Appendix I: What a Contracted 2% Profit Model is Unrealistic and Unsustainable

 Why a Contracted 2% Profit Model in Child Care is Unrealistic and Unsustainable

            Where our economy lands post pandemic and how quickly we recover will surely depend on our government’s policies and market-based industry’s success.  More specifically, it will depend on our government’s support in promoting the sustainability of our essential industries.  Tantamount to this is recognizing what sustainability looks like and costs.  So what is sustainable profitability for a business?  Development is a key aspect of any business.  Every business must have long term goals which incorporate continuous improvement and development supported by their profits.  In addition, it is important that all businesses and industries alike have a sustainable return on investment (ROI) which incorporate an inherent growth rate(G).  The rate of a business's growth is a key determinant for outside financing, as creditors use G to determine the likelihood of default.  Therefore, profitability becomes an obvious important factor to any company's ability to improve, innovate and expand.  Clearly factors needed in an economic recovery. 

            This becomes a crucial factor in the partnership between our state and the market based child care industry to deliver child care and preschool services, most importantly in desert areas.  Current Department of Education rules pertaining to public/private partnerships in the delivery of Universal Pre-Kindergarten (UPK) dictate  a 2% profit cap on any such partnership.  This is not only unrealistic, it is unreasonable and unworkable.  Depending on the location, the average 10,000 square foot child care center costs between $549,228 to $767,635* to develop (not including real estate).  This is a large investment.  While all investments have some intrinsic risk, a 2% cap on profits not only makes it insurmountable to recover initial cost it makes it impossible to keep up with the economy rising costs to remain viable.  The risks therefore far outweigh any possible reward simply by the fact that it is impossible to have any reward.

            Since it’s inception in 1975, COLA has ranged from 0% to as high as 14.3% which occurred in 1980. Over the last decade (2010-2020) COLA averaged 1.65%.  However, in the preceding decades (2000-2010) it was 2.78%.In the 1990’s it averaged 3.24% and in the 1980’s it averaged 6.26%.   The current COLA is 1.2% based on the CPI of the last 12 months ending in November 2020.  Over the last year all items, less food and energy, rose 1.6%.  Food rose 3.7% while energy fell 9.4% as a result of widespread quarantines.  According to the Federal Open Market Committee (FOMC), personal consumption expenditures (PCE) inflation will be 2% for 2021, while other agencies predict that CPI inflation will range between 2.1-2.3%  

Obviously, the inflation rate depends on the balance between aggregate supply and demand within the economy.  But as we know, labor market conditions and inflation expectations are the major supply forces-- decreases in unemployment means the supply of workforce falls, which in turn increases wages and inflation.  In 2019, we saw our lowest unemployment rate since 1969 at 3.5%. Presumably, this would have triggered some level of inflation in our economy had it not been for the fact that we were subsequently thrown into the social and economic tailspin of COVID-19.  This was also demonstrated in the unusually conflicting CPI numbers above.

            In an about face, COVID19 has created a situation with historic unemployment rates which should mean that inflation will be incredibly low.  However, there is a monkey wrench thrown into the mix because New Jersey administrative policies have altered the natural consequences of our labor market cost indexes due to minimum wage mandates.  Over the next 5 years, minimum wage will be increasing respectively by; 9%, 8.3%, 7.6%, 7.1% and 6.6%.  This is far above our Consumer Price Index.  As a result, New Jersey’s economy will be facing many unusual situations simultaniously with historic unemployment, rising labor costs and a significant recession saddled with a huge budget deficit. 

The child care business is very labor intensive.   It will be impossible to operate in support of this minimum wage mandate without significantly raising already high tuition rates.  Staffing costs are usually 45 - 50%  of even the most successful business’s overhead.  Mandating that businesses increase their most substantial operating cost by its very nature will reduce profits.  The free market will dictate where capital formation occurs.  Historically capital formation will pursue those endeavors with the highest profit margins.  Industries with little to none or restricted profit margins will see little to no capital investment. This is contrary to what our state wants or needs right now, particularly in one of our essential service sectors.  The success of our recovery will be in providing jobs to lower and middle class wage earners.  On the other side of the coin if we let child care centers currently operating  fail we will not get that supply back.   Human beings are rational.  They will invest where they can get the highest return.  If you mandate smaller profits than most other industries nobody is going to want to be in this industry let alone expand into underserved markets, i.e. deserts.  Here is just a small sampling of alternative industry investment opportunities for capital:

                                                       Net profit                    Gross Profit

Auto repair & Maintenance                12%                           21%

Construction.                                      5%                             19%

Hotels & Hospitality.                           8%                             76%

Maintenance Services.                       10%                           30%

Restaurants.                                       15%                            67%

Retail.                                                  5%                             22%

Tax Services.                                      20%                           90%

Transportation.                                   19%                           47%

Few industries have as many regulations as the child care industry, certainly none that also have profit caps.  The only industry that could compare would be utility companies which are also essential services.  However, utilities are de facto monopolies because they can only be delivered through a single passageway to consumers.  While effective for this industry, we also have seen huge societal problems with this delivery, for example Flint water system.  The COVID-19 pandemic has shown us unequivocally that the child care industry is a foundational essential service.  It is also needed for almost every other industry to be productive.  It is pivotal to our economies' aggregate supply and demand.  However, unlike many other essential services, it is already set up with the safest and most effective delivery system by allowing consumers choice and flexibility. Critically it also already has many billions of dollars of infrastructure built and contributes many billions of dollars to our state's revenue.  It is vital that our policies support the sustainability of the child care industry.

* Source: Lightbridge Franchise Company’s 2020 Franchise Disclusre Document, Item #7 – Estimated Initial Investment