Financial considerations critical component to successful merchandising

For years, a debate has raged about the merits of merchandising in the veterinary practice setting.setting.setting. The debate has been as much a philosophical one as anything else. Veterinary professionals must reconcile aspects of marketing in competitive retailing with prescribed ethics of professional conduct and appearance.

Retailing to one extent or another, seems to be a fact of today's veterinary practice. Beyond the more complex and intangible philosophical challenges, administrators must attend to important financial and management considerations inherent in merchandising.

The debate

Merchandising by its very definition refers to the buying and sales of tangible personal property: goods and commodities. In the context of the veterinary hospital, merchandising refers to nearly everything that is not professional services: dietary products and supplements, drugs and prescribed medications, parasite control products both for pets and environment, and the myriad of ancillary supplies that could be found at any retailing establishment formed for the purposes of animal care supplies. In veterinary hospitals, such ancillary products could span from collars and leashes to behavior enhancement equipment, such as Kong toys and Gentle Leaders.

Today's veterinary practices generally take a holistic approach. In the course of physical examination and wellness care, health and other animal-care related issues come to light, resulting in a doctor or technician's recommendation. If that recommendation entails the provision of a certain medication or nutritional supplement, the course is clear. Having the recommended goods on hand is a convenience to the client and results in better compliance. Hasn't every veterinarian felt the relief of being able to provide the client with exactly what they need at the time of the office call? Isn't it psychologically easier to charge for professional time when the client leaves the building with some tangible item in a doggie bag?

Think again. How often have staff anxiety levels increased when the recommended product is discovered not in stock? Or the times when patients did not like the dog food that must now be returned. Worse yet is the discovery months later of unreturned products tucked away in a corner, now expired and without chance of refund.

Here to stay

Merchandising in the veterinary practice is probably here to stay, despite potential pitfalls. Surveys suggest that one-stop shopping and convenience is a significant factor for client loyalty. Additionally, veterinarian comfort levels with charging a fair fee for diagnosis, physical examinations and surgery time seems less than when a medication is dispensed.

Merchandising can be an expensive proposition. The cost not only exists in the original purchase of the item for resale, but also in building enough floor space and adequate storage areas to house it, and investing in the staff to order, manage and move it.

Given the veterinary profession's use of merchandise as support to professional service provision, what are the significant financial issues to be considered?

Tax consequences

The United States tax code provides that certain service-based businesses may maintain books and records on a modified cash basis. Revenue notice (2001-76) is the most recent addition to a long list of rules affecting a business's choice of accounting method. This most recent rule amendment suggests a cash-receipt method of accounting is allowed for many businesses of $10 million or less in gross revenues.

Reading the tax code and interpreting the various procedural pronouncements that have come in recent years is a challenging proposition. Nevertheless, cumulative guidance provides that materials, supplies and retail items cannot be expensed at the point they are purchased, as would occur on a pure cash methodology.

Supply and retail inventories must be "capitalized", that is maintained as a financial asset of the business and not expensed until actually depleted in the course of providing services or sold to a client. Veterinary practices must track the value of supplies and merchandise so that expenses are not prematurely deducted.

A logical solution is voluntary election of the accrual basis of accounting for practices selling any quantities of drugs, supplies or ancillary animal-related products. Under a full accrual basis, inventories are capitalized, just as required on the modified cash basis, but the practice also recognizes liability for amounts owed to outside parties.

Accrual-based accounting records clearly state inventory valuations, accounts payable, and other assets and liabilities. From a financial management perspective, results of operations are easier and more meaningful in their interpretation, while the off-balance sheet accounts are minimized.

Sales and use tax

Another merchandise compliance issue is that of sales tax payments, collection and remittance. Each state has different rules. Be aware of current legislation and its interpretation in regard to your veterinary practice.

In some states, a veterinary hospital is deemed the end user of products purchased for use in the treatment of animals. Drugs, whether used during pet hospitalization or prescribed to clients, may be tax-free to the client when invoiced. If so, the practice must pay sales tax on purchases made from its vendors.

In other states, sales tax is not assessed to the veterinary practice by the vendor. The practice may be required to charge sales tax after appropriate markup on products. When sales tax is collected from clients, it must be remitted on a regular basis to the state.

Practices must be aware of use tax laws. Every state that has a sales tax also has a compensatory tax, called use tax. When the practice has not paid the required sales tax to the vendor, such as with some out-of-state purchases, then it must compute and remit the correct amount of tax to the state.

The state dictates sales and use tax return filing requirements and dates. Practices must voluntarily comply with the regulations. Sales and use tax audits are common, easy sources of revenues based on current statutes for most states.

A significant merchandising concern for veterinary practices is good systems forproduct receipt, storage and payment. Establish purchase order procedures, wherein the purchasing agent creates a sequentially numbered record for each order, including order date, item, quantity, price quotation, and vendor. A purchase order system helps prevent stock outages, tracks back orders, and controls costs through assuring agreement of quoted prices with actual invoiced amounts at a later date. Train staff in proper protocols for handling shipment receipts, such as comparing shipping documentation with items received, before they are placed in storage areas. For retail items, updated price tags must be affixed.

Establish protocols for rotating stored stock, updating listed computer prices for any increases since the last order, and identification of items near expiration. Damaged goods, and items returned from clients must also be controlled so that optimal credit can be obtained from manufacturers.

Notify bookkeepers of impending credits as soon as items are identified for vendor return. Too often, UPS pick-ups occur without bookkeeper awareness of the return. Without safeguards, the probability of lost vendor credits is very high, since the bookkeeper won't be watching for their presence (or omission) on later statements.

Bookkeeping systems

A proper paper trail helps bookkeepers assure item payment is in accord with physical receipt and negotiated price. Here is where the purchase order system provides additional evidence when compared with shipping documents, credit memos, invoices and the final end-of-month statement.

Invest in software that can provide a clear trail of outstanding purchase orders, bills requiring payment, and due date alarms to obtain early payment discounts and mitigate finance and late payment charges.

Space consideration

Many veterinary practices have limited space for merchandise storage. Periodically review items on hand to ascertain what can be consolidated. Obtain doctor agreement as to the items that should be used in routine patient treatment and to eliminate redundant product lines that accomplish the same purposes.

Evaluate storage area security. Large quantities of expensive product held for future dispensing represents a substantial liability in the event of theft. The more that is on hand, the higher the risk level for unobserved theft.

Practices with limited space tend to store products in every available nook and cranny. Outdated products, redundant ordering and superfluous items become par for the course, with fragmented storage schemes. Whenever possible, concentrate merchandise in a single central storage area that is easier to eyeball and secure.

Explore vendor options for "just-in-time" ordering systems. In a just-in-time system, the practice orders no more than what it needs for a short period of time, such as 30 days duration. Quantities can be kept low, but incoming shipments are frequent. Also be aware of new Web site ordering technologies that allow placement of an order and immediate shipping to the client. The practice gains space and saves money by eliminating the requirement to store certain product lines at all, such as dietary product or heartworm and flea preventative refills.

Invoicing

Just as for services, lost income from missed merchandise sales is a common problem in veterinary practice. Evaluate the invoicing software, and monitor staff usage. Match historical invoices against patient records on a weekly test basis to keep staff sharp.

Train employees to invoice capture every dispensed item. Assure staff is well educated to recognize differences in size categories. Mistakenly selling a high cost item with a low price invoicing code is a sure way to devastate practice profit margin.

Watch profit margin

Most practices have experienced tremendously increased cost of drugs, supplies, dietary product and ancillary product costs. Drug and medical supply cost as a percentage of gross income is commonly three to five percentage points higher than what it was 15 years ago.

The percentage increase is due to advanced pharmaceutical agents for arthritis control, holistic approaches in alternative medicine, flea control and heartworm preventative. These drugs have great benefit to animal welfare, but competitive retailing has kept markups relatively low.

By pure volume as compared to services within a practice, retailing results in a greater portion of revenues generated from lower profit margin segments. Without a doubt, the highest profit margins are found in veterinary service activities, particularly consultation and examination time.

Know where the practice's profit margin is through analysis of financial information on a regular basis. Watch for trends that indicate profit margin degradation. Be a leader by charging for everything that is done.

Before adding new merchandise lines, assure that all veterinary staff has a full and absolute belief in the validity and benefit of the items being vended.

Consider separate invoices for retail sales as compared to veterinary services. Two psychological benefits result. The first is that the client perceives a lower total invoice for the veterinary service component, when separately invoiced has been provided for things such as heartworm preventative, flea medication, and pet food.

Invoices could be formatted differently so that one conveys the professional services while the other represents the retail items.

Compensation issues

Regularly review how staff is being paid. In the current world of veterinary economics, doctors are often paid a percentage of productivity. Before productivity can be rewarded, it is important to understand what it comprises. Often, merchandise items are added over time, and included in a particular doctor's provider account code. Because of the lower markup on these items, the percentage paid for doctor time with a higher portion of revenues generated for merchandising compounds the problematic aspects of lower profit margin inherent in merchandising.

Staff wages and compensation may also be an issue. Some practices reward staff on an incentive basis for product sales made. In such a bonus plan, staff belief in the merits of wellness care, prophylactic dentistry, and veterinary procedures must be reinforced.

If incentives are only based on selling product, a danger exists that attention to comprehensive health care will be weakened.

Pricing

Pricing is one of the most crucial issues to consider when merchandising in the context of professional practice. Pricing strategies must be based on cognizance of intra-practice subsidy. Some product lines can generate a higher profit than others. Ear and eye medications, generic drugs and medications prescribed as part of a treatment plan may allow a higher markup than other items that are more routinely shopped. Heartworm preventatives, flea products and pet supplies easily found via the internet or catalogue sales are good examples.

Typical markup spans anywhere from 40 percent to 300 percent. The general rule of thumb is that a 2.5 to 3 times multiplier should be applied if doctors are paid on a production basis for a portion of the sale. Anything less than a 40 percent markup in the veterinary hospital setting (and not included in doctor production) is likely lower than breakeven.

Keep staff aware of the fact that merchandising is only a supplement to excellent veterinary care. The primary purpose in any veterinary hospital should be the provision of excellent services. Charge well for them. Doctor time, consultation, and treatment should take precedence to the shopkeeper's mentality.

Merchandising can be a strong addition to the practice bottom line when handled in a business-like manner. Be wary that a casual approach to managing merchandise in the veterinary setting results in a less economically rewarding practice situation.

Failure in these situations results from veterinarian discomfort with charging for a knowledge base. Are you comfortable with what you know and does your current knowledge base represent a good return to your clients? If you can answer yes to this question, then keep your fees commensurate with that responsibility. Merchandising at all levels then becomes a supplement, providing your clients with the convenience of everything they need for excellent pet care.

Referrals and practice growth will come not from the fact of merchandise on your shelves, but because of the reputation the practice enjoys through the efforts of its professional staff.