Fixed vs. variable
Prune costs to grow your practice
By Eldar Causevic

Successful businesses cut and control costs. That’s one reason they are successful. Cutting costs should be one of the top strategic objectives in operating your practice. And although it may be difficult to believe, the process can actually allow your practice to grow — provided it is done properly.

Managing practice costs is important regardless of the state of your practice. If your practice is doing well, cutting costs will increase its ability to invest in future growth, allow for better compensation of the team members who contribute to its success and increase the practice’s resale value. If your practice is in financial danger, cutting costs is one of the key components in weathering the problems and getting back on track.

Fixed vs. variable costs

Understanding the process of managing costs first requires an understanding of two general types of costs: fixed and variable.

Fixed costs, or sunk costs as they are sometimes called, are those that generally do not vary between payment intervals. Generally, these costs cannot be altered on a short-term basis because of contractual agreements or simply because it is impractical.

One way to determine your fixed costs is to consider the expenses you would continue to incur if you temporarily closed your practice and no patients were being treated. In this case, your rent, car leases, yellow page ad fees and loan payments would still be due. They generally do not change with increases or decreases in business activity.

It is important to note that fixed costs are unvarying only within a certain range of business activity. For example: if the practice grows enough to require additional space or additional employees, the fixed costs associated with rent or salaries will change as well.

Variable costs are those that change as the level of business activity changes. Examples of the variable costs within a chiropractic business would be supplies used for each patient visit, collection fees paid to external billing agencies and wages for hourly, part-time employees. These costs are driven primarily by the practice’s business activity, by number of patients that the practice treats.

The “closed practice” test we used above to determine the fixed costs of a practice can also be used to determine the variable costs. The variable costs are those that would stop if the practice were closed for a month and no patients were treated at all.

Once you understand the difference between fixed and variable costs, it is important to know how to distinguish one from the other. For instance, consider a practice that has fixed costs of $10,000 and variable costs of $5 per patient. (See Table 1 for an example of fixed and variable costs.)

To cover its monthly expenses, the practice would have to earn $10,000 in fees plus $5 per patient treated. If the practice had only one patient visit per month, it would have to charge $10,005 for that one treatment in order to cover its fixed and variable costs!

If the practice had 1,000 patient visits during the month, its total costs would be $15,000 ($10,000 in fixed costs plus 1,000 patient visits at $5 each). Therefore, this practice would only have to charge $15 per patient visit to cover its fixed and variable costs.

This also illustrates that the amount of fixed costs that each patient visit must cover depends on the total number of patient visits across which these fixed costs are to be spread. Table 2 demonstrates the fixed cost allocation based on number of visits.

As you can see, fixed and variable costs play a critical role in determining your pricing strategy for services. A careful analysis of the cost structure is the guide to determining the standard and minimum fee levels that you should be willing to accept for services performed.

Making this determination is often a complex process involving other considerations such as the competitive land-scape, geographical location, the payers sought and practice sales and marketing efforts. But the most important step is understanding — and documenting — the fixed and variable costs, especially if your practice relies heavily on reimbursements.

In view of the need to allocate the fixed costs, you can also understand some of the driving factors behind a business’s desire to expand its product offerings. Some doctors, for example, attempt to expand their practices and spread fixed costs across more patient visits by offering complementary products or treatments. If done properly, this business strategy can add value to a practice.

However, quite often this strategy is difficult to execute and results in an increase in fixed costs without the additional customer base to share the burden.

ANOTHER ALTERNATIVE

One effective cost-management strategy is to minimize the number of fixed costs and convert as many of them as possible into variable costs. This allows for easier estimation, tracking and management of those costs. Practices with minimal fixed costs can weather “rainy days” a lot better than those burdened with high overhead.

Here are several steps you can take for better cost management:

• Understand the cost drivers. To manage a problem, first you have to know what it is. You must clearly understand the factors that drive variable costs and how they affect the practice. Once these are known they will be easier to control.

• Constantly evaluate costs. Check all variable costs regularly to determine if they are adding value to the practice. Remember that cost management is an ongoing process and should not be done only when things go downhill.

• Evaluate services, too. All services provided by a practice are not equally profitable. Analyze your services and related fees on a regular basis to determine the most and least profitable. Channel your available resources toward increasing the volume of the most profitable services and minimize the less profitable ones.

• Optimize the system. Often, practices will incur increased variable costs due to the inefficiency of their systems. Consider adopting a new budget management system to reduce the time spent retrieving records and managing patient flow, billing or collections. Encourage your office manager to keep an eye on the financial operation of the practice and continually seek new ways to manage costs.

Eldar Causevic is the founder of Celwel, LLC, a medical technology business development consultancy. Prior to forming Celwel, he was CEO of Everest Biomedical, a prominent neuro-diagnostics company. Mr. Causevic provides business management consulting services to clients nationwide and can be reached at 636-578-6000 or by e-mail at Eldar@celwel.com.