Quality of Revenue
In my last two posts in our series on veterinary practice financial performance, we discussed the financial metric EBITDA and a broad overview of strategies to improve EBITDA at your practice.
Previously I mentioned a concept called “Quality of Revenue” which will be the focus of this article.
The final calculation of EBITDA treats revenue as a single pool of money where every dollar is the same, but a deeper look at revenue reveals that pool can be divided into many categories and sub-categories which all have different “quality” in terms of attributable expense (and therefore effective profitability), sustainability, pricing elasticity, growth potential, and charge capture.
The majority of EBITDA at veterinary practices is driven by the highest-quality subsets of their revenue.
Therefore, identifying and maximizing high-quality revenue is one of the most effective ways to improve profitability.
This logically makes sense: You only have so much time and energy as a practice owner, so it is important to focus your efforts on the things that will move the needle the most. If your profit margin is 5% on one revenue class and 20% on another, you’d need to drive $4 of incremental revenue of the former to create the same amount of profit as driving $1 of incremental revenue of the latter.
When properly priced, service revenue is much higher quality than inventory sales revenue.
Fundamentally, the “what” and “why” of a veterinary clinic is to provide veterinary services. While most clinics provide many other peripheral goods and services to their clients beyond professional services, the true drivers of a veterinary clinic that defines and drives their success is the knowledge and skills of their professional workforce including veterinarians, technicians, and support teams.
Professional services drive most of the EBITDA at profitable veterinary practices.
There are three of the primary drivers for why this is true:
Margins: The margins of inventory sales are mostly consumed by Cost of Goods Sold (COGS). While there are many things that can be done to reduce COGS in general profitability at veterinary clinics is driven by professional services due to their lower COGS component than inventory sales.
Pricing power: Elasticity in pricing is generally much higher for professional services than inventory. This wasn’t always the case, but the rise of big box internet pharmacies has significantly constrained the ability of veterinary clinics to markup pricing for inventory.
Put simply: You’ll never beat Chewy on price and the more distant you get from pricing on online pharmacies, the less likely you are to generate any pharmacy revenue. What your clients can’t get from online pharmacies is the knowledge and services provided by your team. Less “shopability” means more flexibility in pricing. Valuing the services provided by your team is critical in operating a financially successful practice. Obviously, this must be balanced against the important drivers of cost control: The ability of your core clientele to pay for care and your ethical responsibility as a veterinarian to ensure that your services remain financially accessible to responsible pet owners. There is a Goldilocks space between undervaluing the expertise and hard work of your team and undervaluing your moral obligation to keep your services accessible to pet owners in need. That middle ground is where profitable pricing on services should sit.
Growth potential: Increasing the amount of service revenue is much simpler than trying to increase the amount of inventory revenue. While there are ways to increase your inventory sales, particularly by improving compliance with preventatives and utilizing an online pharmacy to improve capture of pharmacy revenue, in general you’ll have an easier time driving incremental service revenue. This is best accomplished in two ways: recommending gold standard care and attracting new clients.
Recommending gold standard care is the perfect intersection of doing good for your patients and doing good for your business. Gold standard care involves taking a proactive rather than reactive approach to utilizing diagnostics and arriving at confident diagnoses on which to initiate intervention. Ensuring that every dog with unexplained vomiting gets abdominal radiographs, every senior pet gets routine annual CBC/chemistry to screen for underlying health issues, and so on creates opportunities to intervene earlier and arrive at better health outcomes by providing more services to your patients. Obviously, gold standard care is not an option financially for all clients. However, it is important both medically and from a business mindset to recommend the best care option first and then adjust your approach from there based on a client's financial situation rather than making assumptions about a client’s ability or willingness to pay or rushing to conclusions without sufficient diagnostic evidence that a presenting complaint has a more benign or common underlying cause. A thorough physical examination gives you an incredible amount of information (and should be priced appropriately as a critical diagnostic tool) and tests should never be used as a substitute for a good physical and your clinical intuition, but that doesn’t diminish the importance of your other diagnostic tools to supplement or adjust your understanding of your patients’ health.
Incremental revenue is inherently higher quality revenue.
Most people are familiar with the phrase “economies of scale”. Economies of scale apply to veterinary clinics too! You don’t need to be part of a group to unlock at least some benefit of scale, although there is at least one great group out there to consider. The general concept behind economies of scale is that you can achieve cost advantages due to scale of operation, improving profit margins. Most notably, fixed expenses can be blended down by growing your practice’s top line to maximize utilization of the fixed assets that you’re already paying for such as rent and equipment. For example, a facility with fair market rent of $50,000 means that rent is 10% of revenue at $500,000 of revenue and 5% of revenue at $1,000,000 of revenue. If the clinic had 5% EBITDA margin before growth ($25,000), you would initially expect that doubling revenue would double EBITDA to $50,000. However, thanks to the economy of scale of blending down the clinic’s rent expense by better utilizing the facility, assuming all variable expenses scale without change (all expenses in this example), the EBITDA quadrupled to $100,000 because EBITDA margin expanded from 5% to 10% as the revenue doubled and 5% EBITDA margin was freed from the rent expense category.
Economies of scale are possible with variable expenses too. As your clinic grows, you can pursue more economical bulk ordering while minimizing spoilage of perishable goods. Just be careful: bulk ordering can have the opposite effect if not done carefully. Spoilage can quickly erase any benefit of ordering more of anything perishable at once, and storage or shelf space used on low-turn items reduces your ability to fill your clinic with things you sell regularly.
In net, this means that incremental revenue is fundamentally higher quality (more profitable) than existing revenue assuming all else is equal. There will be scenarios where this doesn’t apply, such as needing to upgrade to a new, more expensive facility to accommodate further growth or the stepwise nature of increasing staff (I.e. a new employee might not be fully utilized right away until you drive enough additional growth), but in general top line growth tends to translate into bottom line growth not only by increasing the size of the “pie” (direct bottom line growth) but also by increasing the slice of the pie that you keep as profit (margin expansion).
Charge capture significantly impacts quality of revenue.
I probably sound like a broken record about charge capture because it makes an appearance in almost every financial-themed article I write, but that is for a reason:
Every dollar of failed or successful charge capture translates dollar-for-dollar into the bottom line.
Charge capture is especially relevant to the conversation about quality of revenue, as charge capture is usually not evenly distributed across revenue. Instead, usually specific revenue items or categories of revenue items are disproportionately affected by charge capture problems. Generally, charge capture tends to be poorer for services than inventory sales. This is especially problematic since, as we discussed above, services are also the main profit drivers for your clinic and therefore the last place that you want to have “leaks” in the process between services being performed and those services appearing properly and consistently on invoices.
At Associated Veterinary Partners we strive to provide all the “corporate” resources that come with being part of a veterinary group without any of the “corporate” feel that usually accompanies them. We provide our partners with operational resources and expertise, help drive recruiting and retention to grow and strengthen their team, and allow them to spend less time on administrative work and more time with their patients and away from your business. Our experienced team draws from industry best practices and proprietary knowledge learned from our network of partner practices in order to provide our partners with actionable information that allows their clinics to achieve greater success, both financially and medically. Gaining access to strength in numbers doesn’t require giving up the legacy and identity of your practice anymore. If you’d like to find out more about AVP and our partnerships, please contact me at email@example.com or use the contact form on our website.