Pricing Animal Health Items

While the sale of veterinary knowledge in the form of professional services is the core business for a veterinary practice, the supply of animal health items also contributes to veterinary business income. Thus, veterinary businesses have two main components: sale of professional services and sale of animal health items. Veterinarians, both owners and employed, need to understand inventory management and accounting methodologies for arriving at pricing of veterinary supplied items so they can contribute to the strength and success of a veterinary business.

In veterinary practice, clinical services are provided to clients for acute and ongoing pet health management, and these services require the business to stock and supply prescription only and non-prescription animal health items. In addition, veterinary clinical practices, and animal health consultancy practices, utilise pathology tests or the attendance of visiting specialists as required for monitoring or diagnosis of animal health status. For the purpose of simplicity, prescription and non-prescription medications, and external services, are all termed animal health items, and examples of these include:

• prescription only medicines and prescription pet foods
• pathology panels for in-house diagnostics
• pathology tests performed by external laboratories
• non-prescription goods e.g. general pet foods, worming medication, dental care
• attending specialist visits e.g. ultrasonographer, behaviouralist, orthopaedic surgeon

It is important that both components of the veterinary business, professional services and animal health items, contribute significantly to the profit margin of the business. In fact, practices that rely on sales of animal health items for a higher proportion of profit are vulnerable to large suppliers with increased purchasing capacity taking the market share. Recent examples of this include:

• dairy farmers in New Zealand are now able to request a prescription from their veterinarian and have the drugs supplied by a pharmacy, so veterinarians are not guaranteed income from product sales
• supermarkets, pet barns and on-line suppliers of pet food, flea control products and worming medication are significant suppliers of these items to animal owners

Demand for animal health items can be highly variable. Due to variability in demand, animal health items, visiting specialists or laboratory tests are known as variable cost items as these are costs for which the veterinary business orders as needed. Variability in demand for animal health items can be related to:

• normal or abnormal seasonal variability, for example summer vs winter, drought years or floods
• economic variability, such as local employment levels in suburban areas, national or global economic effects (recessions), or sector economics of production (e.g. high Australian dollar depressing beef export demand and value of stock)

A veterinary business orders, records, stores and labels prescription and non-prescription items, and communicates with clients about appropriate use of a product or the results of the test performed. Furthermore, the veterinary business is responsible to pay for ordered items. Thus, when an animal health item is provided to a client, the correct charges must be added to the invoice, otherwise the veterinary business may lose money.

On occasion, animal health items may be damaged or the use by date may expire before an item is sold, these items are classified as wastage. To generate a margin, and cover the cost of wastage and staff time involved in handling stock, items are charged to the client at a higher price than the purchase price to the business. Thus, the item is marked-up before sale. The formula for determining the sale price of a product is to multiply the cost by a factor to increase product price to higher than cost. The mark-up factor is always a figure greater than 1.0, unless the product is designated as a loss-leader product and is priced below cost. For example, a $1 item with a mark-up factor of 1.5 will have a selling price of $1.50. Mark-up is also commonly referred to as an amount or a percentage. To illustrate, a $1 item that sells for $1.50 is marked up the amount of 50c and has a 50% mark-up.

• Selling price is determined by the equation:
  • cost x mark-up factor = selling price
• Calculation of mark-up percentage:
  • mark-up % = (mark-up amount/cost) x 100

Difference between mark-up and margin

Mark-up and margin are related, but different, concepts in regard to determination of selling price. Selling price for an item is determined by multiplying cost by the mark-up factor, whereas margin is the difference between the selling price and the cost. Thus, selling price is determined either by multiplication by a mark-up factor, or by adding a required amount of margin to the cost. The equation for margin is:

The equation for margin is:

• cost + margin = selling price

When considered as an amount mark-up and margin are the same, but when expressed as a percentage they have different values. As shown above, mark-up percentage is calculated as:

• mark-up% = (mark-up amount/cost) x 100

and, margin percentage is calculated as:

• margin% = (margin amount / selling price) x 100

For example, a $1.00 item that sells for $1.50 has a mark-up percentage of 50% and a margin percentage of 33%.

Table 1 below provides examples of mark-up and margins, illustrating how the mark-up factor is usually > 1.0* x the cost price and the margin is always < 1.0 and < 100% of the selling price. *Note: for loss leaders, the mark-up factor can be <1.0.

For a more detailed discussion of margins and loss leaders see the topic notes: Fee Setting.

Optimal mark-up and sale price

The optimal mark-up for animal health items is determined by balancing a range of considerations. The most important considerations are:

• price paid by the business to purchase the product
• demand for the product
• financial return the business owner wants to achieve

Other considerations that influence mark-up:

• the cost of holding items prior to sale, as opposed to the monies being invested elsewhere
• the cost of storage, including infrastructure and meeting legal requirements
• rate of wastage/loss
• prices set by competing businesses, including non-veterinary businesses, such as large pet barns and supermarkets who have high purchasing power
• the value delivered to the customer

Many animal health items have a legal requirement to be ordered, prescribed and dispensed by a veterinarian and full records kept, for these items the final price incorporates a professional fee. Table 2 shows examples of pricing of various non-prescription and veterinarian prescribed items. Non-prescription goods are also known as over the counter (OTC) items.

* dispensing, injection or sampling fees, all of which are professional fees, are incorporated into the final price of prescribed items

**these items are usually accompanied by professional fees such as consultations, or euthanasia fees, which are shown as separate items on the invoice

Mixed veterinary practices and production animal veterinary businesses are likely to apply lower mark-ups, also known as quantity breaks, for large quantities and full boxes of animal health items.

Table 3 shows examples of quantity breaks for veterinary prescription only and non-prescription items.

The inventory includes all animal health items held in stock. This is in contrast to animal health items that are ordered as needed, such as laboratory tests, special order drugs or non-prescription items for a particular patient or client's situation.

Inventory level optimisation, and minimisation of wastage, can have a large impact on cash flow and overall margin generated the veterinary business. Effective inventory management and allows the animal health item component of the veterinary business to contribute to the overall profit margin.

The better the profit margin, the greater the ability of the business to increase remuneration to employees, invest in development of practice facilities, or provide support for continuing education.

Inventory levels

Effective inventory management aims to achieve a balance between maintaining the minimum level of inventory (stock) while ensuring client expectations are met. Consider the amount of money in stock to enable supply for the next six months as opposed to the next one to two months. Carrying less stock can allow the veterinary business to put this money to better use, such as minimising interest paid on loans.

See Table 4, below, for an example of average stock levels for a veterinary business and the opportunity associated with reducing stock levels.

Inventory turnover

Inventory turnover is an indicator of stock management. It is calculated by dividing the cost of drugs and other animal health items by the average inventory value. The higher the calculated number, the more often inventory turns over, resulting in less outdating, less damage, and less inventory on hand at any one time. A related concept, days in stock, is related to inventory turnover, and is represented by the number of days the average inventory item is held in stock. The calculations for inventory turnover and days in stock are:

• Inventory Turnover (IT) = Total inventory expenditure in a year/Average inventory value
• Days in Stock = 365/IT

Overall inventory turnover is important, as is individual inventory item turnover. Items slow to turnover are more likely to go out of date. As a rule of thumb items should be turned over every 30 - 45 days. Veterinary practices should strive to turn inventory over 10 - 12 times per year (Remillard 2007).

For a more detailed discussion of inventory turnover see the topic notes: Key Performance Indicators.

Inventory controls

By law, prescription drugs, and in particular Controlled Substances (Schedule 8 drugs), require higher levels of management than general animal health items. All prescription only drugs must be securely stored away from public access. The rooms or cupboards in which the drugs are kept must be locked unless a veterinarian is on site. The higher scheduled drugs, such as drugs of dependence and poisons, require by law, higher levels of operational controls. Typical operational controls, required by the local legislation, for stocking these higher level Controlled Substances by a veterinary business are listed below. Failure to meet these control measures results in legal and/or logistic implications.

• Wholesalers are legally required to keep signed documentation of poisons and drugs of dependence that are received by their business and then sold to a veterinary practice
• Poisons and drugs of dependence (Schedule 8) drugs need to be ordered a staff member, usually a nurse, who has a good understanding of inventory control.
• Wholesalers generally engage external couriers to deliver goods to a practice.
• The drugs are received by the business from the courier.  It is important for delivery dockets to be kept and filed.
• Veterinarians are legally required to sight and sign for drugs of dependence or scheduled drugs received from the courier by the business (Controlled Substances Act) and wholesalers are required to keep this signed documentation.
• Drugs of dependence received at a veterinary practice are signed into a Dangerous Drug recording book which must be sighted and signed by a veterinarian.
• When drugs of dependence are used they must be signed out by the prescribing veterinarian and the administration supervised or conducted by the prescribing vet.
• Clients must be invoiced for drugs used, in line with accurate inventory charging.
• Audits of drug books must be conducted each week and discrepancies reported to the practice owner or manager. Spot check audits by other veterinarians or delegated highly qualified nurses must be carried out regularly.

Inventory items that are damaged, used but not charged to the client, or that remain in stock until out of date are a financial loss to the business.

In such instances the planned or potential margin of total inventory is reduced to a lesser margin. The more wastage, the less likely the planned margin will be attained, placing downward pressure on the overall profit margin of the business. Flow-on effects of excessive wastage may include upward pressure on prices and cost cutting measures. Some product lines are more prone to missed charges, going out of date, breakage, damage or being incorrectly sold as a cheaper product.

Table 5 illustrates the effect missed charges and stock losses this for a single line of inventory.

Table 6 illustrates this for overall inventory, showing how to calculate overall margin achieved after adjusting for wastage.

1. Describe and demonstrate the difference between mark-up and margins.
2. Discuss the effect of missed charges, breakages, out of date items on the cost of goods sold, and thus the actual margin obtained as compared to the planned margin. What are possible flow-on effects of wastage?
3. List and discuss the flow-on effects of holding too much inventory.

• Ackermann, L. (2007). Blackwell's Five-Minute Veterinary Practice Management Consult. USA, Blackwell Publishing, Ames.
• Remillard, J. and Bellavance, E. (2007). Effective Inventory Management in Blackwell's Five-Minute Veterinary Practice Management Consult. L. Ackerman (ed), Blackwell Publishing, Ames, pp. 326 - 329.

Authors

• Dr Adele Feakes, Lecturer, School of Animal and Veterinary Sciences, Roseworthy campus, University of Adelaide.
• Dr Dana Thomsen, Researcher, School of Animal and Veterinary Sciences, Roseworthy campus, University of Adelaide.

Acknowledgements

• Mr Craig Broadbridge, Finance Officer, School of Animal and Veterinary Sciences, Roseworthy campus, University of Adelaide.
• Ms Diane Whatling, Practice Manager, Companion Animal Health Centre, School of Animal and Veterinary Sciences, Roseworthy campus, University of Adelaide.
• Prof Noel Lindsay, Director, Entrepreneurship, Commercialisation & Innovation Centre (ECIC), University of Adelaide.
• Dr Ed Palmer, Senior Lecturer, School of Education, University of Adelaide.