Originally published in the May 2002 Dental Practice Report. Copyright 1999-2002 Medec Dental Communications.
Rather than making across-the-board cuts, understand where
you’re overspending and where cutting would reap the best benefits.
by Deborah Odell MBA
In my role as a practice management consultant, the most common questions dentists ask me have to do with managing overhead. “Am I spending too much on staff salaries?” “How can I cut expenses?”
In turn, when I ask them about their current method of managing expenses, I find the most common technique is “slash and burn.” For example, a dentist may spend an inordinate amount of time focusing on minimizing his or her supply costs. Yet if you look at the whole picture, it is estimated that a 15 percent reduction in supply costs only translates into a 1.5 percent reduction in total office expenses.
The key to effective expense management is to know where and how to cut. It’s not that the “slash and burn” approach is never appropriate. In certain situations it is the best solution. But, if you want to effectively manage your expenses, it’s important to know what cuts will reap the most benefits. In some expense categories, such as promotional expense, you may even find that you should be spending more.
Before you implement any cost-control strategy, you first need to identify whether your expenses are currently within reasonable range norms (see chart on page XX for examples of typical expense ranges). Once you’ve gotten your expenses within their acceptable ranges, it’s important to develop systems that will monitor your percentages on an ongoing basis. Whether you use accounting software or a manual system, be sure to review your expense percentages monthly. This will help prevent runaway expenditures.
Finally, remember, cutting expenses is only part of the equation. The easiest way to get your percentages within the norm is to increase productivity.
Let’s begin by breaking down common practice expenses into measurable and manageable categories.
Employee expense is the fastest-growing expense category. Just five years ago the average practitioner in a metropolitan area was spending about 30 percent of total office production on employee expenses. Now, the percentages can easily reach 35 percent. Why the increase? Lack of available personnel is one factor, but another component is the increase in fringe benefits offered to attract experienced personnel. This alone can represent as much as 9 percent of total office production. Current employee range norms have increased from 22 – 30% of T.O.P. to 25 – 35 %.
The best way to control your employee expense is to set up a structured salary increase system based on practice performance. Too often salaries increase because they are expected or because of tenure. This is the fastest way to lose control of your employee expenses. For more on this, see the September 2001 issue of Dental Practice Report, where I outline a “gainsharing” model of compensation in the article, “Sharing the wealth to motivate employees.” (You can read this report online at www.dentalproducts.net. Click on the “Web Extra” button and follow the “Sharing the wealth” link.)
Another alternative cost control is to reduce the practice’s fringe benefit expense by increasing the employee’s financial responsibility for insurances. A win-win strategy is to implement a “Section 125 Plan” or cafeteria plan. A cafeteria plan is a flexible employee benefit plan that enables employees to choose from a menu of certain fringe benefits and pay for those benefits with pre-tax dollars.
The advantages of a cafeteria plan for the employee are:
There are several cafeteria plan alternatives. A common plan includes Flexible Spending Accounts (FSA). FSAs allow employees to set aside pre-tax dollars from their salaries into special accounts to pay for unreimbursed medical expenses or child care assistance. This includes deductibles and co-pays, prescriptions, lab fees, child care, summer camp, etc.
The expense reductions for the practice can occur in two ways. Because employees can set aside funds to help with medical expenses, practices can lower their premiums by increasing the deductibles and co-pays. Also, since dollars are being deducted pre-tax, the practice’s payroll tax liability is reduced.
There are a few strategies to reducing your overall facility expense. Obviously, with the dramatic reduction in interest rates over the last year, refinancing is one option to reduce your mortgage payment
| Existing Mortgage | $350,000 | |
| Interest Rate | 12.5% | |
| Term | 30 years | |
| Monthly Payment | $3,735.40 | |
| Refinance: | $350,000 | |
| Interest Rate | 7.5% | |
| Term | 30 years | |
| Monthly Payment | $2,447.25 | |
| Savings per month | $1,288.15 |
If you lease, you can renegotiate your cost-of-living increase. Most leases include a standard cost of living increase that rises exponentially. In other words, the CPI is added to each new lease amount at the beginning of each year. You can negotiate your lease to cap the CPI at the percentage increase of the base lease.
For example:
#1 – A 3% CPI adjustment is included in each year’s lease payment
2002 2003 2004 2005 2006 2007
4000 4120 4243.60 4370.91 4502.04 4637.10
#2 – The 3% CPI is locked at base lease amount of $4000 for a maximum increase of $120 per year
2002 2003 2004 2005 2006 2007
4000 4120 4240 4360 4480 4600
This will reduce your facility expenses over the term of the lease.
(For tips on negotiating an office lease, see “Smart strategies for negotiating an office lease,” which ran in the April 2002 issue. You can view it online at www.dentalproducts.net. Click on the “Web Extra” button and follow the “Lease strategies” link.)
Ironically, this is the one expense category we ask clients to increase. The typical expense percentage in our client base prior to working with us is 0.5 percent. Our goal is to help them reach 1-4 percent depending upon where the practice is in its lifecycle. For practices that have just opened or are within the first two years, we recommend allocating approximately 4 percent of total office production to promotional expenses. For practices that have been operating for ten or more years, the percentage can be as low as 1 percent. Regardless of where you are on the lifecycle curve, you most spend dollars on attracting new patients.
As you commit to spending more on promotional expenses, it’s important to track the effectiveness of these expenditures by developing measurement systems to determine each promotional activity’s return on investment (ROI). Most practitioners invest dollars in a telephone book ad, newspaper ad or direct mail piece without determining a reasonable ROI prior to incurring the cost of the program. Historically, direct mail programs typically generate a 1 to 5 percent response rate, with 5 percent being a homerun. Other marketing strategies include 1-800–DENTIST, or similar programs. It is critical with these types of programs that you know your response rate, and more importantly, you know the average amount of treatment accepted per patient coming from each of these programs. The successful control of marketing/promotional expenses comes from the analysis of ROI, not just the number of respondents.
Let’s look at a couple of scenarios:
1) Yellow Page ad
| Cost | $1,200/year |
| Response rate | 60 patients/year |
| Investment | $20/patient |
| Return (fee for new patient exam) | $135/patient |
| ROI | 85% |
2) Newsletter
| Cost | $2000/year |
| Response rate | 10 patients/year |
| Investment | $200/patient |
| Return (fee for new patient exam) | $135/patient |
| ROI | -32.5% |
As you can see, some marketing strategies are more productive than others. Also consider that these examples are based on the immediate return of the investment and do not include the lifetime return on each patient.
Again, like promotional expenses, lab expenses tell an interesting story. Many doctors are tempted to reduce their lab bills by finding a cheaper lab. This can be short-sighted. The truth is, the higher the lab percentage, the greater the likelihood that the office is focusing on comprehensive, quadrant procedures. This is not to say that you should try to exceed the range norm. The range norm assumes moderate lab fees and an increase in crown and bridge procedures. The quickest way to exceed the norm is to chose a lab with exorbitant fees. Ironically, controlling this expense may result in an increase in your lab percentage. But the trade-off is worth it.
There most cost effective inventory control strategies rely on the principles of Just-In-Time (JIT) inventory systems. Too often offices carry excess supplies unnecessarily. JIT inventory systems allow you to be adequately stocked, but not lose your interest-bearing potential by investing in hard goods. The most common JIT system is the tag system.
Here’s how it works, create a tag for each inventory item. The tag includes the product code, ship time, supplier and cost. The tag is placed in the stack of inventory right below the number of pieces you will need before the next shipment. For example, you just received 40 boxes of gloves. You use 10 boxes of gloves a week and it takes one week for the inventory to arrive once it’s been ordered. The tag is should be placed below the 30th box. This system ensures that you only have the supplies you need when you need them.
Another way to cut your expense percentage in this category is to use the clipboard method. At the beginning of each month, the staff member in charge of ordering supplies is given a clipboard with a pad of lined paper attached and a dollar amount at the top of the paper. The dollar amount represents the percentage goal for supplies in relation to your monthly production. For example, say you are trying to reduce your supply percentage from 8 percent to 6 percent. Each month calculate 6 percent of your monthly production goal and write it at the top of your pad of paper. The staff member knows that she or he cannot order any additional supplies after the balance has reached zero. As simplistic as this may sound, you’ll be amazed at the aptitude with which your employees will be able to keep the office stocked and stay within budget.
Minor expenses encompass the remaining operational expenses, such as dues, licenses, insurance, office supplies, etc. The key to controlling minor expenses is watching the percentage of each expense as a function of total office production (TOP). No one minor expense should represent more that 2 percent of TOP. An added benefit of watching each category is the detection of potential embezzlement. Office supplies, postage and petty cash are all targets for embezzlement. If you find that your postage expense has exceeded 2 percent in a month, determine whether you instituted a mass mailing that month and be sure to review each receipt!
This category can have the most dramatic fluctuations depending upon the strategic decisions you make each year. If you are implementing new practice management software, or considering leasehold improvements – your capital expense percentage will fluctuate
The rule of thumb is that the capital expense percentage should not exceed 10 percent of total office production. There are a couple of exceptions however. The percentage can increase to as much as 17 percent under the following circumstances: if you have just purchased a practice, built an office or taken on an associate, but it can only remain at 17 percent for up to 36 months. If your capital expenses exceed 10 percent for more than 36 six months, the time it will take to recoup the lost owner’s compensation increases by 30%.
The key to managing capital expenses is calculating the necessary production increases to keep the percentage in line. Setting an appropriate production goal for your associate is one way to do that. Determining a cash flow analysis prior to the purchase of a practice is another technique.
Cost controls are an essential part of practice profitability. But, it is the strategy of “controlled burns” that will give you the greatest return.