New ideas in setting fees (Proceedings)

Setting fees properly is an important task in a veterinary practice; yet many hospitals don't really give much thought to how this should be done. They simply increase the current fees by some percentage every few years and assume that is enough. Unfortunately, it's not. In order to have a good quality fee schedule that contributes to practice profitability, you must have an understanding of all the key factors that impact fees, and more importantly, clients' willingness to pay them. Setting the fees isn't enough; a practice must also make sure they are providing the value that supports the fees as well as capturing all the charges and controlling discounts. These activities are as important as determining the fee itself.

The most important financial measurement to be made in a practice is that of true practice profitability. However, neither the "net income" figure on a practice's financial statements nor the "taxable income" line on the tax return represent true operating profits due to personal accounting choices, the type of entity a practice operates as and the IRS regulations for preparation of tax returns. Therefore many practices really don't know what their true profitability is. Not only is profitability critical to current cash flow, but practice value is largely based on profits and, in the last few years, the number of practices with no or little value has been increasing—to the point where the Valuation Committee of the Association of Veterinary Practice Management Consultants and Advisors coined the term "No-LoSM practice" to describe these practices.

The impact of fee increases on profits can be dramatic but if you don't know what your true profitability is, how can you determine if your fees are helping you reach your financial goals?

Impact on profits

Therefore, rule one in the fee setting process is to calculate what your true profitability is and understand the impact of fee increases. You may need to get help from your financial advisor to determine what your profitability is. Another resource is the No-Lo PracticeSM Threat Advisory Worksheet (a practice profitability tool provided by the Association of Veterinary Practice Management Consultants and Advisors) available at www.avpmca.org.

Fees can be grouped into 3 different categories—price shopped fees, fees for services and fees charged for products. The fee setting process for each group needs to be approached differently.

In setting the fees (i.e. the markup) for products, you must first understand all the components of product costs:

• Unit cost

• Sales tax, if applicable

• Ordering costs

• Holding costs

Ordering and holding costs in most businesses comprise about 35-40% of the unit cost of an item. For example, if you order a tube of medication that costs $4.00; you are really paying about $5.60 for that tube after you factor in the ordering and holding costs. This may seem like a lot until you consider the components of these costs:

Ordering Costs

• Time

o Determing need to restock

o Placement of order

o Reviewing shipment and invoice

o Unpacking

o Shelving

o Paying bill

• Phone/fax/computer costs

Holding costs

• Interest rate to finance inventory

• Insurance

• Personal property taxes

• Theft/shrinkage

• Maintenance of inventory

• Space and utilities

• Bigger orders = higher carrying costs

• Time value of money

• Licenses

• Repackaging

• OSHA compliance

These costs can have a significant impact on the profitability of different kinds of revenue streams generated in your practice:

Profit comparison

In general, the product profitability is not as high in many practices as one might think and it is critical that this be calculated when making decisions to match internet competitor prices, offer discounts on certain products to certain clients or otherwise not raise product prices appropriately.

There is no perfect method for setting service fees; however, understanding the cost of the service, the current market rate for the service and the client value associated with the service can all help.

The current market price for a service is, in essence, what everyone else charges. This can be difficult to determine and there is usually a wide range. Published averages and ranges are helpful to know, but you have to blend that information with the value you bring to a client. (For example, why does a fecal cost $5.00 at some practices and $25.00 at others?) And be careful about talking too much about this to your neighboring practices; the Federal Trade Commission has big ears!

Most practices don't know what it costs to provide their most common services and this is an important calculation to perform. Once you know what the cost is for some base-line services, you can use this information to estimate the cost for other similar services.

In calculating the cost of a service, include the following:

• Compensation costs for doctors based on the time spent performing the service

• Compensation costs for staff based on the time spend performing the service

• Benefits (insurance, CE, uniforms, retirement plan contributions, etc)

• Drugs and supplies used in performing the service

• Equipment costs

• Facility costs (space, utilities, etc)

Some estimates have to be made in doing the above calculation and estimates may be less than perfect. However, calculations based on reasonable estimates are better than no calculations at all.

Software is available, customized to the veterinary market, that will let you make these cost calculations easily for many fees in the practice. The clinic enters its labor costs, drug costs and equipment costs and then the program uses this information along with the average time it takes to perform the procedure, the desired profit margin and several other factors to calculate a right fee for the procedure. Obviously, this may need to be modified based on value factors in your practice but it is an excellent starting point.

Value is the hardest factor to determine though ideally this is how you'd best like to price your services. Value is based on the intangible factors that bring clients through your doors and keep them coming back:

• Location

• Facility appearance

• Years in operation

• Reputation in the community

• Client service—responsiveness and reliability

• Equipment/technology available in the practice

In addition to setting the right fee, it is important to increase it regularly. The cost of everything a practice buys (drugs, supplies, staff compensation, utilities, etc) goes up every year and if the practice is not raising its fees correspondingly, the practice is losing purchasing power even if profits appear to be rising.

Effect of Inflation on Earnings

Assumptions

• Gross revenues in year 0—$1,000,000

• Inflation—3% per year

• Practice growth rate—10% per year

Year 1 to Year 3

If your practice does not increase its fees, then over a 10 year period, gross sales increase 159%, net profits on an absolute dollar basis increase 159% but true buying power only increases 82%.

In addition to looking at the impact of fee increases on the fee schedule as a whole, it is also important to periodically review specific services. Not only do you want to look at the dollar fee itself, but it is important to understand if the fee is actually being collected. The more complicated a fee schedule is, the less likely it will be used properly. The fees charged will be those that are easiest to understand, and, generally, the lowest.

One are to review is the number of similar services. For example, how many different kinds of exams do you have? How many are essentially the same? Do your recheck exams and hospitalized patient exams take approximately the same time to perform yet have different service codes and different prices in the computer? How about your "referral from another veterinarian" exam and your regular sick pet exam?

Many practices have 15 different kinds of exams that could be collapsed into perhaps three categories such as:

• Brief exam

o Recheck

o Inpatient

• Regular

o Annual

o Sick patient-multiple problem, single problem

o Health certificate

o Behavior consult

o Second opinion

o Referral

• Extended

o Emergency

o Very sick

Surgery is an area in which many fee inconsistencies exist. A useful exercise is to group your surgeries into a matrix based on the difficulty of the surgery and the time it takes (on average) to perform. Such a matrix would like this:

Surgery matrix

Once you've grouped the surgeries, look at the prices in each box. Is there any reason they aren't similar?

In addition to setting the right fee and collecting it, you must make sure you aren't discounting it. The dollar effect of discounting can be dramatic. If a single doctor sees 5000 transactions in a year with an ATC of $90, his or her gross revenue will be $450,000. Assuming a 20% profit margin, the dollar profits will be $90,000. If the doctor discounts 10% of the transactions by 10%, the profits will be reduced by $4,500 to a total of $85,500. The doctor now must see 250 more patients to bring the profits back up to $90,000.

The most effective way to identify and estimate discounts in a practice is through a medical record audit. Pull 20 records for each doctor in the practice in a given week. Get a mix of cases proportional to the activity—wellness exams, hospitalized cases, surgery. Also pull cases from through out the week so all days are represented. Compare the medical record to the invoice and record all discrepancies. These charges could be lost either due to deliberate discounting by doctors or staff or because they simply slipped through the cracks and weren't added to the invoice. Information to capture on the audit spreadsheet for each invoice includes:

• Doctor

• Technician

• Receptionist

• Date

• Patient

• Dollar amount of invoice

• Procedure performed

• Correct fee

• Fee charged

• Lost or discounted amount

Once you have calculated a total for the missed charges, calculate that as a % of the total invoices in the sample. Then multiply this by the total production to get an estimate of the total missed charges in one year. This should be done on a total practice basis as well as an individual doctor basis. The dollar amount of missed charges directly reduces the practice profitability. In addition to the financial ramifications, discounted charges create confusion amongst staff and clients regarding clinic pricing.

In order to correct this problem, it is necessary to understand the underlying cause. The audit worksheet should help you see the pattern. If the charges are truly just missed, then streamlining the paperwork and clearly designating who is finally accountable for the accuracy of the invoice will help. If the charges are due to deliberate discounting, then the owner group needs to come to a consensus regarding the practice's philosophy on discounting and monitor records on a go forward basis to insure everyone is adhering to it.