Pricing of veterinary products and services – fair pricing for profit?

Since the start of the recession just over 5 years ago, many veterinary practices have been facing increasing challenges — rising costs, reducing client numbers and increased competition (Wright, 2011). In the past, the automatic response might have been to simply increase prices. However, today's clients demand fairness, transparency and clarity of pricing and if they experience a lack of these, are more likely to seek them elsewhere.

The prices a practice sets for the services it provides and for the products it sells lie at the very heart of everything it is able to do and everything it will achieve in the future. Shilcock and Stutchfield (2008) argue that there must be a rational basis for pricing, which must not undersell the service or the products, but which, at the same time, must not open the practice up to accusations of profiteering or taking advantage. Irrespective of the various factors that influence a practice's pricing strategy, such as geographical location, positioning or practice type, a rational pricing strategy must achieve four key aims. It must:

• Cover the practice's costs (labour costs, materials used and overheads)
• Provide an adequate return on the owner's investment
• Allow for investment in facilities and equipment in order to maintain the quality of care
• Be fair to clients.

Of course, this assumes that every practice is run efficiently and effectively without any undue waste of resources, which is not always the case.

Pricing strategies

There are a number of different pricing strategies in operation in veterinary practices in the UK and most practices will use more than one.

Cost plus markup

For products, practices generally apply a markup to the cost price (i.e. the price they pay the supplier). Practice management systems can be updated with suppliers' prices either manually by the person in charge of ordering supplies or by the use of a price update disc, which the wholesaler provides every month. The computer system is configured to automatically apply an appropriate markup. However, decisions about how much should be added as a markup must be made beforehand by the practice owner or manager with due consideration of the market. The markups that are applied must cover the costs associated with selecting, purchasing and storing drugs and medicines as well as provide a profit for the owner. In addition, because of competitive pressures and because clients tend to shop around for routine items, such as vaccinations, flea and worming treatments and pet food, the same markup cannot be applied to all the products the practice sells. A common method has been to add a higher markup to faster moving items and a lower markup to items that are not sold often, but this is no longer justifiable in the eyes of the client. The practice owner will need to regularly review both the range of drugs and medicines that the practice supplies and the markups that are applied to each one in order to ensure that the price the client pays is both fair and competitive.

Profit centres

Profit centres are a way of costing activities or services. A profit centre is an area of the practice where the same income-earning activity takes place every day. Thus, a small animal practice may be split into the following profit centres:

• Consulting
• Surgical suite
• X-ray
• Laboratory
• Pharmacy
• Procedures room
• Dentistry
• Wards and hospitalisation.

The administrative activities and reception are included in the overheads calculation and the cost of running these is apportioned between the profit centres. Other overheads, such a heating, lighting and insurance, are also apportioned to the profit centres, usually based on the floor space occupied by each centre compared to the total income-earning floor space of the practice.

For profit centre costing to be reliable, it is essential for all the direct costs that a practice incurs to be accurately charged to the relevant profit centre and this must be done when an order is entered into the accounting software or at the point when the invoice is paid. Accounting software is available, such as SAGE, which enables profit centre analysis and the appropriate allocation of costs as well as income. The biggest challenge when setting up profit centres is ensuring that all of the practice's costs are allocated to them and that none are missed out. There will, of course, be activities which do not fit neatly into a profit centre, such as puppy parties or practice talks, the cost of which will have to be included in general overheads, which is not ideal.

Value pricing

Ackerman (2002) argues that one of the most important determinants of setting fees is the client's perception of value. Clients generally understand that a service which requires the application of a veterinarian's skill and expertise will cost more than one where the same veterinarian's input is minimal. Thus, value pricing is pricing based on the value that is added to a product or service by the veterinarian. Thus, using this strategy, medications would automatically be priced competitively, because no value is added to them — the practice simply buys them in and sells them on — although it could easily be argued that the veterinarian is using his or her expertise in selecting and prescribing the most appropriate medication at the most appropriate dosage rate for the condition and that this is the value-added component. Value pricing allows for higher prices to be charged for all those services that only a veterinarian can provide. The assumption, however, is that veterinarians know how to value their own professional expertise and skills, which is often not the case. It has become anecdotal that veterinarians in the UK tend to undervalue themselves and often undercharge for their services. To make matters worse, there is a lack of suitable benchmarking data to enable comparisons to be made in order to inform pricing decisions.

Competitor pricing

Many practices base their pricing structure on the prices that their competitors are charging, irrespective of how much it actually costs to deliver the product or service. This occurs most often when competition is severe and when practices are forced to compete with each other for the same client base. This strategy works quite well in the short term and can attract new clients, especially pet owners who tend to shop around for spays and neutering fees, consultation fees, vaccinations and routine pet healthcare products, but it cannot continue to be applied in the longer term. At some point, perhaps sooner rather than later, the practice owner and manager will have to consider costs in order to ensure that the prices charged actually cover these and that the practice is not, in fact, running at a loss.

Some practices will aim to set themselves apart by setting their prices higher than the competition. Moreau and Nap (2010) argue that this can be an effective strategy and give examples of practice owners who did just that and actually gained new clients as a result, but in each of their examples the practices had something different and better to offer than their competitors — one was a brand new hospital offering specialist surgical services, the other two marketed themselves as offering higher quality surgical services provided by Diplomates of the European College of Veterinary Surgeons. Obviously, there is no reason why a practice cannot aim to be more expensive than its competitors, but it must have a very good reason to be and must be able to justify the higher prices in terms of a superior quality service and additional benefits that competitors are unable to offer.

Pricing fundamentals

Irrespective of which strategy or combination of strategies a practice adopts, the price of a product or service must take into account the costs and can be worked out using the following formula:

Price = direct labour + direct materials + direct equipment costs + overheads + profit

Calculations are carried out using VAT (value added tax)-exclusive figures. The result is the net price to which VAT is added at the end. Once all the costs are known, a percentage is then added for profit.

Direct labour costs are the costs of a veterinarian's and/or veterinary nurse's time, which is spent on delivering the product or service. This time cost includes their gross salary, to which are added employer's National Insurance contributions (around 13.8% of gross salary), employer's pension contributions, employee bonuses, training costs and any employee benefits (car, accommodation) for which the employer pays. The cost of staff time is usually calculated per hour by taking the total annual employee cost and dividing this by the number of chargeable hours that employee works in a year.

Direct materials are all the consumables that are used in providing the product or service — for example, anaesthetic gases, syringes, swabs, bandages, needles, suture material etc, excluding drugs and medicines, which are priced and sold separately. It is essential to include the cost of all of the materials used, taking care not to miss any out. For surgical procedures which use the same direct materials, the cost need only be worked out once as a ‘surgical pack’, for example, and this can then be used for costing all subsequent procedures.

For many procedures, such as x-rays, operations, dentals or endoscopies, special equipment is needed and the use of this equipment must be factored into the cost of the procedure. Wear-and-tear or depreciation costs, maintenance and servicing and equipment hire or rental costs are all direct equipment costs that must be taken into account.

Overheads are those costs that a practice incurs whether or not it carries out any clinical work at all. Usually grouped under the heading ‘administrative costs’, they include council tax, water rates, insurances, heating, lighting, telephones and the internet, postage and stationery, legal and accountancy fees, amongst others. Overheads can be accounted for in two ways — by taking the total practice overheads cost for the year and dividing this by the total number of chargeable veterinarian hours or by apportioning overheads to profit centres. The first method will recover the overhead costs based on a veterinarian's time. The second will recover the overhead costs per procedure by taking the total overheads allocated to the profit centre and dividing these by the total number of procedures or operations carried out within the profit centre during the year.

Direct costs are often referred to as variable costs, because they tend to vary with the amount of clinical activity undertaken — the more operations are performed, the more consumable materials are used. Overhead costs are referred to as fixed costs, because they remain the same irrespective of the level of activity and are subject only to annual increases imposed from outside the practice.

The following two examples will illustrate the costing and pricing process.

Example 1: pharmacy profit centre analysis

During the 12 months to the 31st of May 2014, ABC Veterinary Practice purchased £150 000 worth of drugs and medicines for sale to clients. In addition, the practice incurred £3500 worth of carriage costs. Stock at the start of the year (1st June 2013) had been valued at £15 000 and stock remaining at the end of the year (31st May 2014) was valued after a stock-take at £17 500. Sales of drugs and medicines for the year amounted to £245 000 (excluding VAT). The practice has a dedicated, secure pharmacy, which occupies 1/20th of the practice space. A nurse orders the supplies and manages the pharmacy with input from a veterinary surgeon who reviews the range of stock, researches new drugs and recommends new purchases. The total overheads for the practice amounted to £56 000 for the year.

Step 1

Calculate the cost of drugs and medicines sold during the year

Opening stock + purchases + carriage costs − closing stock = £15 000 + £150 000 + £3500 − £17 500 = £151 000

Step 2

Step 3

The profit represents an overall markup on cost of 55.12%

Step 4

Review the range of stock held and the markups to be applied for next year, bearing in mind likely increase in costs by at least the rate of inflation (around 3–5%). Is the markup fair?

Example 2: setting the price of a surgical spay (10 kg female dog)

Step 1

Calculate the cost to the practice of carrying out the spay

Step 2

Decide on markup to be applied for profit — competitive pricing or other?

The above examples have been simplified in order to illustrate the principles involved. In reality, it is time consuming to establish the exact costs of providing a service and the time spent by staff on income-earning activity and non-income earning activity can only be determined through detailed time sheets completed over a minimum period of 3 months — that is assuming that there are no major changes in that time and that things will proceed very much as before, which may not be the case. However, it is a worthwhile exercise to pick ten or 20 of the most common operations and procedures that the practice carries out and to cost these out fully.

Being transparent about prices

Shilcock (2013) argues that the practice–client relationship would be greatly enhanced if practices were much more proactive in relation to explaining costs. She recommends that practices maintain a notice board in reception showing the prices of routine procedures and pet healthcare products. Price lists can also be distributed to clients in leaflet form or with the practice newsletter and certainly on the practice website. Newsletters and the website are also an opportunity to explain what is involved in an operation or procedure and to highlight the level of care provided. This helps to clarify to clients the work that goes into providing care.

Estimates can be given verbally, but must be noted on the pet's record. Quotations when given in writing by the practice and accepted by the client are legally binding. Staff should strive to ensure that both estimates and quotations are as accurate as possible. If it is not possible to be accurate, because the condition is complex or difficult to treat, then this should clearly be pointed out and the client should be assured that any additional charges will always be notified before going ahead with further treatment.

Itemised invoices and receipts will help to explain the different charges applied, but receptionists, nurses and veterinarians should all be able to explain, on request, what the charges are for and why they were included. This requires the provision of regular staff training in understanding the practice's prices, the overall pricing strategy and structure.

Finally, staff must bear in mind that many clients are reluctant to ask about prices, even though they may well be concerned about them. The practice policy should be to always explain the cost to the client of any proposed treatment plan, drug or medicine, alongside the different treatment options available and the risks involved.

Conclusion

In conclusion, practice owners and managers should aim to set prices following sound principles of clearly established costs and a fair profit for the practice owner. A knowledge of all of the practice's costs and cost drivers is, therefore, essential when establishing a pricing strategy, alongside a clear awareness of competitor pricing and clients' willingness and ability to pay. Fair pricing for profit is about considering the needs of all of the key stakeholders in the practice and coming up with solutions that everyone can live with.

Key Points

• Clients demand fairness, transparency and clarity of pricing and if they experience a lack of these, are more likely to seek them elsewhere.
• The practice's pricing strategy must not undersell the service or the products, but at the same time, must not open the practice up to accusations of profiteering or taking advantage.
• A rational pricing strategy must achieve four key aims: it must cover the practice's costs, provide an adequate return on the owner's investment, allow reinvestment for practice growth and be fair to clients.
• One of the most important determinants of setting fees is the client's perception of value.
• Receptionists, nurses and veterinarians should all be able to explain, on request, what the charges are for and why they are included, which requires regular staff training in understanding the practice's prices, the overall pricing strategy and structure.