Getting Inventory Under Control

Managing inventory can be difficult to discuss concisely but here are a few starting points.

Most practices can keep their cost of goods sold (associated with inventory) in the range of 18 to 20% of gross revenue. Meaning everything that has to be constantly reordered (pills, vaccine, gloves, needles, etc...) is the inventory. Not equipment (monitors, forceps, clippers). If you devide the cost of goods sold by the revenue you will get a percentage. Since it’s a percentage, two things can change that percentage up or down. Either the revenue goes up and expenses stay the same or revenue stays the same and expenses go down. You may need to work on both since getting a big change in either independently may take time.

Tips to getting it in the 20% range:

Revenue:
Not all practices have the same cost of doing business. Certainly the sales clerks at Nordstroms are going to be a bit more costly to hire than those at TJ MAXX or some other discount clothing store. The best locations have a higher rent cost, so restaurant menus have to take that into account as well. In some instances you will need to adjust your fees reflective of your cost of doing business. Not only accounting for these costs but possibly management's inefficiency in adhering to good management policy.

Prices:
Need to raise revenue? Three ways, more client visits, more invoice items or higher fees. Getting more clients can be costly and will take time, better client education will increase invoice item count, and a few well placed fee increases automatically increase revenue even with the same volume of sales.

Price Increases and Discounts:

Be careful in this economy with price increases. Shoppable items (spay, nail trim, vaccines) should be off limits, but non-shoppable items (in house hematocrit, second view of radiograph, IV catherization) are all fair game. Who is going to ask you what the second view costs for their dog's broken leg, then rush down to the competition to shoot that second view if it's a bit cheaper?

Discounting is dangerous. It immediately reduces income, and it can be difficult to raise the bar later. Lower prices too much and clients may pschologically reclassify your practice, making a return to higher prices nearly impossible. The time to discount other than a quick sales campaign is only when you've reached survival mode (need cashflow drastically) otherwise its best to go easy with discounts and specials.

Where do COGS amounts increase?

There are three zones in the practice that affect inventory costs.

1. Front door 2. Treatment and Surgery 3. Backdoor

1. Products leave the frontdoor without contributing to revenue either by clients not paying for an item (misbilled) or embezzlement. If Mary carries a bag of catfood out to the client's car but Bill at the front desk doesn't get it on the invoice, the practice pays the supplier the cost of the food but never collected the corresponding revenue. If the client pays Bill, and he slips it in his pocket, same effect.

Think embezzlement can't happen at your practice? Think again. It happened at mine, its commonly the most trusted employees. Every year practices tell me about the discovery of embezzlement, sometimes after I've helped them discover the high percentage amount spent on inventory, prompting them to look harder.

2. Two common occurances in the middle part of the hospital causes loss of revenue. Busy practices often forget to put a treatment or service on an invoice, especially vulnerable is the multi-day hospitalization case or complex surgery. The second common cause is discounting. Generally the doctors should never complete the computer invoice other than identifing procedures completed. Doctors adjusting the invoice total or giving away services means no revenue but overhead expenses are still present.

3. Products leave the backdoor two ways, the trash (expiration/breakage) and theft (backpacks/purses). An otherwise well meaning employee might think a few doses of flea preventative or bandage material is not going to make an impact on the practice but it does. Large practices with a big staff are greatly affected even if each staff member only steals occassionally. Expiration and breakage is also a cause of lost revenue. Be very wary of the buy 8 get 2 free deals. You've just now committed to selling 10 units, have likely paid for those up front, and the responsiblity of warehousing those items was just transfered from the distributor to you. To prevent inventory swell and potential loss of sales on excess products, don't let specials cause your inventory turn over to extend. In otherwords, buy close to the amount of units you normally would for any period and enjoy the cost savings. If you sell 30 units in 90 days, order 30 units, you'll get 6 free. Becareful about ordering 60 units to get 12 free if it means you'll have some units on the shelves twice as long as you normally would.

Theft can be reduced with the use of cross checks, inventory counts, and security devices like security cameras.

You'll need to work on all three areas, front, middle and back to be effective. a 15% improvement in each zone has a 45% net effect, so small wins can lead to big victories.

Urgency Guide:

If your inventory costs consume 20% or less of your revenue, just keep working to fine tune it, but right now you are doing fine.

22-25% - set up a monitoring plan and get busy, loosing extra profits can hurt in a bad economy, and luckily the correction back to 20% isn't going to be a big one.

26-30% - If high inventory costs were a cumbustable item, someone would be ringing the fire bell. This is certainly getting to a level where it should become a top management priority. Too long at this level and other areas of the practice will suffer.

>30% - unless your practice is doing a large amount of retail sales on very low profit items (ie. bovine practice that sells a lot of vaccine and other OTC items) you need to sound the alarm. Next to payroll, inventory is the second largest cost in your practice. No other expenses savings can make up for high payroll and/or inventory costs because these two categories are just so large. If your inventory costs are 30% or more, and its not a result of retailing a large amount of low cost products, then the practice is at risk of financial failure. Loosing an additional 10% of gross revenue can mean thousands of dollars annually. If you're in this category look to these three areas first a) embezzlement b) doctor discounting c) product or services mis-pricing.

On more than on occasion, practices investigating high inventory costs have found they had inadvertently failed to adjust their prices reflective of new manufacturer or provider costs. Failure to increase fees in step with fee increases from other providers (lab fees following a referral lab pricing increase, failure to reset pet food prices subsequent to price hikes from the manufacturer, failure to adjust fees when insurance costs increase), and failure to insure quantity or size correctly matches your prices (new shipment of 500mg tabs put under the 250mg tabs code) in the computer are commonly found mistakes.

Byron Farquer, DVM, AVA

Author:
Dr. Farquer is a recognized expert in practice valuation, published author and national lecturer on ownership transition and practice management/marketing. He is currently on a year-long national tour speaking on inventory related issues including product sales within and outside of the veterinary hospital.

photo courtesy of geekologie