Date: September 15, 2016

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Covenants Not to Compete Part 2 – Podcast



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  1. Covenants Not to Compete, Part 2

Hello. This is Scott McDonald and welcome to the Perfect Place to Put a Practice Podcast.

 

In our last podcast episode, we covered some of the theories regarding how to determine a viable and reasonable covenant not to compete that would stand up in court and, at the same time, help everyone feel that the definition of the radius was fair.

So, let’s look at how people REALLY consider locations and distance when looking at professional practice. Some of the best research comes from real estate agents.

Consider for a moment that realtors want to provide listings of homes and business properties to perspective Clients.  But they have to set a limit on how large a database to include.  They don’t want to waste a potential Client’s time while still having the priority to inform potential buyers of properties that are “in their market.” Realtors are faced with the dilemma of trying to create a rational database of homes to show their perspective Clients.  If you live in Boston, do you really need to know what the housing market in Boise looks like?  So, what Matthew Ferrara, a real estate consultant on the topic, did was consult the numbers in the real estate transactions. He looked at NAR’s 2010 annual survey of buyers and sellers which indicated that the typical buyer of a home will move 12 miles from their previous home.

 

As a second source of information that would include a large dataset, he went to the U.S. Census. They publish the Annual Social and Economic Supplement (ASEC) which takes in moves over the last 60 years. After comparing the data with the NAR data, he concluded the following:

 

  • 59% remained in the same state they were born in
  • 67.3% of  remained within the same county
  • 17% moved to a different county within the same state.
  • 40% of intercounty moves were less than 50 miles apart.
  • 21% of intercounty moves were 50-199 miles apart.
  • 24% of intercounty moves were more than 500 miles.
  • The total number of transfers between all states accounted for 6.8 million people

Only 1 in 7 people moved from one state to another. The majority of people (roughly 40%) stay within a fairly small geographic radius.  What Mr. Ferrara did not take into account was the demographic characteristics of those who move.  There are factors such as age, education, and income that tend to describe those people who move more often and with greater distance.  Additionally, he didn’t consider that there are lifestyle (psychographic) factors that impact whether the distance involved in getting a particular practice type that will influence how far they will go to the new office.  Let me describe some of those factors here.

 

In communities that are more spread-out (have a lower population density) traveling a great distance is taken as a given.  It is not unusual for people in Montana or Wyoming to travel by car 45 minutes and not think that it is too far.  This is as much a matter of habituation as it is of psychology.  Additionally, there are some types of practices that provide services unavailable elsewhere so the trip will be worth the effort.  The common example might be a cancer treatment center.  If a particular location in Baltimore is the only one in the nation that offers a treatment that will save your life or the life of your child, making the journey is no big deal. Perhaps somewhat less dramatic will be the pediatric kidney specialist.  There are not many around so traveling three or four hours does not seem out of the ordinary.  On the other hand, services that are considered more generic (meaning similar services may be available no great distance away) will not be tolerated by the potential patient- or client base.  This simply indicates that a covenant area will vary based upon the type of practice being considered.

 

Occasionally, we will get into an argument with some of our Clients about how far someone will travel to their office.  They often pull out a database that shows that they have a patient who will travel up to four hours to get to their office (or have an uncle in Chicago as I mentioned in the last episode).  My response is always the same: Why are they making that trip, do you think?  Why would that person do what an otherwise sane people would not?  The answer usually comes back that this is their brother-in-law or close friend whom they may be treating free or at a huge discount.  Obviously, we are not looking for the outliers. The exceptions to the rule only prove that these are exceptions that tend to prove the rule. 

 

That is why in defining the “sweet spot,” we use the 80% rule.  I recommend placing the practice where roughly 80% of patients and clients are likely to originate because it presents the basis for a rational algorithm that will reflect the type of practice for which we need to consider boundary radius.  For general dentists, that figure is usually 3 to 5 Zip Codes.  For an urgent care facility and primary care medical practices (including optometrists, internists, and veterinarians), it will likely be between 5 and 7 Zip Codes in most cases. 

 

Another way to define the boundary is to consider that in a suburban area, we consider the core of the practice to be between a 5- and a 10-minute drive-time radius.  Specialists should usually consider the population in the 10- to 20-minute drive-time in a medium-density, residential area.  Very rural areas may be as much as 45 minutes.  After that point, people start looking at other remedies and alternatives to treatment and care.

 

Granted, there are some people who do not trust the “invisible hand” of the distribution of a patient or customer base.  In case you have missed it, the “invisible hand” is a term coined by Adam Smith in his 1776 work “An Inquiry into the Nature and Causes of the Wealth of Nations.” In a manner of speaking, he is saying in the book that there are natural boundaries that are geographic and non-geographic that define where to place a business and how to carry it out. As the Economic Times defines it, it is “The unobservable market force that helps the demand and supply of goods in a free market to reach equilibrium automatically.”

 

Those non-free market enthusiasts believe that distribution of professionals can be made from a rational government office that is dedicated to looking after the needs of the citizenry. As we have lectured in Europe, for example, their socialized medicine models set up an artificial distribution of professionals throughout the population.  This top-down model ignores how people actually behave and replaces it with a bureaucratically created model that has no reflection in the real-world.  It is why Europeans regularly express frustration that there are either too few or no providers of services within a reasonable distance of their work and homes when one gets outside of an urban center.  It should be no surprise that the authors of these models tend to live and work in these urban areas themselves. 

 

We will discuss accountants and lawyers along with other non-healthcare related practice in another chapter of my book as there are some imperatives that they share that other professional practices do not.

 

I am aware that this is a theme I will repeat throughout this podcast episode but for different reasons. There are several reasons why reasonable boundaries will matter:

 

  1. Finding that “sweet spot” will tell you the size of the potential patient or client base. If you need to get a loan for a practice as either a purchase or a start-up, this tells the borrower that there is sufficient population to keep the practice going within a rational boundary area.  To calculate the actual numbers, we have to consider the demographic characteristics that will most likely define the population you want to have in the practice.  As an example, orthodontists have to determine the number of 10-to-14 year olds in a given radius around their office.  If we assume that this is a 10-minute drive-time, it is simply a matter of getting a number of the residents in the area (i.e., 30,000) and multiplying by the percentage of 10-to-14 year olds there are in the area.  Let’s assume that number is 6.2% (30,000 multiplied by .062 = 1,860).  The hard part is that relatively few people know that age, income, lifestyle, health condition, or other demographic factors that define their based and this is where an analyst who is familiar with your type of practice will be invaluable.

 

  1. Only by knowing the limits of the service area or “market” of the practice can wise decisions be made regarding practice promotion as well as covenants not to compete that are enforceable because they are reasonable. For example, does it make sense to purchase a yellow-page ad or direct mail list for a community that is not close enough to provide business?  Absolutely not.  As we have repeated often in this episode, professional practices have a geographic or niche area that is reasonable for the practice.  Advertising outside of that area is a waste of money.  Furthermore, attempting to restrict a professional to practicing in a poorly defined or unreasonably determined covenant area will be unenforceable as a restraint of trade.

 

At the conclusion of this episode, I should state emphatically that reasonable boundaries for covenant areas are a protection for both parties when they reflect the value and security of the existing practice’s interests while ensuring that the other party can continue to practice in an acceptable situation.

 

Now that I have shared with the theories of how to choose the reasonable covenant area, if you want help in setting or evaluating such an area, contact us at doctordemographics.com or have your attorney drop us a line.  We are always happy to help with all types of practice. Keep in mind that my future book, Practice and Place, will be available this fall.

 

I know this was a long session but I hope you found it informative.  For more information contact me at info@doctordemographic.com and thanks for listening.


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