Veterinary Practice Management Fees for the Modern Practice Fees are obviously an important factor in the economic wellbeing of any practice. But, they also have a significant impact on a client s view of your practice. Clients are much better informed on alternatives to your services than ever before. You must make sure that your fees represent a value that s meaningful to clients. Arbitrary and outdated rules for calculating fees do not meet that requirement and methods based on sound business principles must be used. 2012 RxWorks, Inc. www.rxworks.com Page 1
Executive Summary One of the most critical tasks in managing a modern veterinary practice is building its fee structure. It should satisfy two needs which are potentially conflict with each other. The fees must Represent a value that is perceived as fair by the client for the services received Provide sufficient income to sustain and grow the business as well as reward owners for their investment. Veterinarians do not have a clue as to how to set proper fees. Developing a veterinary fee schedule can be confusing and difficult at best. Historically, veterinarians have literally "pulled their fees out of the air" or they base their fees on those in "the area" or the cost of a first class stamp, and even worse, what the fees were when the practice was started. John F. Grote, DVM Outdated fee strategy Neither requirement is satisfied by using a fee strategy based on economic and social conditions from the 20 th century. But, the majority of practices still use that strategy! Currently, they add a fixed percentage margin to the cost of products. They calculate fees based on a percentage of the examination fee or multiples of the veterinarian s compensation, or some other arbitrary rule. That s not exactly the same scientific approach you use in the rest of the practice. To compound the problem, most veterinary fee studies are based on comparing practices that use that fee strategy. That s like measuring the performance of cars built in the 1980 s and using the result as the benchmark for the way current models should perform. Current business environment The veterinary practice landscape has changed significantly and continues to evolve. You now have: a pet population that is either reducing or flat depending on which study you accept, clients who use the internet to search out information and alternative sources for care and products, clients who want to be kept aware of the needs of their pets, increasing practice costs for medical and information technologies, increasing staff-related costs, and growth of non-veterinary outlets for products traditionally restricted to veterinary practices. Make sure your fee strategy matches current conditions You must revisit the logic of your fee strategy, adjust it to meet the current conditions and learn from successes with methodologies used in other businesses. Profit is the measure of business success Most managers agree that the main indicator of the performance of a business is profit. In a veterinary practice that s basically a result of the number of patient visits multiplied by the average profit for each visit. Page 2
Profit equals the fee less its cost. Now here s the problem, how do you work out the cost for a procedure? The general opinion is that it s too difficult to calculate. But there is a way around that. Use other industries experience to help build your fees Practices accept the need for standards of care for services. It s also generally agreed that in a large percentage of visits, the services provided are common from one patient to the next. The same conditions exist in other industries which have common regular processes and they use the standards to establish costs. To do that they build a database of estimated times for processes and multiply those by a rate to arrive at a standard cost. That can be done for a veterinary practice. We already have a database of several thousand procedures with standard times that are ready to be used with your rates. Cost-effective method for establishing fair fees Spending a lot of manual effort collecting the various cost components is very expensive. In the short term there is a simpler way of using standard times to build a fee structure based on sound business principles. The basic idea is that employees are the source of your major expense and their time is the major factor in the cost of a procedure. When working out goals for your practice, you will no doubt have an annual revenue figure that you expect each veterinarian to produce. You also know roughly how many hours you expect them to work in the year. You can calculate a billing rate per hour by dividing the annual revenue by hours worked (less administration time). Use that rate with the time from the standards database to come up with a recommended fee for each procedure. Use a similar process to calculate fees for other resources, such as lab and x-ray equipment. You can adjust that fee to allow for shoppable services as well as services that are high expertize. But you are now using fees that are based on time and they provide a good guide to the profit each procedure (and producer) is delivering. All the time you are using this method, make sure that your computer system is collecting details that can be used later to establish a truer cost of procedures. Using variances to measure your progress Taking this approach one step further, you can measure how you are progressing towards your profit goals by using the difference between recommended fees and adjusted or actual fees. The difference is called the variance. Negative variances mean you re below the fee you expected and positive means you re doing better. The mix of negative variance and positive variance procedures you provided in a period determines your total performance. You can see the total of those variances and if necessary make adjustments in fees for individual procedures. Variances help you to focus on the procedures that are causing poor performance. You re not waiting until you get your financial accounts to make the decisions. The objective is to bring your fees into a justifiable and sustainable methodology. As with all fee changes, you will also need a consistent client education plan that s supported by all of your practice staff. The plan must inform clients of the value of your services and put the fee in its proper perspective with regard to the wellbeing of the patients. Page 3
Components of Modern Veterinary Practice Before starting a fee management project, you must look at the components of the modern veterinary practice, current factors that influence them and also identify sources that can help create a better fee strategy. A Practice provides professional services like an attorney, physician or dentist acts as a pharmacy sells feed, pet food and other supplies as does a pet or feed store provides other services such as grooming and boarding. Factors that Impact a Practice s Fee Strategy Client perception of the value of veterinary services Competition from colleagues and non-veterinary sources Practice overhead costs and expenses Veterinary and other staff compensation Purchase and operating costs of specialized equipment Desired profit Your fee structure must support every one of the practice components and address the factors that influence them. For professional fees, most veterinary practices do not charge clients based solely on the time expended (billable time) as do law firms. Also, you are not governed by insurance or government payments as are physicians or dentists. However, in many countries pet insurance is on a fast growth path and you must recognize its potential to play a major role in the way you get paid for services. For products, you have a much higher cost of running your business and do not sell enough of any one product to reap the advantage of bulkbuying as do internet pharmacies or pet store chains. The veterinary practice is a hybrid business model requiring specialized pricing methods for each business component. Your challenge is further complicated by having several of your more common professional services shopped by clients. This results in those services being considered as commodities by the public. How can you cater for the mix of business? To address the business mix and be successful, a modern fee strategy should utilize two different pricing models: value-based pricing and cost-based pricing. Page 4
Establishing a Fee Strategy Before you can establish a sensible fee, you should know the costs associated with that fee. As other industries have shown, calculating cost is best and most efficiently -achieved using information technology tools. A few definitions: Fee = Direct Cost + Overhead Recovery + Profit. 1. Direct Cost is the cost of the provider(s) time in delivering the service for professional fees or the amount we paid to a vendor for the product or the cost of operating any equipment used. 2. Overhead is the total of all expenses involved in running the practice less the total Direct Cost 3. Overhead Recovery is the portion of the total Overhead that is allocated to each of the services/products when it is sold. 4. Profit is the amount of money left to provide re-investment in the practice and to give a return to the practice owners. Your fee strategy goal is to create a process and system that easily, effectively and consistently calculates these three elements. Let s start with easiest of the two fee types: Cost-based Products and Equipment Operating Costs. Direct Costs Most modern practice management systems record the cost of products as they are received into inventory. The only decision you have to make normally with advice from your accountant is which of the inventory costing methods to use. The choices are First in First out (FIFO), Last in Last Out (LIFO) and Average Cost. Any equipment that is used in providing a treatment also carries a Direct Cost which consists of the depreciation of the original purchase cost of the equipment plus any materials used in its operation. Equipment necessary for providing Radiology, Ultrasound and other diagnostic services fall into this category. Ambulatory practices also have vehicle costs to consider - particularly important in the present climate of increasing fuel costs. Equipment (including vehicle) costs are typically defined on a unit basis per radiograph, per mile, etc. We recommend that you discuss depreciation costs that should be allocated to each piece of equipment with your accountant. Page 5
Overhead Recovery The next step is to determine the percentage of the total Overhead that will be recovered by the product or equipment. This is the part of the strategy currently used by most practices that arguably has caused the most problem. Typically the percentage used to establish the total cost of an item has been the same for both products and professional services. This means that medications and other products have borne a share of such items as medical equipment depreciation and other medical operational costs, which are used solely for professional services. These costs typically constitute the majority of the Overhead in a practice and result in inflated medication/product prices and reduced professional service fees. The single percentage approach distorts the practice s performance in both areas. As medications and products can now be shopped by the client, their inflated prices can be perceived by the client as an indication of how the practice sets all of the fees - creating an impression of price-gouging. Is it possible that adverse media reports about veterinary fees (E.g. Consumer Reports article) were triggered by global allocation of overhead? Probably - as Medication/Product prices are presently the only part of the veterinary business that clients can easily compare to alternative sources. Why not make sure Medications/Products bear only the overhead costs that are directly attributable to their purchase and storage? Then, the majority of overhead costs will be attributed to service (not Medication/Product) fees. A word of warning! Discuss overhead allocation with your accountant or financial consultant. Also recognize that too much detailed analysis may not impact the resulting costs and fees sufficiently to make it worthwhile. Desired Profit Once the percentage Overhead Recovery for the product has been determined, you must establish the average profit margin desired from product sales. As you are competing with outlets that typically have better buying power and higher gross sales of products, it is very unlikely that you will consistently get the same margins from Medication/Products that you can from professional services. Value-based Professional Fees You have the same three elements as you do for Cost-based products. Direct Cost The Direct Cost is the compensation that is paid to the provider for the time taken to perform the service. The components of Direct Cost are Time X Rate. Calculating the Time needed for each service obviously depends on estimating a normal time that the practice expects to take in providing the service. Some are fairly easy such as 10 minute examinations, 20 minute exams, etc. Others are more complicated, especially surgeries. The challenge is to establish a time that is acceptable as a standard for the practice. Each of the doctors and nurses will likely have Page 6
different times, but as you do not know ahead of time which doctor will provide the service for a patient, it is impractical and a waste of effort to develop individual times. The rate should also be a global or standard amount that can be used for all of members of the category of provider, example: doctor or nurse. For the same reasons as discussed in the previous paragraph, calculating individual provider rates has no advantage. Overhead Recovery To allocate the percentage to be used for Overhead Recovery, you need to estimate how much of your Total Overhead is attributable to providing the professional service part of the practice. This should be as accurate as you can make it, so that you get as close to actual cost as possible. Profit You then need to determine what profit percentage you want to have from professional services. This should be an average for all services and is a standard you set for the practice. For those professions that have used cost-based fees for many years, there is a rule of thumb the two-fifths rule. Two-fifths of the fee recovers Direct Cost, two-fifths accounts for Overhead and the remaining fifth is Profit (or 20%). Fee Building Blocks You ll have realized by now that you are establishing a whole series of cost and fee standards for the practice. For the same reasons you have standards of care for your patients and client services, you also have standards of cost that you will use to measure performance. Standards do not only apply to the protocols used in treating patients but flow through to standards used in calculation of costs and then to their fees. Creating these baseline costs and fees may appear to be an onerous task, but once established, they serve as building blocks that can be easily modified in a changing environment. As with all standard-based systems, the foundation is laid for consistent, accurate and dependable operation of the practice processes. Establishing Fees There s a basic concept that must be understood to effectively use standard-based costs and fees. What is called a fee in most computerized practice management systems is in fact a collection of component services and other factors. You build the services you offer using combinations of these components. Each of the components has a standard cost and a standard fee. The key in establishing a true fee structure is to have a comprehensive list of these components. It is equally important to understand that one component can be used in many different services. The advantage of this method is that if the standard cost or fee of a component is changed it is immediately reflected in the cost and fees of all of the services that use it. Page 7
How can you create a Standard Fee structure? You need to know your projected income and expenses. This is typically done by taking the figures from last year s Profit and Loss report and extrapolating them for next year with the percentages by which you expect them to change. Then there are a series of operational factors you have to establish: 1. Do you bill for technician/nurse services? This can be for services done without a doctor or time helping a doctor and you want it included in a client s bill. 2. Do you pay doctors on production? Does the doctor s production include worked charged by the nurse? 3. Are doctors compensated for the sale of medication, food and other items? 4. What is the number of hours you reasonably expect a doctor (and nurse, if applicable) can bill. These are the hours actually providing services that a client will pay for. Anything above 70% of the total hours worked by the doctor or nurse is unusual and should be carefully reconsidered. There are other factors that impact the fee strategy and you must consider them when establishing the fees: 1. The majority of a practice s income ultimately should be generated by services, not product sales; this emphasis is particularly important in light of the escalating impact of internet, retail stores and other non-veterinarian outlet competition in product sales. It is sensible to concentrate on your core strength, competence and training rather than be distracted by commodity sales. 2. For clients to accept increased fees, the shift of focus from product to service and corresponding fee increases should be gradual and accompanied by ongoing client communication. 3. Client communications need to convey value of services and professionalism focusing client attention on value rather than fees and encouraging compliance with doctor instructions for patient care. The client invoice is valuable tool in this task it should include easy-tounderstand descriptions of what you did.. 4. Information technology should meet the needs of the various practice users - and easily facilitate income capture, create timely and appropriate client communications, generate accurate and understandable medical records and bills, as well as ensure follow-through on patient cases. The prerequisites for success in establishing the strategy are the availability of all of the information outlined above and a computer system that will: Calculate all of the standard costs and fees generated from the information for fee components Organize and store the fee components Create the structure to build Service Fees that are to be billed from the components Use those Service Fees in the practice management system to bill clients Provide management tools to monitor performance based on variances Allow costs and Fees to be quickly recalculated when you have a changing environment. Page 8
Alternative Method for Standard Fees without Knowing their Cost As you ve no doubt recognized, collecting the data to work out the cost of procedures involves a significant effort. It s one that most practices cannot justify. You need your computer system to automatically collect the data and it needs to be done over a period of time - not less than a year. There is a method that gets you part of the way towards a standard profit based fee. And that s basing fees on a planned revenue goal. You will most likely have an annual revenue target for each of your veterinarians and your nurses if you bill their services separately. You also have an estimate how many hours they re expected to work in a year. The hours worked will have to be adjusted to allow for estimated administration and other nonchargeable time. You can calculate a billing rate by dividing the revenue goal by the adjusted hours. Use this rate multiplied by the standard time for the procedure to arrive at the standard fee. You re not going to be able to show the profit of each procedure, but your fees will be based on a sound business principle the time needed to perform the service. Adjusting Standard Fees It is an unfortunate fact of life that in a competitive climate you cannot always use the calculated standard fee. You have business influences that cause you to use loss-leaders and reduced margins for shopped items. The difference between the fee that you actually charge and the standard fee is called a variance (Actual Fee Standard Fee). These result in lower profits for the shopped services than the standard fee would provide and give us negative variances. Fortunately you also have those services that are value-based which require specialized medical knowledge and time. They can be charged at a higher fee than your standard and give us positive variances. The challenge is to balance the number of services that have positive variances with those negative ones you did, so they give you at least your projected profit at the end of the year. Meaningful Management Reporting You can analyze these variances on a weekly or monthly basis to check how you are doing against your profit projections. This is a much better way of determining our performance than the historical comparison of gross revenue. If comparing gross revenue is our only management tool, results can be misleading. Increased revenue over last year does not necessarily mean that you are doing better as your costs could be increasing at a much higher rate. But if you have a zero or positive variance as well as increased revenue, you know that your profit is at least what you planned. You can use the combination of gross revenue and variance for each category of service or product to accurately identify those areas of your practice that are meeting goals and those that need more attention. Page 9
Summary Clients are becoming more demanding of practices to provide services at what they perceive as a fair price. They are also willing to pay for those services that they consider valuable to the well-being of their companion whether it be a dog, cat, horse or gerbil. Products that were traditionally sold only by veterinarians are readily available from retail and internet sources. Cost is the major reason for their growth as competitors. Prices charged by veterinarians for the products are often not seen as fair and perhaps by association, so are the fees for professional services. You must implement a fee strategy taking these factors into account and develop fair pricing based on having an idea of the cost of the services and products you are charging. Using sensible, supportable fees coupled with effective client communications, you can eliminate the unfair pricing perception, improve your return from the business and strengthen your client/practice bond. Page 10