Calculating the real cost of labor in setting fees

"Oh, Doctor, how can we charge $18 for this service?"

Good question. Let us figure out this fee.

How long will it take you to perform this duty?

"Well, 30 minutes."

And how much soft-time work is generated per 30 minutes of hands-on time?

"Well, 30 minutes."

So, one hour of labor has gone into this service.

But before we continue, let us consider other industries that use industry-specific formulas to calculate fees or cost to the consumer:

» Feed stores will use 1.10 times the wholesale price of the grain to set the retail price.

» Various jewelry stores will use three times their cost to set the price of items.

» General contractors tend to add 15 percent to subcontractors' fees to determine their fee. Subcontractors use the cost of materials in a formula to set labor costs to install the items.

» Fast-food restaurants use the cost of goods as 40 percent of the price to set prices.

» Hotels use cost of goods at 20 percent of the price to sell banquet meals.

In short, industries use these formulas with the variables when setting their fees or prices.

Veterinarians are more interested in the latest in cancer treatments, knee-surgery options, humane euthanasia and vaccine risk management. In general, we would rather just enjoy the profession of James Herriot.

Table A

But as the profession matures, it is increasingly important to keep an eye on the economics of our practices if we want to survive and thrive in coming years.

The one undeniable truth in veterinary practice management is that we can time how long it takes for support staff to complete tasks.

Another undeniable truth is that income is linear with support-staff numbers, not numbers of veterinarians within our practices.

For example, there may be two-veterinarian practices with 18 employees and four-veterinarian practices with 18 employees, both grossing $1.7 million.

We recently discussed the upside-down practice, where 70 percent of the income is from the outpatient zone, which generates 30 percent of the overhead. In the upside-down practice, the inpatient zone generates 30 percent of the income and 70 percent of the overhead.

Thus, the outpatient zone subsidizes the inpatient zone.

Practices wishing to right the ship can set fees for professional services based on variable costs to produce those services, using a mathematical formula.

To do that, we must understand and determine the real cost of hourly wages paid to staff members.

The staff is divided into two teams: The T Team, or technical hands-on team; and F Team, or front-office, soft-time team.

In reality we cannot specifically charge for soft-time work, because it is a qualitatively determined item.

We can track and time hands-on duties. And with hands-on time associated with soft-time in equal portions, we then use a 1:1 formula to make the time allocation for fee calculation.

Most industries have a good handle on labor costs, but that's not true of many veterinary practices.

The real cost of labor can be confusing, so let us lay it out:

Consider workplace daily pay first. Typically, the employee looks only at dollar-per-hour wages. Everyone knows his or her hourly.

The employer, however, must determine the total cost of the employee and then the total cost of the staff per hour, using that data to set fees according the cost per hour to provide a given service.

Review Table A ("An illustrative employee cost-per-hour analysis," ). Into the basic labor cost goes these factors:

» Hourly (the basic hourly rate)

» Overtime (1.5 times hourly rate)

» Special pay (e.g., incentive pay, profit-sharing, awards)

Then comes the unseen employer's share of the following:

» Health insurance

» Social Security (required)

» IRA (retirement)

» Vacations and holidays

» Employee discounts on products and services

» Worker's Compensation (required)

» Unemployment rates (required)

Add these together to get the total cost of the employee. Divide by the hours worked for a pay period. These generally add about $6 to the per-hour cost of the employee.

As noted in Table A, this employee earns $14.50 per hour, but his or her total cost to the practice is $20.60 per hour.

Before the check is cut, make the necessary deductions, including Social Security, Medicare, insurance, IRA or other retirement, federal and state taxes.

Further, as noted in Table A:

» The employee's hourly rate is $14.50, with and time and a half for overtime.

» The employee also receives monthly profit-sharing and/or awards of $88.

The employer then must pay all the fixed expenses previously mentioned. From the employee's share, deduct Social Security and Medicare, state and federal taxes and the group health plan.

Employees who participate in an employer-sponsored IRA can match up to 3 percent of their wages toward it.

In the end, while the employee appears to net a mere $909.02, the actual cost to the practice for that employee (at $20.60 per hour) this pay period was $1,813.37.

Now, let's again consider the $18 fee:

For this $18 service, because we're paying the employee $20.60 per hour, we are losing $2.60 in real dollars.

If we wish for the cost of labor to be 25 percent of the total P & L at the end of the month, then that fee should have been about $80 ($20 / 0.25 = $80).

Thus this $18 service is worse than a basic loss leader. With loss-leader items, we expect at least to break even.

We should all understand these issues when setting fees based on the true cost of labor.

This calculation makes the payroll more transparent to staff.

Employees should clearly see the connection between their time and fees collected.

Recommendation

1. Each practice should keep a running true hourly cost of each employee.

2. Each employee should get a copy of a these calculations with their paycheck (Table A).

3. Make a specific analysis of inpatient fees to right the upside-down practice.

Next month: Calculating annual payroll per hour

Dr. Riegger, dipl. ABVP, is the chief medical officer at Northwest Animal Clinic Hospital and Specialty Practice. Contact him by telephone or fax (505) 898-0407, Riegger@aol.com or www.northwestanimalclinic.com. Find him on AVMA's NOAH as the practice management moderator. Order his books "Management for Results" and "More Management for Results" by calling (505) 898-1491.