Paying Attention to Productivity

Productivity is a principle that has been gaining more attention in our industry during the last year or so. The reason is that managing productivity is key to managing the costs that stand between providers and profitability.

And, providers have greater need to use techniques like productivity improvement than ever before. In a recent talk with a longtime provider about reactions to productivity improvement techniques in the 1990s, he declared, “It was too damn easy to make money, so we didn’t manage all that stuff.”

Productivity is equal to revenue per full-time equivalent employment. The economic benefit of improved productivity and, conversely, the cost of low productivity, can be calculated just as easily. For example, a provider with annual revenue of $2 million, a gross profit margin of 60 percent and a pre-tax net profit margin of 7 percent has productivity of $125,000.

If management determines that it should have productivity of $137,500, then the variance between actual and target is 10 percent.

The economic benefit of improving productivity equals 10 percent × 60 percent × $2 million, or $120,000 per year. Since the company’s net profit was 7 percent, or $140,000, the new net profit would be 13 percent, or $260,000.

The statement that describes this example is the impact of a variance from the productivity target is equal to the percent variance multiplied by gross profit margin, multiplied by revenue.

There are at least three reasons why HME managers should measure and manage productivity.

1. Productivity can level the playing field between large and small providers. About 80 percent of the industry participants are small providers. It is unquestioned that large providers qualify for volume discounts on the goods they purchase that small providers will never get. What large providers (and small providers) don’t have is a lock on the forces of imagination, focus and agility. Using these forces, some providers have already created productivity that wipes out any advantage derived from the volume discounts of large purchases.
2. Productivity adds or deducts discounting ability. Discounting ability is the Medicare provider’s most coveted treasure. Discounting ability is the difference between a company’s current net profit margin and its target net profit margin. If a company has a target net margin of 7 percent and a current net margin of 10 percent, it can offer a discount and still be profitable. Since productivity is reflected in the bottom line, changing productivity increases or decreases net profit. Providers who believe their discounting ability is insufficient to compete favorably can improve their competitiveness by increasing productivity.
3. Productivity offers more opportunity for profit improvement than purchasing discounts. More revenue is consumed by people doing things in a provider company than is consumed by purchases of products. On average, 53 percent of the money spent by a provider is spent to have people to do things, and the other 47 percent is spent for products. Managing productivity is the only effective way to manage the lion’s share of costs.

To manage productivity, it must first be measured. The frequency of measurement and placement in management information should be on par with revenue and gross profit margin.

Second, a target must be set. The target may be based on a number of factors like achieving a certain discounting ability, getting to a higher net profit margin or just doing better than the current level. In any case, achieving a higher productivity with the same gross profit margin will improve productivity.

It is important to recognize that normal levels of productivity are different for different product lines. Companies specializing in custom rehab will typically have greater productivity than those specializing in oxygen services. Pharmacy and supply companies have higher productivity still. That doesn’t mean that they have greater profitability. Since the gross profit margin of pharmacy is lower, productivity must be greater to get to the same net profit margin.

Finally, managing productivity requires commitment to two more principles. One is that marketing resources are allocated only to the product-payer combinations that contribute the most to the bottom line (not the gross profit). The other principle is that at least 5 percent of the time must be removed from every business process every year.

The first principle can be achieved by applying activity costs to the significant product-payer combinations to select the high-yield opportunities. Once the targets are known, the marketing strategy can be adjusted to acquire the best customers. It doesn’t mean that providers eliminate low-yield products, although that is acceptable. It does mean that no money or effort should be spent asking for weak business.

The second principle can be achieved by following the counsel that one Georgia provider gave his team: “We have to eliminate keystrokes, footsteps and miles.”

Wallace Weeks is founder and president of Weeks Group Inc., a Melbourne, Fla.-based strategy consulting firm. He can be reached at 321/752-4514 or by e-mail at [email protected].