Trends in Dentistry: Navigating High Overhead Costs

Let’s start with the facts.

Of the respondents to the HPI survey, 21.5% identified increased overhead costs as a top challenge for practice owners. Additionally, 20.5% indicated plans to make major equipment purchases in the coming year. Based on our client data, we see both rising overhead costs and increased borrowing costs due to higher interest rates, both of which are impacting profitability.

According to the HPI data, medical practice expenses per dentists (excluding share holder salaries) remained relatively steady from 2011 to 2021, with an average annual increase of 2.1%. However, from 2021 to 2022, this figure jumped by 12.9%. The State of the Dental Economy – Q3 2022 Update indicated that nearly all practices saw an increase in major cost categories including:

• 91% reported higher staff costs
• 82% saw lab costs rise
• 95% experienced increased supply costs
• 77% noted higher equipment expenses
• 35% faced growing facility-related expenses

It’s important to recognize that not all cost categories experience price pressures simultaneously. Costs can be classified as either variable or fixed. Variable costs fluctuate in real-time based on production volume, while fixed costs do not change with patient volume and are generally harder to adjust within a 12-month period. In dentistry, lab fees and supplies are variable costs, which is consistent with the survey showing an 82% increase in lab fees and a 95% rise in supply costs. On the other hand, equipment and facility costs are typically fixed, often tied to loans and leases. While fixed costs aren’t immune to inflation, they tend to incorporate rising costs more slowly.

As practice owners manage profitability amidst rising costs, they are also grappling with increased borrowing costs due to inflation. For the first time in four years, the Federal Reserve reduced rates on September 18, 2024. Prior to this, the federal reserve rate was at its highest level in 23 years. As the saying goes, "rates go up like a rocket and come down like a feather."

While inflation has been gradually slowing and rates have begun to decline, what can a clinician-owner do to combat persistently higher operating costs and transient rate spikes?

Maximize your marginal profitability.

Most clinician-owners are familiar with the term profit margin but often overlook their marginal profitability. While profit margin measures your overall practice operating profit over a defined period, marginal profitability refers to the profit percentage on each additional dollar of collections. By understanding your fixed versus variable costs, you can target production goals that maximize profitability at different levels of capital expenditure.

For example, let’s say you can increase production by $100,000 before the need to hire additional staff, expand hours, add another operatory or invest in more equipment. Your only additional expenses would be the true variable costs, such as lab fees and supplies. In a hypothetical practice with operating costs of 56%, where 77% of costs are fixed and 23% are variable, a $1 increase in production would yield 85 cents in marginal profit. By maximizing production at your current level of fixed costs, you can capture this marginal profitability and improve your overall profit margin.

Seek positive cash flow on capital expenses.

When making capital investments, it’s crucial to plan for how you’ll maximize your investment return. While financial metrics like return on investment (ROI), net present value (NPV) and break-even analysis are useful, a focus on cash flow can often provide the clearest insight. It’s important to explore considerations such as if your equipment purchase will generate positive cash flow after accounting for financing and maintenance costs or which piece of equipment or financing option will provide the best cash flow. If the equipment is financed for its estimated useful life and generates positive cash flow over the full period, you’re making a profitable investment. This can leverage the time value of money and increase your practice’s market value.

Date the rate and marry the asset.

For larger investments with a long useful life, such as practice buildings, real estate or practice merger, it’s a good time to review and negotiate prepayment penalties. The market anticipates that rates will continue to fall as inflation moderates. While we may not return to near-zero rates, a downward trend is expected. By shopping around for lenders during a purchase and making it clear that you’re comparing terms, you can push banks to offer their best rates and terms. Emphasize the importance of limiting or avoiding prepayment penalties. If that’s not possible, ask about internal rate resets, where a bank allows for a single or limited number of rate adjustment if refinanced internally. It may also be worth considering variable-rate options, as these can be locked in at a lower fixed rate in the future as rates fall. If an asset is a good investment at today’s rates, it will only improve with lower financing costs.

While both high inflation and elevated borrowing rates are likely temporary, these strategies will help ensure efficient financial management and profitable investment decisions for your practice. If you would like to explore other ways to help your practice stay lucrative during turbulent times, our team would love to help! Schedule a conversation with a practice integration advisor today!

For informational and educational purposes only and should not be construed as specific investment, accounting, legal, or tax advice. Certain information is based on third party data and may become outdated or otherwise superseded without notice. Third party information is deemed to be reliable, but its accuracy and completeness cannot be guaranteed. Neither the Securities and Exchange Commission (SEC) nor any other federal or state agency have approved, determined the accuracy, or confirmed the adequacy of this information. R-24-7855