Whether you run a small one-doctor general practice or a multi-doctor, multi-disciplinary specialty practice, managing an inventory of drugs and medical supplies as well as over-the-counter products such as diets, flea/tick/heartworm preventatives, or even retail items, is a big part of your business. Since Cost of Goods Sold (COGS) is the second largest expense in any veterinary practice (with doctor and staff compensation being the largest!), closely managing this expense is essential to overall financial success.
On the other hand, closely managing inventory and COGS can take a lot of time and require a lot of resources. Learning how to effectively manage your inventory while still minimizing your time investment will not only help keep your inventory costs down but will also free you up to do what you do best - generating revenues!
What's at stake?
In a service based industry such as veterinary medicine, inventory sales are typically a secondary source of revenues. However, according to the most recent AAHA Financial and Productivity Pulsepoints, pharmacy, food, preventatives, and other over-the-counter products can account for between 15% and 34%
[LAM1]
of total revenues. Of course, this does not take into account the inventory of drugs and medical supplies used as part of providing anesthesia, surgery, hospitalization, and other treatment services, which can be as high as 15-16
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% of total revenues.
Stay focused:
Consider the 80/20 rule: 80% of the money spent on inventory is usually on 20% of the items purchased. Identifying these key inventory items is a great strategy to managing the bulk of your inventory costs while still minimizing your time investment.
Allocate your inventory items (or groups of inventory items) into the appropriate quadrant
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of the cost-use window. Inventory items in the upper right quadrant that are high cost and are used frequently should receive the most of your attention, followed by high cost, low use inventory items in the upper left quadrant. Use this method to determine your "Top 10" inventory items that will warrant most of your time and attention.
Set key metrics:
For each of the ten inventory items you identified above, determine the following key metrics:
- Economic Order Quantity ("EOQ"): This model helps to determine the optimal quantity to order so that you can minimize the total cost associated with the purchase, delivery and storage of the product. Essentially, the EOQ for an inventory item is a function of the number of units sold, the cost per order (including shipping costs), and the holding or carrying costs per unit (storage, financing, refrigeration, insurance, etc.).
If you are unable to determine your inventory holding costs, the "rule of thumb" is that holding costs are approximately 25% of the cost per unit. However, depending on your specific circumstances, holding costs can be as high as 55% of unit cost.
This model is rather complicated and is only worthwhile using for your highest cost and highest use items. However, once you have calculated the EOQ, you will know exactly how much of each product to order to keep your costs as low as possible.
- Reorder Points: This is the minimum level for a particular inventory item that initiates a refill order. To set a reorder point, you will need to understand how frequently the product is sold or used ("turnover"), the difficulty and length of delivery ("lead time"), the shelf-life or expiration of the product, how much space is needed to store the product, and the consequences of running out of the product e.g. emergency CPR drugs. To simplify:
Reorder Point = Normal Consumption or Turnover during Lead-Time + Safety Stock
where Safety Stock is the minimum quantity of the inventory you would want to have on hand at all times to prevent running out of the item.
Example:
3cc luer-lock syringes are typically a high use, higher cost item for most veterinary practices. Let's suppose your practice uses an average of 15 boxes of 3cc luer-lock syringes per week. Your veterinary supplier is able to deliver to your practice within three days of ordering and, because you are able to use other size syringes (e.g. 6cc) if you run out of the 3cc syringes, you have determined your minimum safety stock to be 3 boxes. What is your reorder point?
Reorder Point = 15 boxes/7 days per week X lead time of 3 days + 3 boxes safety stock
= approximately 9 boxes.
In other words, when there are 9 boxes of syringes remaining, it's time to reorder. Enter this number as the reorder point in your management software to trigger automated reminders.
Now let's assume that a shipment from your veterinary supplier costs $50 regardless of size and your holding cost per box is $3. What is your EOQ?
Every order of 3cc syringes should ensure that the inventory level is as close to the reorder point as possible. Let's say that your supplier will give you a bulk purchase discount if you order a case of 10 boxes. Let's also assume that at the end of week one, there are nine boxes of 3cc syringes in inventory. To take advantage of the supplier discount, you order one case (10 boxes). At the end of the second week, your inventory of 3cc syringes is now down to four boxes (9+10-15). This is below your reorder point and is why it is important to order at or near your EOQ. Ordering two cases (20 boxes) at the end of week one would leave you with 14 boxes on hand at the end of week two. You then have until midweek when your inventory reaches the reorder point of nine units to order another shipment at or near your EOQ.
Investing time at the beginning to save time in the long run:
While determining your cost-use window and calculating EOQ and reorder points may seem like a lot of work, the up-front time investment will allow you (or anyone else in your practice!) to know exactly when to order inventory and how much to order. This means that you can delegate this task to almost anyone in your practice. It will also allow you to maintain the lowest possible quantity of drugs and supplies on hand, while minimizing the risk of stock-outs and product wastage due to expiration. Additionally, the systems and controls over inventory items will be improved, thus keeping theft and other shrinkage to a minimum.
Conclusion:
Effective inventory management is the key to keeping your COGS under control. Not only can this have a huge impact on your profitability, but it is actually one of the easier things to do well (and to delegate) in a veterinary practice.
