Stanley R. Creighton, DVM, Diplomate, ACVIM, Internal Medicine
CEO, National Veterinary Associates, Inc.
Dick Goebel, DVM
President, Simmons Great Lakes
Practice owners too often are focused on the day to day challenges of patient care, client service and staff management that they overlook factors affecting profitability and practice value. In this session, the authors will discuss the most important factors that drive down value. Some factors may involve circumstances beyond your control. Others are quite manageable if properly addressed. We encourage you to use this discussion to assess your practice circumstances and make positive changes to enhance profitability and increase practice value.
PRACTICE OWNERS FAIL TO OFFSET COST INCREASES WITH GROSS REVENUE INCREASES
Most practices see increases each year in the cost of doing business. Wage pressure from doctors and support staff, rising drug and supply costs, and normal inflationary increases in other costs all contribute to a picture of steady erosion in the practice‘s profitability. Practice profit is a major determinant of practice value. Practice value will go down if the cost increases are not offset with growth in revenue.
Without growth in gross revenues, it is very difficult to maintain the value of a practice. Revenue growth comes primarily from three areas: fee increases, more client visits, or providing more services to the existing client base. The typical practice has all three factors moving one way or the other at various times.
Practice owners can have the most predictable impact on revenues by raising fees. When it comes to raising fees, the key question to ask is “How much do I need to raise fees in order to raise gross revenues by a certain amount? Practices should try to increase revenues as a result of fee increases by at least 3% per year. Note that raising some fees 3% will not result in a 3% increase in revenue unless every treatment and inventory code in the hospital‘s practice management system is increased 3%. This is unlikely to happen due to items that are competitively priced. Fees need to be raised on those treatment or inventory items that are frequently utilized or the impact of the increase will be less than expected. Let‘s look at a real hospital.
Dr. Smith has 800 codes in his computer practice management system. Of those, 360 are treatment codes and 440 are inventory codes. The practice‘s gross revenues last year were $1,800,000 of which $1,300,000 came from treatments given and $500,000 came from the sale of inventory items. His practice management system can do a report that tells him the gross revenue from the top 50 treatment items (excludes inventory). That report shows him that 80% of his treatment revenues ($1,040,000) come from the top 50 treatments provided in his practice. If Dr. Smith raised fees 5% on all 50 of his top treatment items that would result in a revenue increase due to fee increases of $52,000 ($1,040,000 X 5% = $52,000). The additional $52,000 only represents a 2.9% gross revenue increase as a result of raising prices on all 50 of the practice‘s top 50 treatments ($52,000 divided by $1,800,000). If Dr. Smith‘s cost of operating the hospital went up by the same percentage, then he would have broken even in the given time period.
Of course most practices are unwilling to raise fees on the top 50 treatment items because some of those items such as office visits, vaccinations, elective surgery, etc. are competitively priced. If we look at Dr. Smith‘s practice more closely we find that in his top 50 treatment codes five of the codes are for various office visits, eleven are for vaccinations and four are for elective surgeries. They represent $183,000, $202,000 and $43,000 of revenue, respectively. If Dr. Smith excludes these competitively priced items from any fee increase and raises the remaining items in his top 50 treatments by 5% the result is additional gross revenue from fee increases of $20,000. This amount is equal to a revenue increase due to a price increase of only 1.1% ($20,000 divided by $1,800,000). Adjusted net earnings and practice value are both reduced because the cost of doing business grew faster than gross revenues. It is important to use price increases as one tool to maintain practice value and to appreciate that sometimes one must be aggressive if the cost of doing business is increasing rapidly.
Another way to increase gross revenue is to see more clients. We are told that by hiring additional support staff that we can free up a veterinarian. If that happens and if there is client demand, then the veterinarian should be able to provide professional services to more clients. Let‘s say that we hire one additional support staff person and pay them $26,000 per year. The intent is to increase revenue by leveraging off of the new staff member. Let‘s assume that the average charge per transaction in Dr. Smith‘s practice is $100. If he saw 520 clients in a year that he would not have been able to see without the one new staff member, then the practice would see an increase in gross revenues of $52,000. In order to see 520 clients in a year the doctor would need to see eleven clients per week that would not normally have been seen. This scenario assumes he worked four days per week for forty seven weeks a year. The $52,000 per year will benefit the practice, but what is the impact of adding the new staff member and paying that person $26,000? Is the $52,000 all profit, is only half of it profit,
or is none of it additional profit?
In order to answer the question, one must understand the concepts around the cost structure in a typical practice. All practices have fixed and variable costs. Fixed costs are support staff (approximately 25% of revenue) and facility costs (approximately 10% of revenue) for a total of 35%. Variable costs are the cost of drugs and supplies (approximately 20% of revenue), doctor‘s compensation (approximately 25% of revenue) and miscellaneous costs (approximately 5% of revenue) for a total variable cost of 50%. Another way to say this is that for every $100 increase in gross revenue, $50 (50%) of that additional revenue goes to pay for the variable costs in the practice.
In our example above, we added one additional support staff member and that allowed the veterinarian to see 520 cases that he would not have been able to see had the new staff member not been present. This generated $52,000 of additional gross revenue, of which $26,000 went to pay for the new support staff person. We know that in Dr. Smith‘s practice that 50% of the costs vary with the revenue, so $26,000 went to cost of supplies, doctor compensation and other miscellaneous costs. In this example, hiring the new support staff person and allowing the veterinarian to see more cases and generate an additional $52,000 of gross revenue was a break even event ($26,000 to pay the support person + $26,000 of variable costs equals the $52,000 of additional revenue). Point of Clarification: We use this example to make a point. When you add support staff, you must increase revenues beyond their compensation in order to breakeven. This is because of the variable
costs in most practices. In actual fact, less than 50% of the costs would be variable because the $52,000 of additional revenue is incremental to whatever revenue base is already there. Thus the breakeven point would be something below the $52,000 of additional revenue.
PRACTICE OWNERS FAIL TO APPRECIATE THE IMPACT OF CHANGES IN THE REVENUE MIX IN THE PRACTICE
The revenue mix in a practice is the sum of all the items for which clients are charged a fee. The revenue mix in a practice with 30% of its revenue coming from the sale of flea and heartworm products is different than one in which these products represent only 10% of the revenue. We know that the profit margin is different on each treatment or inventory item a client buys. For example, the profit margin on a cystotomy is higher than on the sale of a package of Heartgard. Over the past ten to twenty years the profession has seen a shift in the revenue mix away from more profitable treatments to less profitable medications such as flea and heartworm products and dietary products. As the mix shifts more toward products, overall profits and practice value go down. The best way to maximize practice value is to shift the revenue mix towards professional services as much as possible and be less dependant on product sales.
PRACTICE OWNERS FAIL TO RECOGNIZE AND CORRECT FACTORS THAT INCREASE THE RISK OF BUYING A PRACTICE
As risk to a buyer goes up, practice value goes down. The primary factors that should be considered in the assessment of risk include:
- The growth rate of adjusted net earnings and gross revenues. If they are going down, the risk goes up because they is some dynamic at play eroding profits.
- The ability to transfer the practice goodwill to a new owner. Niche or “personality practices are dependant on the seller and the risk to a new buyer is greater than it would be in a practice that had multiple providers offering a variety of treatments and products.
- Location. The neighborhood is important as well as the practice‘s visibility and access.
- The quality of the staff. A well trained happy, motivated staff is clearly better than one that is not and is a lower risk to a new owner.
- The revenue mix. Practice‘s that provide mainly professional services that are in demand and likely to remain in demand are lower risk than those with more ancillary item sales and services that can be provided by someone other than a veterinarian.
- Quality of the facility. There is no question that a nice, clean modern facility is a lower risk to a buyer than an old run down hospital.
- Demographics. Population trends, employment, income levels and education are just a few of the demographics that should be positive in a practice that has low risk.
- Practice stability. A low risk practice should have consistent year over year revenue growth, low staff turnover, been in the same location for a significant period of time and weathered a number of business cycles.
- Competition. If there are many practices in a small area from which clients can choose, then this practice has more risk that one with less competition.
- Lease terms. A favorable lease reduces the risk to a buyer.
- Effective management systems. A low risk practice has systems in place that allow the manager easy access to all the information that is needed to monitor the health of the practice.
- Non-competition agreements with associate veterinarians. The absence of non-competition agreements greatly increases the risk to a buyer because an associate veterinarian can leave the practice to compete nearby.
- Effective management systems including computerized business, patient and client management systems.
- Marketability risks: 1) Predominantly small animal practices with a significant mix of food animal, equine or avian components may be more difficult to sell as the number of buyers interested in these variations on the small animal theme is quite small. These practices are most often successful in ownership transition by selling to associates and not on the open market. 2) Practices that provide non-traditional services such as holistic, chiropractic or acupuncture face the same dilemma. While they may be very successful businesses as currently operated, the market of buyers is quite small and an open market sale may be difficult.
The authors trust that the listing and discussion of factors that drive down practice values (as well as profitability) has been useful in sensitizing practice owners to these sometimes subtle but very real threats. We suggest you use this presentation as a checklist in assessing your practice circumstances. While some may seem to be beyond your control, many can be addressed and corrected. The reward can be increased annual profitabilityas well as increased practice value. We suggest you formalize this review process and conduct it on an annual basis.
This article was originally posted on www.simmonsinc.com. Any reproduction on any other site is prohibited and a violation of copyright laws.