Article Date: 10/1/2003

business advisor
Third-Party Plans & Your Cost of Goods
Here's some not-so-obvious effects of managed care on your overhead.
By Jerry Hayes, O.D.

When I talk to other optometrists about practice overhead, there's always some confusion about what happens to a practice's cost of goods as percentage of gross when you discount your fees: Do they go up or down?

As with most issues involving managed care, there's no straightforward answer. Much depends on who supplies the frames and lenses -- you or the managed care company. To illustrate my point, let's look at the practices of Drs. Privat, Mann and Agee, all of whom have a collected gross revenue of \$400,000 and an average cost of goods of 30% of gross for private pay patients.

 ILLUSTRATION BY GRAHAM PARSLOW

A look at three practices

Dr. Privat's practice is all private pay. His cost of goods is 30% of \$400,000 or \$120,000.

Dr. Mann grosses \$300,000 on private-pay patients and \$100,000 in revenue from third-party plans. These plans require him to fill the patient's prescriptions and pay his own cost of goods. Dr. Mann's cost of goods on the private pay portion of his practice is \$300,000 x 30% = \$90,000. The calculation for cost of goods on his managed care patients is a little trickier.

If Dr. Mann saw 500 patients at his normal fees and averaged \$250 per patient, then he would gross \$125,000 (500 x 250). His cost of goods would therefore be \$125,000 x 30% = \$37,500.

However, when Dr. Mann discounts his fees 20%, the average for each patient drops to \$200 (80% x \$250) and the gross for those patients is \$200 x 500 = \$100,000. For the sake of illustrating my point, we're assuming he doesn't use cheaper materials on this group, so his cost of goods remains the same, \$37,500.

If we add his lab expenses for both private pay and managed care patients and divide that by his total practice gross of \$400,000, then we'll have his cost of goods as a percent of his gross (\$90,000 + \$37,500 = \$127,500 / \$400,000 = 32%. This is 2% higher than Dr. Privat, whose practice accepts no managed care.

Dr. Agee also does \$300,000 in private pay patients and \$100,000 in managed care revenue. Her cost of goods on private pay patients is \$300,000 x 30% = \$90,000, which is the same as Dr. Mann's.

But Dr. Agee's managed care plan doesn't allow her to supply frames or lenses. So unlike Dr. Mann, Dr. Agee has no lab bills associated with her managed-care patients. Therefore, her overall cost of goods is \$90,000 + 0 = \$90,000 / \$400,000 = 22.5% of gross.

Life should be so simple

I've made my illustrations somewhat simplistic. In reality, your overall cost of goods is always a blend of expenses based on a continually changing mix of private pay and managed care patients and how those plans reimburse you.

However, you should understand two important points: 1. Your cost of goods will go up as a percent of gross if a managed care plan requires you to discount your fees and supply the product; 2. Plans that don't let you supply the materials can actually cause your cost of goods as a percent of gross to go down, even when you discount your professional fees.

Don't be too quick to blame the higher cost of goods on your managed care plan. You may have to look other places in your practice to fix the problem.

A frequent writer and speaker on practice management issues, Dr. Hayes is the founder and director of Hayes Consulting.  You can reach him at (800) 588-9636 or JHAYES@HAYESCONSULTING.NET.

Optometric Management, Issue: October 2003