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The market for veterinary services: cracks in the foundation

Upside-down pricing, inadequate benchmarks hinder practice performance


May 27, 2019
By
Michael Dicks
& Melissa Maddux


This is part 3 of an 8-part series.
Part 1: Urgent fix needed
Part 2: Stymied by inertia
Part 4: Reimagining education
Part 5: Practice consolidation
Part 6: Labor volatility

About six out of 10 American households include one or more animals. Approximately 70,000 veterinarians are available to provide medical care for those animals, which on average amounts to more than 1,045 households per veterinarian.

Overall demand and supply of animal health care services is a composite of many small markets. The area from which each veterinarian draws clients might be smaller than a two-mile radius in urban areas, or as much as a 150-mile radius in rural areas. Regardless, in most cases, the local market is an oligopoly — that is, it has relatively few sellers (veterinary practices) and many buyers (animal owners). Such a structure enables sellers to maximize profits by raising prices. This behavior is reinforced by the common veterinary practice pricing strategy of setting price in line with those of other practices in the immediate area.

Independently owned veterinary practices are diverse, each having its own culture, guidelines for care, percentage of income generated by each of its various enterprises (wellness care, internal medicine, surgery, diagnostic imaging, boarding, grooming and so forth), the number of staff between the client and the veterinarian, the species treated, and standard operating procedures. While each practice may feel unique, most hospitals share numerous practices. They include:

Photo by Scott Nolan
Michael R. Dicks directed the American Veterinary Medical Association Veterinary Economics Division from 2013 to 2018.
  • Adherence to a "gold" standard of care (following guidelines established by the American Animal Hospital Association or American Association of Equine Practitioners, for example)
  • High markup on products (60% or greater)
  • Focus on profit margins as the principal financial objective
  • Using financial benchmarks for a "typical" small animal practice (in the case of small animal practices)
  • Using an income statement as the primary source of financial information for the practice (e.g., having no balance sheet or cash-flow statement)

What is the evidence that practitioners and clients alike are well-served by these common practices?

Consider veterinary medical standards of care. While such standards are backed by the best-available scientific evidence or expert consensus, in clinical practice, the client must participate in deciding a course of care, and must comply with that course. What the pet owner does might not be what science or expert consensus dictates. For instance, most pet owners use less heartworm control than is recommended.

Now imagine if the conventional understanding of standard of care in veterinary medicine were to be replaced by a concept of spectrum of care that allows for a variety of possible courses of care. The options could vary by practice based on the needs of the animals in the area; the willingness and ability of patients' owners to meet that need; and the local culture of human-animal interactions or human-animal bond.

We realize this proposal may be difficult for some practitioners to stomach. The core values of many veterinarians place animal health and welfare significantly above money — thus, their desire to hold clients to a gold standard of care. Unfortunately, strict adherence to the highest standard of care that medicine can provide ironically may serve to widen the gap between animal health-care needs and the treatments to fulfill them. By saying that the only way to treat Fluffy's condition is through an expensive procedure or surgery, a veterinarian might be losing any chance to help Fluffy at all if the owner decides that sole option is prohibitively expensive or complicated, and does not come back for care.

A presentation by Idexx in 2016 at a meeting of the American Animal Hospital Association put the total cost of meeting the gold standard of wellness care in a dog over a 12-year life span — including exams, vaccines, parasiticides, dental cleanings and nutrition counseling — at $17,700. Our research examining care guidelines of veterinary practices found that the national average cost runs somewhat less — between $1,200 and $1,400 per year, or $14,400 to $16,800 over 12 years.

Dr. Melissa Maddux was an AVMA Economics Fellow in 2016-2017. She contributed to research and helped communicate economics concepts to a veterinary audience.

The Idexx study found that of the $17,700 in potential care, the average practice provided only $3,600 (20%) of that to their clients. Considering that half of Americans in 2017 had household incomes of less than $61,000, one explanation for this gap between care needed and provided is that pet owners can't afford the gold standard in wellness care, especially if purchased from a veterinary clinic with high product markups.

Moreover, some pet owners don't see the need or value of certain items in the wellness category. Others choose not to obtain all the services from the veterinarian, seeking lower prices and/or convenience at retail outlets (think vaccination clinics at the pet or feed store).

Upside-down pricing

In reviewing the financial information of roughly 460 practices, we found that their share of revenue from the suite of services under the rubric of wellness care varied widely, from 30% to 70%. With less than a quarter of the potential wellness revenue earned in the average practice, wellness care presents an enormous opportunity to improve animal health, the client relationship and the practice’s bottom line.

Veterinary medicine is a service industry, but it doesn't necessarily seem so, judging from the way most general practices price their offerings. Consider wellness, the most frequently provided service. Revenue from the sale of products, such as parasiticides, vaccinations and food, is more than 35%, whereas revenue from the labor of veterinarians and staff accounts for about 17%. In other words, sales of products rather than veterinary expertise are by far the main source of wellness revenue. This is the exact opposite of what we'd expect in a service industry.

Furthermore, many wellness products, including pet food and parasiticides, are commodities that pet owners can buy outside the clinic. Through high markups on product prices, practices may be inadvertently encouraging clients to shop elsewhere.

Accounting terms defined

Veterinary expertise, on the other hand, is not a commodity. It is available only at the veterinary practice. A strategy that values labor more highly and uses lower markups on products makes more sense. How did the profession get into this upside-down pricing paradigm?

The financial objective for most practices is to maximize profit, and the main strategy is to increase total revenue by raising prices. However, raising prices improves the clinic's net income only if the increase in profit margin exceeds the value of sales lost because of the price increases. Put another way, how much can you raise prices before would-be buyers turn away?

Price elasticity refers to change in quantity demanded of an item as the price of the item changes. The veterinary profession has no published measures of price elasticities for any products or services.

Another way to obtain a larger profit margin is by cutting costs. But effective cost cutting requires understanding what the costs are and how they affect revenues. In general, veterinary practices don't have this information. So, they obtain profit increases almost entirely by raising prices.

Research could help. What if, rather than looking only at how to increase the quality of animal health care, veterinary researchers sought to increase the quality of health care per dollar expended on that care? How different would the care guidelines be today?

A need for better benchmarks

One way that practices differ from one another is in the percentage of revenue generated by their various enterprises. Each enterprise, such as wellness, surgery, boarding and grooming, has its own labor cost as percentage of total revenue and a "cost of goods sold" (COGS) as a percentage of total revenue. As the amount of revenue generated by each enterprise differs, so, too, will the practice's overall labor and COGS as a percent of total revenue.

The most recognized average benchmark for a small animal general practice is: 45% of total revenue goes to pay labor, and 25% of total revenue covers COGS, leaving 30% of revenues to pay facility costs, office costs, bank fees, taxes, interest, depreciation, amortization and profit or money to invest back into the practice. Ergo, practices that spend less than 45% on labor and/or less than 25% for COGS are doing better than average and presumably have better-than-average profits.

Here's the rub: These benchmarks were derived from small animal clinics practicing general medicine. They do not apply to practices that focus on wellness, or on high-volume practices, mobile practices, emergency or specialty centers and numerous other business models that differ from the clinics upon whose finances the benchmarks are based. So, what actionable information do these benchmarks actually yield for many practices? The profession needs more and better information to serve the diversity of practices that comprise it.

A veterinary practice first and foremost is a service business. It should have the primary goals of providing for the community it serves (animals and clients, as well as the people it employs) and making a normal economic return on the investment required to provide those services.

These goals are difficult to simultaneously and fully attain without basic financial literacy. For a practice owner, this means being able to construct and use an income statement, balance sheet, statement of cash flow, budget and set of financial ratios to help guide the practice. Yet, few practices have all of these, and some have none.

The heart of the profession is the veterinary practice. Moving forward, profession-wide data analytics are needed that provide specific benchmarks and guidelines to help improve the performance of individual hospitals.

This process is comparable to that which veterinarians use to care for patients: Take a history, diagnose the problem, apply a course of treatment, then recheck the patient. Just as veterinarians don’t use the same diagnostic guidelines (e.g. blood counts, blood pressure) for every species, veterinary practices need guidelines specific to their type of practice.

To accomplish this goal, the profession needs to rally behind the collection, analysis and distribution of financial data. The first challenge will be to commit to managing veterinary practices based on financial evidence. The second challenge will be deciding who should collect, analyze and store the data.

Next: Is today's approach to veterinary education outdated?

About the authors:

Michael Dicks, PhD, established the veterinary economics division of the American Veterinary Medical Association in 2013 and was its director until 2018. Dicks earned a BS in biochemistry and animal science from California Polytechnic State University, taught chemistry as a Peace Corps volunteer in Kenya, then completed a master's and doctorate in agricultural economics at the University of Missouri.

He was employed by the U.S. Department of Agriculture Economic Research Service for five years before joining the faculty at Oklahoma State University, where he spent nearly 24 years prior to his stint at the AVMA. Dicks now works as a consultant in several capacities, including as data chief at Erupt LLC, which provides data analytics and educational outreach to clients in the veterinary realm.

Melissa Maddux, DVM, is a 2016 graduate of the University of Tennessee College of Veterinary Medicine, a former AVMA Economics Fellow and CEO of Erupt. She also practices equine and small animal medicine in Knoxville.




VIN News Service commentaries are opinion pieces presenting insights, personal experiences and/or perspectives on topical issues by members of the veterinary community. To submit a commentary for consideration, email news@vin.com.



Information and opinions expressed in letters to the editor are those of the author and are independent of the VIN News Service. Letters may be edited for style. We do not verify their content for accuracy.




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