (perhaps through Uber) then you need to replace your car every 6 years. So while each tour might only cost new fuel and personal wages, you still need to earn enough excess profit to cover replacements later on. This is why depreciation is listed on the income statement.In very competitive industries companies with large asset depreciation can often be long-term unprofitable as they are forced to sell their services above immediate cost, but below costs when including the need for replacement.

By having these two attributes the waste sector is much more stable and efficient through communal contracts rather than individual use.

As a result natural monopolies often consolidate customers and bid them in contracts, to ensure that a bidder can be insured optimal volume while still promoting price competition through the auction process. 

To provide a concrete example for economics of density in the waste sector: Imagine 6 areas that need trash collection.


Authors creation. Simplified Model, Economics of Density.

If a collection route has to operate above economic cost (including depreciation of trucks) there are two important factors:

1. How many circles you operate in (keeping utilization high on fixed assets)

2. Keeping the length of lines to a minimum (keeping variable costs low)

Below are two images that contrast potential solutions.


Authors creation.

It should be clear why the entire waste industry operates on contracts. This is one reason why waste operators generally consolidate areas over time, and the reason that operators are generally densely focused in terms of geography. Only the big players have nation-wide operations.

There is an important caveat to above model that illustrates the first major industry dynamic. Only certain markets have economics of density. Whether a market benefits from economics of density depends on the volume in each market. 

Volume & Economics of Density Explained

There is only a certain amount of space in a garbage truck. If a truck could be filled from one circle there would be no regional economies of scale.

In Bruce Greenwalds book Competition Demystified he outlines how a supermarket in a rural town will have complete dominance. There is simply not enough demand to sustain two supermarkets, so nobody attempts to enter. However a metropolis will have enough volume to sustain multiple supermarkets who will have to compete on prices.

The same is true in the waste market. De-minimis size requirements make isolated markets attractive. If (in our illustrated example) each circle had enough trash to sustain a whole operation, there would be no economics of density. As such there would be regular price competition.

When operators who focus on exclusive markets, such as Waste Connections (NYSE:WCN), acquire urban contracts the EBITDA-margin is at least 500 basis points lower. 

The team at Waste Connections generally include the following slide in their presentations.

Source: Page 5.

We cover integrated versus non-integrated in our article on: “How Landfills Drive Consolidation”

The table clearly shows that exclusive markets are preferable to competitive markets. As explained above “exclusive markets” simply means that the areas are rural enough that regional economies of scale manifest themselves.

What Does This Mean for Investors & Entrepreneurs?

For investors it is important to recognize that margins are not comparable across companies with different market compositions. In the United States operators such as Waste Connections have margins in vast excess of peers such as Republic Services or Waste Management, but not because the other two have inefficient management. One cannot simply expect margin differences to close or use them as arguments for return to the mean.

Investors should also consider if rural markets will turn urban or enough people will migrate to make rural markets less attractive over time. Investors should keep market-composition in mind when setting margin-targets for companies that haven’t realized full utilization on assets.

For entrepreneurs the exclusive/non-exclusive market paradigm illustrates what both companies and customers are interested in. Waste operators are interested in purchasing solutions that solve volume-issues in urban areas.

Customers, such as municipalities, are interested in making bids competitive in rural areas. The task is vastly more difficult for an innovator here, but could include alternative logistics solutions or software that optimizes consolidation of municipalities for contract-offerings.

Most of all both investors and entrepreneurs need to comprehend what drives profitability and market paradigm for businesses and customers alike.


A Primer On The Staffing Industry

Human resources are like natural resources; they’re often buried deep. You have to go looking for them, they’re not just lying around on the surface. You have to create the circumstances where they show themselves

– Ken Robinson

This is Herskind & Agarwals primer on the staffing industry. For deeper insights read our essays. The primers goal is to introduce the space to investors, entrepreneurs, and laypeople. With a mixed demographic, certain terms may be unclear. Questions are therefore encouraged in the comments.

Since we provide this article at no cost or paywall, consider leaving your feedback as payment at: HerskindAgarwal@gmail.com

Defining the Staffing Industry

The staffing industry is quite easy to define. It primarily holds one type of company: Staffing agencies.

Staffing agencies connect companies with a temporary workforce. A staffing agency uses labor, through recruiters, and brand-name to attract potential employees. The agency also attempts to demonstrate to companies that they can provide superior talent, faster, and cheaper than internal HR. Thus the primary competition for staffing agencies consist of in-sourced corporate recruiting.

The staffing agencies are the original platform businesses. As such they also compete with (and utilize) the modern labor platforms of today such as LinkedIn and Indeed.com.


Description of the staffing space by Recruit Holdings’ 2017 Annual Report.

Why Do Staffing Agencies Exist?

Getting a job can be hard. Most jobs either don’t fit your needs, are extremely crowded, have extreme requirements for prior experience or low compensation. Sometimes several of these ‘unique attributes’ combined. Even the most ambitious individuals can burn out while applying for hundreds of jobs.

On the other hand hiring is almost equally difficult. You have to sift through hundreds of CV’s with various formats, deciphering which candidates make true claims and where the information provided is less accurate. Even worse the process of finding, reaching, and attracting the proper talent pool takes time and money before the process even starts.

Sometimes that workload is worth the trouble. Consider having to put together a new department for supporting your sales teams. You would have to comprehend how the sales team is currently structured and what the corporate goal is with the support function. Furthermore the entire team would have to work together, which requires deeper insight than simply adding one team member. An HR department shines in that scenario.

Other times the trouble of sifting through potential hires is not worth the effort. If you need 200 people to move boxes from one spot to another the work is homogenous enough that reaching the employment pool is the difficult part. If you need a chemical engineer for 3 months to handle a single project, a large part of the search costs come from simply finding and contacting potential employees. Many project-type employees wouldn’t even consider a 3-month employment status in an isolated case.

This is where staffing firms provide utility. By reducing search costs for both employees and employers, while providing consistent project-based work for niche employees, the companies earn a fee. Employment agencies, as they are often called, work as brokerages. Putting potential employees and potential employers in contact, all while taking a fee. They reduce search costs at both ends of the spectrum.

But staffing agencies are more complex than they look. There are several types of placements, each with a distinct financial and operational profile. Agencies often integrate themselves into their customer companies in various capacities and there are several mega-trends that will fundamentally change the industry in coming years.

When trying to invest or build in the employment space the first crucial step is to understand the current ecosystem.

Which Services Do Staffing Agencies Provide? 

Staffing Agencies provide a wide range of services. Many of the larger agencies have branched into traditional human resource management, but in this primer we focus on the core staffing agency services.

They can be broadly categorized as:

  • Traditional staffing which entails temporary placement of low-skill labor.
  • Specialist staffing which entails temporary placement of skilled labor.
  • Permanent placement fees.

Traditional staffing contracts often come at high volumes and with long-term commitments from both sides. The industries served are often seasonal and high turnover by nature. The take-rate for traditional staffing are low for two reasons:

(1) Little room for differentiation. The jobs are fairly commoditized so price competition is intense. It’s hard for companies to see how staffing agencies can add any value besides low price and expediency.

(2) The high-visibility of sales make the contracts attractive which creates more competition. Highly visible sales lead to cheaper financing (and therefore less money paid to the bank). Staffing firms need less compensation for a reliable income stream.

The staffing agency is paid a percentage of the employees wages, usually referred to as a take-rate.

Specialist staffing contracts often focus on skilled labor spaces such as IT, engineering, finance, or medical services. The work can be projects or a test-period for permanent employment. The full compensation therefore often depends on their temporary workers being hired full-time. The specialist business is also more cyclical as much of the work is capital expenditures for improving the business, whereas traditional staffing is often operating expenditures to keep the business going.

The cyclical nature and lack of long-term visibility generally leads to a higher take-rate for the staffing agencies.

The staffing agency is paid a percentage of the employees wages. In addition a  fee is paid when a temporary employee is hired by the customer company. These fees are called ‘permanent placement fees’.

Specialist staffing carries higher stakes for customers. In the book ‘Who‘ by Geoff Smart it’s estimated that a wrong hire costs 15 times the employee base salary. Employing the wrong engineer could easily be a $1.5 million dollar mistake. Thus specialist staffing firms require higher credibility.

Permanent placement fees constitute the 2nd component of specialist staffing fees, but can also be relevant in traditional staffing. If a company decides to hire the contingent/temporary workforce permanently they have to pay a fee to the staffing agency. Seeing as the agency has to do no additional work (besides potentially paying a bonus fee to the hired employee) the permanent places fees can be extremely lucrative on a income-statement profitability basis.

Staffing firms have also begun to integrate themselves into payroll processing and other HR functions, but that is an entirely separate discussion. The core service remains placing workers with businesses.

Industries Served & End-market analysis.

The business of connecting workers and companies relies on a suitable economic climate. That makes the business slightly procyclical (it moves in tandem with economic development),  but what really determines the level of cyclicality is which end-markets the agency serves and in which capacity.

An end-market is a term for the category of your customers.

The end-markets for traditional staffing is often retail, warehouse, construction, or manufacturing jobs. All industries rely heavily on the well-being of the economy when hiring. Luckily the services provided are often essential for the company so firing the laborers entirely is almost impossible.

The end-markets for professional staffing are often less cyclical, but the nature of the work is often very dependent on the economic cycle. Far from cancelling out the professional staffing segment is more reliant on a positive economic environment as permanent placement fees depend heavily on an expanding labor base and often decrease materially volume-wise in recessions.

Be sure to analyze the end-markets of any corporation you analyze or interact with to determine their position in a recession.

An average staffing firm will derive roughly 50% of its sales from industrial staffing jobs, 25% from service-related staffing jobs, and 25% from professional staffing jobs (of which the majority will be IT-related).

Statistics on The Staffing Agency 

We’ve covered what staffing agencies do, why they’re needed, how they earn a profit, and how the composition of customers influence risk during a recession.

The next step is to grasp a few basic numbers. Let us first look at the United States.

According to the American Staffing Association the staffing industry had total wages paid of $161 billion in 2017. With a take-rate of 15% that amounts to a total market size of ~$25 billion for staffing firms. Roughly 80% of the market is temporary staffing, while 20% of the market was professional staffing aimed at permanent placement.

The ~$25 billion dollar market has 20,000 staffing companies. Roughly 50% of companies are in the temporary and contract staffing space. Combined with the knowledge above the implication is that there are a lot of fragmented specialist firms and fewer, but larger, temporary staffing firms.

Staffing firms employ roughly 2% of the U.S. nonfarm workforce.

On a global level the staffing industry produced $428 in wages in 2016 which amounts to a +$60 billion dollar market on a global scale. This implies that even the largest firms such as Adecco only posses a ~5% market share. The industry is clearly fragmented.

From a laborer point of view the agencies are often a way to get a permanent job. 49% of staffing employees openly state that permanent placement is their goal. 35% of employees have been offered a permanent job and the acceptance rate is 66%. The average temporary placement wage is $17 per hour in the United States.

The Unit Economics of The Staffing Industry 

So what does an actual temporary employee result in financially? Take the $17 per hour average above as an example.

The $17 average wage would be billed as $26.35 to companies. Why? There are a few pass-on costs such as legally mandated labor costs (WC, SUTA, FUTA, FICA) that amount to $3.34 in total. This leaves a discrepancy of $6.01. This is the gross profit / take-rate for the staffing agency.

$4.93 go to general and administrative expenses. The vast majority goes to employees, but costs such as offices, marketing, and research costs often grow slower than sales, leading to expanding margins with volume. The fixed costs amount to roughly ~20% of the administrative costs. That means only ~$4 actually go to the variable expenses related to the employee hired.

That leaves $2 of profit per $17 of wages received (for incremental EBITDA margins of ~12%). The staffing agency then has to pay interest and other corporate taxes along with fixed expenses. The fixed expenses tend to be fairly variable in the long-run which means that most profit margins (even with large, scaled agencies) end up below 6%.

In the example above there is a profit of $1.08 when you include fixed costs. That amounts to a 6.3% profit margin. Considering we still need to pay interest and a few additional taxes it’s easy to see why few firms manage to break +6% profit margins consistently.

Those are the economics of the industry on a micro level. On a macro level the industry is slightly more complex.

Industry Dynamics: What Staffing Is Really About

There are a few key dynamics to understand.

  1.  The limited scope of control,
  2.  Human Resources – horizontal integration,
  3. Technology implementation.

(1) The first key dynamic is the impossibility of trying to improve the product or change inventory. Employees won’t change their personality to accommodate a recruiter, nor will a 3-week app education materially contribute to their skills.

That also means the sphere of influence for improvement is quite small. You cannot improve your product (make it better, make it cheaper). You cannot charge more to customers (non-captive customers). The only control you have is pure corporate efficiency. The less rent, employee costs, and marketing you need to succeed the higher the profit margin and the more effective incremental volume will be.

That means succesful staffing firms are fiendishly focused on reducing overhead. The most succesful approach I’ve seen has been Japanese Recruit Holdings. They utilize a decentralized corporate strategy where each department manager holds a large responsibility for costs. This reduces bureaucracy and increases autonomy. Recruit has best-in-class margins and I expect competitors to increasingly adopt the model over time.

An alternative has been to consolidate everything into a common back-office enhanced by technology. For now the strategy has not been succesful, but with a new age in tech the plan could work out long-term.

Not all staffing agencies are focused on remaining lean, but succesful ones are.

(2) Staffing is largely a commoditized space which makes operators branch out into more attractive adjacent verticals.

The easiest example is when agencies manage payroll services for companies with a large contingent workforce. Since staffing agencies already handle the temporary staff payroll, why not take over the remaining services for synergistic purposes? While the staffing agencies generally deliver the services at a lower price than pure-players, the integration of payroll services deepens the partnership between staffing agency and customer. The partnership increases switching costs on the staffing side while providing a steady source of high-margin income on the payroll side.

One of the most popular verticals for integration is recruitment process outsourcing (RPO). Despite the overly complicated name the service is straightforward. The staffing agency takes over the full recruitment process for their customers. Seeing as the staffing agencies are constantly monitoring the specialist talent pool there are scale advantages to managing multiple talent acquisition divisions across companies.

Staffing agencies offer a multitude of similar services. Each cover a HR service that is partly associated with a temporary workforce. Most have a different margin profile from traditional staffing, which should be considered when comparing margins across companies. For a full example of the breadth achievable I recommend researching Randstad.

(3) Another attempt at differentiation in the world of staffing is the continued integration of technology. Large firms like Adecco have spent hundreds of millions on attempts to implement technology into their recruitment process. The space for technology aimed at staffing agencies is quite attractive (from an entrepreneur perspective) as most staffing agencies are generating mountains of cash with no easy redeployment opportunities.

Some companies simply attempt to use new tools for old processes. An example would be AI for identifying good recruiting opportunities or apps that keep track of your work-week for you.

On the other hand a few truly innovative companies, such as TrueBlue, have attempted to build entirely new structures. Trueblue attempted a brief foray into this with their JobStack app. With JobStack you have the ability to see jobs in your vicinity and apply based on your profile at TrueBlue. While the application still relies on a centralized system (TrueBlue) it’s an interesting foray into technological adaptation. The project could potentially connect staffing agency customers with the network of people looking to join ‘the gig economy’ through a formalized channel.

The adoption of technology will fundamentally change the economics of the business. Whereas the current unit economics (as demonstrated above) are highly variable and largely scale with use (the $4 of administrative costs), the unit economics in a tech world would require little variable expenses, but heavy investments into research and marketing. This will mostly benefit larger operators.

Summary and Putting It All Together

The staffing business is a brokerage business between employees and employers. Staffing agencies fulfill a series of needs, from high-volume low-skill labor to specialist IT work. Each type of service has its own margin-profile and growth runway.

The staffing agencies suffer from a commoditized product. The solution has been to try and integrate higher skill services along staffing offerings. Most staffing firms are turning partly into HR firms. Each staffing firm has a unique risk profile based on which type of service they provide (cyclical project-based work or consistent low-skill work) and to whom (cyclical industries versus stable industries).

What To Read Now

Having gone through this document you’ve hopefully acquired a foundation for comprehending how and why staffing agencies make money. The next step is to learn a few intermediate concepts, depending on your end-goal.

If you goal is to invest in the industry we highly recommend our essay on the accounting for staffing firms. It explains why people (even from prestigious publications like Forbes, Nasdaq) often hype or pass up on investing in staffing stocks due to not having full comprehension of the accounting employed. The essay is titled “How Accounting Distorts The Staffing Industry

No matter what your goal is you need to comprehend the growing importance of automation. The best source of information is a recent McKinsey Global linked here. It explains the timeline and scope of automation well.

If your goal is to build tools for the staffing industry, we recommend looking at what projects have currently been acquired by Adecco, including Vettery and JobPilot. We also recommend looking at the recent technology from TrueBlue, an industry leader at implementing technology.

The most popular startup strategy seems to be a clear focus on a small, but coveted, pool of laborers. Focusing on the labor/supply-side is currently the strategy for most recruitment platforms.

If you plan to work in the industry there exist a few “recruiting handbooks” on Amazon. None of them have proven very insightful. For professional staffing the major trends seems to be comprehending the new recruiting landscape (I recommend “Social Media Recruitment” by Andy Headworth) and how important your function is. The best book for all around insight is in all likelihood ‘Who‘ by Geoff Smart. The book is based on interviews with over 300 CEO’s and proposes a structured attempt at finding & hiring the best people for the job.


How Accounting Distorts The Staffing Industry

And he read Principles of Accounting all morning, but just to make it interesting, he put lots of dragons in it. ― Terry Pratchett, Wintersmith

Accounting is a wonderful tool for understanding a business. It outlines the amount of capital employed, how the capital is financed, the amount of cash the business is producing, and illustrates expenses across all levels of activity.

Yet accounting can also be treacherous. Revenue can be front-loaded, expenses can be capitalized, and a thousand other tricks can lead to a mirage for investors.  There are multiple tools to counteract these mirages. Cashflow awareness, footnote diligence, and a broad knowledge of accounting all reduce the risk of miscomprehension.

Like any tool accounting is great if you have control, but a lack of comprehension or focus leads to danger.

In the staffing industry the unique accounting related to sales & profitability lead to a wide range of misconceptions both when screening for the stocks and when judging investment merits. I’ve heard multiple times that staffing had too low margins to be an investable business. I’ve also heard that the Price-to-Sales ratio indicated a good purchase on many staffing stocks.

Below is a small compilation of times that not knowing the accounting on staffing revenue would have led to overlooking or overestimating staffing stocks.


Produced by Author. Sources range across 5-10 investor-focused articles from major websites such as Forbes, Nasdaq, etc. 

The Business and Accounting of Staffing Agencies

The staffing business is at its core a brokerage business. As covered in my primer the business centers on joining individuals seeking temporary placement and corporations seeking a temporary workforce for several reasons.

Regular brokerage businesses carry transaction volume as a separate footnote or line item and the take-rate is revenue. If you want a boat and I introduce you to my friend who owns one in exchange for a $200 commission, brokerage accounting would have $200 as sales while traditional retailers would carry the whole boat as sales (seeing as they carried it at cost in inventory).

Visa and Mastercard don’t carry total transaction volume (in the trillions) on the income statement, only their >0.5% take. Online brokerages such as Ebay carry their “bite of the cake” as net revenues and show gross merchandise value in footnotes. Actual stock brokerages use the same model.

For sales almost every brokerage model doesn’t use the gross transaction volume, but only the slice that ends up at the firm. Investors could be excused for assuming that staffing would operate similarly, but it doesn’t.

Staffing sales are counted as the total wages paid to the employee. That includes employee wages, workers’ comp, federal unemployment, state unemployment, health, and insurance costs. Gross profit is the take-rate of the staffing agency. The categorization of payments leads to the what should be sales ending up as gross profit.

The sales of staffing agencies are in effect the GMV of online retailers, the transaction volume of card networks, or the total sums managed by brokerages. The gross profit constitutes the true sales.

How the Accounting Distorts Screening and Cross-industry comparisons.

As the sales of staffing agencies include ALL the wages paid to their placed temp. staff, the margins are extremely thin and the price-to-sales ratio is equally low.

For investors focused of net profit margins (as demonstrated in the top image) this might lead to categorizing staffing firms as ‘dogs’ and commoditized. Many investors have minimum requirements for margins which is extremely rational. It is traditional micro-economic theory and investment considerations (from the time of Graham) that the lowest cost manufacturers (lowest margins) are leveraged towards commodity prices.

It is entirely reasonable to avoid certain commoditized, low-margin business models, but not when they’re only optically low-margin due to an accounting exception.

For investors focused on low price-to-sales (as showcased in the photo above) the unnatural accreditation of sales will result in a seemingly “value-style” stock on a revenue basis.

The low margins might inspire false confidence as I’ve heard from some commentators on manned security and staffing agencies. They will argue that margins are so low that nobody wants to disrupt or compete. In reality the margins at some firms are in line with most industries today on an adjusted basis.

On the other hand I’ve seen arguments that certain aspects of staffing that doesn’t involve employee wages, such as recruitment process outsourcing, will face contracting margins because they’re so “attractive” when compared to staffing revenues.

All of these arguments are entirely invalid based on traditional accounting measures. My argument isn’t that staffing stocks are likely to be under- or overvalued as a result of this phenomenon.

My comment is simple: Be extremely wary if you see an argument related to margins or price-to-sales of staffing stocks.

Staffing Companies on an Adjusted Basis

I’ve tried to summarize the difference in a comparison between a “normalized” income statement and the status quo income statement.


(1) An adjusted Income Statement contrasted with the current version.

While the absolute numbers are the same (e.g. both versions would end up at the same absolute profit figures) the inclusion of wages in sales and cost-of-goods sold severely disrupts any investor screen aiming at “high-margin” companies.

Further Complications

So you’ve learnt how staffing accounting differs widely from what is usually applied to brokerage-type businesses. That means you’re ready to go screen for the best staffing companies.

Not so quick young buck.

There is yet another complication. Staffing companies often derive income from permanent placement fees/direct hire fees. Direct hire fees are charges to staffing agencies for finding an employable candidate.


An explanation of Direct Hire Fees from Talent Plus Staffing.

Direct hire fees don’t have the wage component in goods of goods sold. Aforementioned means it’s extremely high gross margin as most of the expenditures are based in operating expenses.

Direct hire fees are good examples of products that should be treated as direct revenue. As the two different fees mix, it skews the gross-margin upwards. Be aware of this fact when comparing margins across companies within the industry. Industry-relative comparisons are disrupted by direct hire fees not being treated like pure staffing revenues.

With that last explanation in mind you’re now cognizant of the intricacies surrounding staffing margins. Go and impress some girls at the bar with it!