Practice Made Perfect
How to Motivate Your Associate to Think Like an Owner
The right compensation plan is vital.

Last month we talked about an associateship that went wrong. Now we're going to discuss an associateship that's worked out very well.

The problem

Dr. Donald Perlmutter (his real name) is an optometrist with two practice locations approximately 20 miles apart in Ohio. He contacted us in 1998 because he was suffering from burnout caused by a heavy workload, and he was frustrated with his poor net. He worked an average of 62 hours per week, which included his time seeing patients and his time managing the practice. Despite the fact that he worked 3 days a week at one location and 2 days a week at the other, the 2-day practice generated more revenue. Both offices were fully staffed during the workweek, even though there wasn't a doctor at each location every day.

Our approach

Our first step in helping Dr. Perlmutter was to discuss his goals with him. This was important because we wanted to tailor our recommendations to his situation and comfort level. Dr. Perlmutter's goals were to:

• monitor and manage cost of goods more effectively
• determine whether his wages were too high and whether his staff was working too many hours
• improve his net income.

Next we evaluated the overhead structure of each practice location. This involved comparing the doctor's overhead expenses to established norms. We also looked at his fee structure, staff hours and salaries, participation in managed care and inventory turnover.

Our preliminary analysis indicated that his fixed overhead, especially staff costs, was higher than normal. We thought that his staff's hourly wages seemed appropriate, but staff productivity per hour per employee was low, which made his staff costs high.

We believed that his staff costs as a percent of collected gross income were high because he staffed each practice with full-time employees even on days that he was at only one office.

The options

We developed the following options and presented Dr. Perlmutter with net income projections under each scenario:

• Lay off staff. Dr. Perlmutter told us at the beginning of the consultation that he didn't want to lay off any of his staff. However, we presented this option to him so that he could make an informed decision.
• Operate the 2-day-a-week location on a full-time basis and sell the other practice. This option was viable because this location was already the largest practice, and the population in the area was growing.
• Operate the 3-day-a-week location on a full-time basis and sell the other practice. This option would provide a lower net income than the previous one, but we presented this scenario to Dr. Perlmutter because he had strong ties to his 3-day-a-week location.
• Operate both practices full-time. From a financial point-of-view, this was the best option.

We suggested that Dr. Perlmutter evaluate each option relative to his lifestyle goals. We told him that he would have to hire an associate if he decided to operate both locations full time. Because he was already considering this option, this scenario fit in well with his future plans.

The benefits of having full-time doctor hours at both locations are:

• expansion of collected gross income
• an increase in Dr. Perlmutter's net income (he earns a profit on the associate's production)
• the opportunity to greatly enhance patient service through expanded hours and services.

After carefully considering his options, lifestyle and quality of life, Dr. Perlmutter decided to operate both practices full time. Dr. Andrea Earley became his associate. She'd previously worked with Dr. Perlmutter part time throughout most of 1998.

Compensation plans

Now that Dr. Perlmutter had hired Dr. Earley, he wanted to work through compensation issues. His goal was to find a way to pay Dr. Earley so that she'd be satisfied -- without having to sacrifice his own net income.

Many optometric practices pay associates either per diem or a set salary. An O.D. with either arrangement will usually do a good job at patient care. However, she may not be concerned about keeping cost of goods down and profitability up.

Owners who pay their associates like employees often treat them as employees. They use the same policy for hours worked, sick days and vacation for both. But when the associate's out of the office, she isn't generating income even though she's getting paid. Think about this: As the owner, do you get paid when you're out sick, at conferences or on vacation?

Other optometric practices pay their associates based on a percentage of total gross income. This is an easy approach to implement. The problem is that this formula doesn't motivate the associate to keep cost of goods under control. For example, be- cause her compensation doesn't factor in actual practice cost of goods, she doesn't have much of an incentive to avoid careless errors and frequent remakes.

A good compensation plan should meet three criteria:

1. It should be fair to the owner.
2. It should be fair to the associate.
3. It should motivate the associate to think like an owner.

The Hayes formula

We recommended the Hayes formula for production-based compensation to Dr. Perlmutter. The formula works as follows:

1. Project associate's annual gross collected production (let's say $300,000).
2. Subtract the practice's total cost of goods expense percentage (say 33%).
3. Multiply by desired net percentage (say 35%).

Always update the formula for the actual cost of goods sold (COGS) percentage of collected gross revenue for the practice. So, as an example, if COGS was 30% at the time that you made the original compensation projection and it increased to 33% after 6 months, use 33% in the formula rather than 30%.

For the typical practice, we recommend paying the associate somewhere between 30% to 40% of her collected production minus COGS. The percentage is lower for practices with a low net and higher for practices with a high net. The idea is to derive a percent that will give the associate an incentive to increase production and keep cost of goods low. Of course, the formula should take into consideration a reasonable profit margin for the owner.

The net percentage used in the production-based approach should give the associate an opportunity to earn as much as she would earn in another optometric practice, commercial practice, HMO or an ophthalmologist's office. Therefore, it's important to find out what an employed optometrist could earn in your area.

The American Optometric Association reports in Caring for the Eyes of America 2000 that the average income of an O.D. employed by another O.D. is approximately $80,000. The average income of an O.D. employed by an optical chain is approximately $109,000.

Dr. Earley's verdict

Dr. Earley was receptive to the production-based approach from the beginning -- a good sign that she was willing to help the practice grow. She told Dr. Perlmutter that she wanted an opportunity to prove that she could earn her compensation based on her production. She also wanted an opportunity to earn more as her production increased.

The table shows how the numbers would work using the Hayes production-based compensation formula (for confidentiality reasons, we haven't used actual numbers). In this example, the practice net is 30.6%, the associate's collected gross is $300,000 and the owner's collected gross is $700,000.

Why did the associate only earn 23.5% on her gross, but the owner earned 33.7% on his gross? Answer: The owner should make a profit on the associate because:

• The practice is successful due to the owner's investment of time and hard work.
• The owner has all of the financial liability and the associate has none.
• The owner is responsible for covering the expenses of the practice.
• The owner usually continues to perform most of the management duties.

We run the numbers

One of Dr. Perlmutter's concerns was to maintain his same level of income. Using the numbers from the table (not his real numbers), he would have made a profit of $21,450 on Dr. Earley's production.

But would the approach help him maintain what his net income was prior to taking on Dr. Earley? Before she came on board, let's say he'd been netting $176,000, or 22% (for example only). Improving the net had been one of the goals of our consulting project.

Before Dr. Earley, say Dr. Perlmutter grossed $800,000 (again, a sample figure only). The practice grossed $1,000,000 1 year after Dr. Earley joined the practice. The additional $200,000 decreased staff costs, occupancy costs and general office overhead. Because those percentages went down, the practice net went up to 30.6%. The table shows how we calculated the incremental increase in Dr. Perlmutter's (sample) income.

Therefore, his total net increased by $59,650. The increase was made up of the $21,450 profit on the associate and $38,200 simply because the practice became more profitable.

Getting to work

Dr. Earley was busy with patients from the start because of the rapid growth in one of the offices and Dr. Perlmutter's 3- to 4-week appointment backlog. Because of the availability of patients, she went from her guaranteed minimum salary to the production-based approach within 3 months.

She liked the production-based approach because it gave her an incentive to increase production and keep busy. That's exactly the attitude that we want associates to have. It's good for her and it's also good for Dr. Perlmutter.

In addition to helping grow the practice, Dr. Perlmutter tells us that Dr. Earley attends staff meetings and pitches in when he's short staffed. For example, when the optician was out, she dispensed glasses and adjusted frames without being asked.

Because of Dr. Earley's helpful nature and a compensation formula that's based on her total revenue (professional fees and materials fees), she's rewarded for lending a hand when necessary. That's just what an owner would do in the same situation.

Time off hasn't been an issue for the senior or the junior doctor. One simply lets the other know when he or she will be out and the other doctor covers. And Dr. Earley realizes, like any practice owner, that her absence results in lower net income.

A happy ending

The production-based compensation formula for Dr. Perlmutter and Dr. Earley met all of the criteria for a good compensation plan. It was fair to the owner -- Dr. Perlmutter increased his own income. It was fair to the associate -- Dr. Earley benefited by increases in production and decreases in cost of goods. It motivated her to think like an owner -- she understood that she had to work to make money and that she had to pitch in when necessary.

You too can have a successful associate agreement like this one if you set up a plan that focuses on the unique circumstances of your practice.

Marilee Blackwell, M.B.A., C.P.A., A.I.B.A., senior consultant for Hayes Consulting (904-273-1115), and Donna Suter, president, Suter Consulting Group (423-892-3638), team up to offer financial guidance and on-site consulting services designed to increase your gross revenue while significantly improving your net income percentage.