Cutting Cost of Goods Down to Size

Proactive management controls reduced this O.D.'s cost of goods and increased her earnings in 12 months.

Cutting Cost of Goods Down to Size
Proactive management controls reduced this O.D.'s cost of goods and increased her earnings in 12 months.



 Real-life cases of optometrists' practice dilemmas and how these seasoned consultants resolved them.

Donna Suter Marilee Blackwell

In our experience over time, higher-netting practices (netting 31% or more) have significantly lower cost of goods (COG) than lower-netting practices (netting less than 31%). For instance, the Hayes Practice Index, during the second quarter of 2001, showed that of those practices grossing at least $300,000, the lower-netting ones had COG of 33%, while the higher-netting ones had COG of 28%.

The 5% difference in COG between the lower-netting practices and the higher-netting practices can mean a substantial increase in earnings, as you'll see in this month's case history. Dr. Tanya Dewitt (not her real name) is a wonderful example of how one optometrist reduced COG and increased her earnings in just 12 months.

Defining the problem

Dr. Dewitt, who practices in the Midwest, came to us in 1999 with a low net and poor cash flow. During slow months, her cash flow was so bad that she'd have to juggle payments on bills. Instead of paying bills twice a month, Dr. Dewitt had to "hold off" until big insurance checks cleared the bank.

The good news was that her revenue had grown each year. What's more, because of her community's demographics, we saw no reason that growth shouldn't continue. But even with the growing revenues, so far her net had remained in the 24% to 26% range.

Understanding P&L

Our first step was to recast her profit and loss statement (P&L) into a format that's easy for optometrists to understand and use. We call this format the Hayes Seven Key Expenses (see chart below).

When we compared Dr. Dewitt's actual expenses with the recommended ranges, it became obvious that high COG was the main culprit. At 38%, COG was significantly higher than the recommended range, which is 27% to 33%.

Dr. Dewitt had been in practice for 10 years, and COG had been a problem for the last 5. She had even contacted consultants on several occasions for help. But each time, she'd decided she could fix the problem on her own and not gone forward with the consultation.

Once we figured out that COG was the problem, we set out to determine which element was causing it to be so high. We looked at Dr. Dewitt's collections, fees, frame inventory, lab efficiency and lab wages. We also asked about policies and procedures that deter employee theft. We discussed issues like cash sales, who made bank deposits and how she maintained frame and contact lenses inventory. Although theft can be an issue in practices with high COG, this wasn't the case with Dr. Dewitt.

Fixing the problem

A review of Dr. Dewitt's collections policies and her accounts receivable report showed that her staff had let accounts get behind and that they weren't following generally accepted collections procedures. Uncollected accounts wreak havoc on cash flow and net because the practice has incurred the expense but not received the revenue.

Dr.Dewitt had $100,000 in past-due accounts receivable more than 90 days old. Of that amount, about half was older than 180 days. Even though she assured us that payment was expected the day service was rendered, conversations with staff confirmed that the practice hadn't been collecting on past-due accounts for some time. In addition, collecting co-pays and deductibles on the day of the appointment was an ongoing problem for her.

We made the following suggestions for the doctor -- and you -- to follow:

Monitor collections. Collections percentage (collections for the last 12 months divided by net charges for the last 12 months equals your collections percentage) should be more than 95%. If it's less than 80%, your practice may be headed for trouble. In addition, Dr. Dewitt - and you - should keep track of the average number of days it takes to collect on accounts. If the collection period increases, that's an early warning that you may have a problem with collections.

Prepare and review accounts receivable aging reports monthly. Your accounts receivable aging report provides total accounts receivable and the dollar amount of accounts 30, 60, 90 and 120 days or more past due. It also shows the percentage of total accounts receivable that are 30, 60, 90 and 120 days or more past due. The general rule is that accounts that are more than 180 days past due will be almost impossible to collect.

Collect from patients at the time of service. Gather insurance information before the patient arrives so that you can calculate the patient's portion of the bill. Note this information in the front of the chart so that optical as well as check-out knows how much to collect for glasses, contact lenses and specialized testing.

Follow up on past-due accounts. Remember, the older they get, the more difficult they will be to collect. Your insurance clerk should make a personal phone call to patients who have accounts that are more than 60 days past due.

Use your explanation of benefits to identify insurance coding problems. Correct consistent coding problems so that they don't continue to slow down payments.

Remind patients of what they owe. When telephoning patients about glasses or a follow-up appointment, remind those owing a balance of their financial obligation.

Checking on the in-house lab

Although improving collections made a big impact on COG, it didn't solve the entire problem. The efficiency of Dr. Dewitt's in-house cutting and edging lab became our next area of concern.

Dr. Dewitt employed Sam, a full-time optician, to run the lab. Hoping to reduce her COG, she had purchased a patternless edger about a year earlier. When we reformatted Dr. Dewitt's P&L, we classified her optician's wages in COG.

Even with the patternless edger, Sam was only producing 0.63 finished jobs per hour (1,300 jobs in 2,080 hours for the year). This meant that $19,000 of COG was due to lab inefficiency. Our job was to determine if the inefficiency was a by-product of volume, lab procedure or personnel. Again, the answer was a combination of all elements.

Because the bench optician had been hired to manage the optical, he only worked the floor when Helen, the optician who sold the eyewear, was sick or on vacation. No one, including Dr. Dewitt, felt that Sam possessed the "sales personality" necessary to increase optical sales.

Dr. Dewitt's Reformatted P&L

    Actual Recommended
Gross Revenue $650,000    
Cost of Goods Sold $247,000 38% 27%-33%
Staff Salaries & Benefits $110,500 17% 15%-18%
Occupancy Costs $52,000  8% 4%-8%
Patient Care Costs & Equipment $13,000 2% 3%-5%
Marketing & Promotion $19,500 3% 2%-4%
General Office Overhead $52,000 8% 6%-9%
Practice Net $156,000 24% 30%-40%

Making changes

We met with Helen, Sam and Dr. DeWitt and they agreed to the following changes:

Dr. Dewitt's pre-tester would begin using a lifestyle questionnaire. This gave Dr. Dewitt the background information on which to make a professional recommendation from the chair for more than one pair of glasses (computer glasses, golf glasses, occupation-specific eyewear for the plumber, etc.). Dr. Dewitt found that the pre-tester uncovered a need for multiple eyewear in about 45% of all patients. This resulted in an increase in sales of 20%.

Sam would dispense all eyewear, process in frame inventory and be in charge of returning frames for exchange. We estimated that this would shave 20% of his time from COG. Since Helen would no longer be dispensing glasses, it would allow her more time to spend with patients selecting frames and lenses. This helped to solve our other problem, low volume. Sam was a very good optician and could edge more jobs... he just didn't have the work.

Sam's work hours would change. We found that he arrived half an hour before the office was open to set up for the day. The doctor appreciated this because Sam turned on the lights and computers, started the coffee and took the covers off equipment. The problem was that because of the office's remote location, he didn't receive his first shipment of lenses until 11:00 a.m.! This meant that each day, Sam would either hold off edging until the next day or spend two and a half hours performing functions that generated no revenue.

Sam now works from 9:30 to 6:30. During that last hour of the day, he edges "by appointment only" lenses for persons unwilling to give up their frames. This schedule has produced a slight improvement in lab efficiency, but major improvements in patient perception of timeliness. This was important because we suspected that Dr. Dewitt's fees needed to be increased.

Because purchases are made only when the object's perceived value is greater than its price, we needed to beef up the "value" of Dr. Dewitt's services before she raised her fees.

We weren't concerned about her having the lowest fees because only 7% of all consumers make a decision to buy based on price alone. The remaining 93% make the purchase because of non-price issues such as timeliness, convenience and service. Changing Sam's work hours reduced the average turnaround time from 5 to 3 working days.

Dr. Dewitt would raise her fees. To confirm our suspicion about fees, we asked Dr. Dewitt to provide us with information from her patient accounts and invoices from vendors so that we could evaluate her fee structure. We also mystery-shopped her competitors to determine what was customary for her geographic area.

This sample allowed us to evaluate the fee issue before the impact of poor collections and the less-efficient lab: In other words, poor collections and a less-efficient lab didn't complicate the analysis. We were able to estimate what COG would have been assuming the same fee structure, but no other problems. We didn't want to suggest a fee increase to correct issues unrelated to fees. Our analysis indicated that COG would have been approximately 33% if collections weren't a problem and the lab was as efficient as it should have been.

Armed with this knowledge, we determined that a 10% overall fee increase would reduce COG from 33% to 30%. Here are some specific recommendations we made to Dr. Dewitt to increase her revenues without increasing COG:

  • Significantly reduce or eliminate the volume of courtesy discounts given to patients.
  • Increase exam fees. The most recent Hayes Practice Index indicated that the average fee for a complete eye exam for a new private-pay patient in the United States was $69 for practices grossing between $300,000 and $700,000 and $72 for practices grossing more than $700,000. Average complete exam fees for new private-pay patients in Dr. Dewitt's area were $70.

Dr. Dewitt only charged $55. We suggested a gradual increase so that she would be near average within 2 years. The reason we increased it over time was that the complete exam fee is the most shoppable fee. We didn't want to risk driving patients away with the large increase necessary to get up to the community average in 1 year.

  • Selectively increase fees for less shoppable services and products such as polarized lenses, computer glasses, rigid gas permeable bifocal contacts and trifocal lenses.
  • Change frame mark-up from a straight percent to price points. For example, instead of having frames priced at $151, $155 and $158, the "price point" for frames between $150 and $159 might be $157.
  • Negotiate wholesale discounts from frame vendors whose frames sell well, without increasing the total number of frames on hand.
  • Shift all other frame purchases from individual accounts to a buying group that offers discounts.
  • Educate patients from the chair about the long-term effects of ultraviolet (UV) exposure and back up Dr. Dewitt's commitment to preserving vision by increasing the price of her basic lenses to include a UV coating.

Everything's looking up

Dr. Dewitt implemented our recommendations and had COG of 30% and a net of 32% within 1 year. This was an 8% point increase in net, which gave her an additional $52,000 in earnings -- certainly well worth her investment.

Many of the O.D.s who try to resolve their problems themselves benefit from a consultant's insight. Dr. Dewitt did, and so might you.

Marilee Blackwell, M.B.A., C.P.A., A.I.B.A., senior consultant for Hayes Consulting (904-273-1115), and Donna Suter, president, Suter Consulting Group (423-236-5465), team up to offer financial guidance and on-site consulting services designed to increase your gross revenue while significantly improving your net income percentage.