Cutting Down Costs Vs. Increasing Production

Pretty much every owner wishes to increase their net income. Factually, there are only two ways to accomplish that: (1) cut back on expenses and (2) increase production. Now, while it is wise to do both, you might be surprised as to which one generates the most profit. Let’s take a look.

We’ll examine a single-doctor practice that is grossing $600,000 per year and we’ll set the following two parameters:

  1. If the practice runs efficiently, it could generate $1,000,000 per year.
  2. In this particular profession, the staff salary is supposed to be 22% of the gross, but is currently running at 26% – 4 percentage points above the conventional norm.

If the executive pared their staff salary expenses down to the norm (i.e., reducing it from 26% to 22%), that would increase profit by $24,000. Not bad.

But what would the profit be if the executive were to focus on expanding the practice up to the $1,000,000 mark? At that higher level, there would be an additional $400,000. Obviously, not all of that is profit. But how much of it is?

To sort this out, you would need to look at the difference between fixed costs and variable costs. Fixed costs are those that remain constant, regardless of the production level. Rent, certain insurances, license fees, etc., are expenses that are the same amount whether the practice produces $1 or $1,000,000 per year.

Variable costs, on the other hand, are costs that vary with production. Depending on the type of practice, the two greatest variable costs are 1) payroll and 2) either inventory or lab/clinical supplies. Combined, they represent anywhere from 40% to 50% of income, depending on the profession. There are a few other variable costs that will increase the percentage slightly; but for the sake of ease of explanation, we’ll focus on just those two costs.

Let’s factor in the fixed and variable costs to this $400,000 increase and see what our profit is. First, the fixed costs have already been paid from the original $600,000 income; you obviously don’t have to pay more rent because you earned an additional $400,000. The same is true of the costs of the annual license fees and probably accounting, legal and other such fixed expenses. Those bills have already been paid.

The only additional expense you incur when you produce an extra $400,000 are the variable costs. We’ve already calculated that the combined fixed and variable costs will be as much as 50% of production; so, producing an additional $400,000 will cost $200,000. The remaining $200,000 is profit.

While the choice may be abundantly clear, let’s take a look at the ramifications of the direction you decide to take and the effect that it could have on both you and your practice.

By reducing staff salary by a mere 4%, bringing it into an acceptable range, we made an additional $24,000. But by focusing on increasing production by an extra $400,000, we made $200,000 in profit. Now, of course you wouldn’t want to have any needlessly high expenses; but if increasing the net income is your goal, then which of the two factors you should foc­­­us on is quite obvious.  

One could voice the objection that, with increased production, there would be increased stress, maybe to the point that the extra income isn’t worth it. That’s not necessarily true. From three decades of experience in the field, we know that there are a couple of points that have proven to be consistent time and time again:

  1. Depending on the profession, any single-doctor practice should be able to reach $900,000 to $1,000,000 per year in income.
  2. If organized correctly, the increase in production does not result in an increase in stress. In fact, in virtually every practice we’ve analyzed, tremendous inefficiency existed, so much so that when eradicated, the owner experienced less stress producing in the $900,000 to $1,000,000 range than he did in the lower production levels. In fact, the only way to stably produce in the higher ranges is to rid the practice of inefficiency. So, the irony is that the very factors that create stress must be eliminated in order for the practice to stably grow; that will result in a practice that can produce a great deal more with much less stress — one of the few valid cases of having your cake and eating it too.

Will it take a bit of planning to grow the practice? Yes. Will it require learning some new executive skills? Undoubtedly. Each executive must determine for himself the value of learning new skills that will dramatically increase profit, taking into account the time, effort and cost to do so. That’s a formula certainly worth calculating!

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