We work with a lot of clients in our Blueprints for Scale strategic consulting program as well as those who visit our offices for one-on-one sessions (called “Full Day Deep Dives”) that inevitably want to know:
“What’s the magic formula for building a successful group dental practice or DSO?”
They know – and we know – that there’s no “magic formula” or “silver bullet” for success. Having said that, there are some metrics you should know to determine if you’re “on track” for building a successful business.
Let’s face it – you can pretty much find a number to tell you anything you want these days. We liken this to something known as “paralysis through analysis,” but it makes some people feel important. We’d encourage you to start thinking about the foundational aspects of your business in the context of: historical metrics, current metrics, and predictive metrics.
We’ll write more blogs in the future breaking down each of these, but let’s summarize them succinctly as follows:
- Historical metrics are scorecards, operational reports, and financial statements that tell you how you performed in the last period [example: profit & loss statement for Q1].
- Current metrics are scorecards, operational reports, and financial statements that tell you where you stand presently [example: balance sheet for 2017].
- Predictive Metrics are usually more KPI-based reports that take historical performance and extrapolate it into future productivity [example: 90-day advertising spend of $10,000 generates over the following 120 days a total of 20 new patients per month with an average customer spend of $850, so ROI is 6.8X and CAC (cost to acquire a customer) is $125].
Hopefully this approach of “past, present, and future” makes some sense conceptually. If it does, let’s dig into one particular metric of present performance that matters a lot: operating leverage.
Fixed Costs, Variable Expenses, and Incremental Income
It doesn’t matter whether you run a DSO of 20 practices with centralized services or a single location dental practice, you have some amount of fixed costs (rent, wages, etc.) to overcome every month before you treat the first patient. You should know that approximate number.
You also know that (conceptually) after you cover your fixed costs every month, each additional revenue dollar adds a LOT of profit to your bottom line. This is one of several key reasons outside investors are so enamored with buying dental practices and groups, and you probably have a “gut feel” for it at some level.
A high-performing business grows its income at a faster rate than it grows its revenues. Achieving operating leverage means that you’re essentially getting more marginal profitability than it costs you to generate it. I can go into formulas and financial terminology, but that’s going to get confusing very quickly. Here’s the point…
Far too many founder-owner dentists think that “growing the top line” is the only thing that matters. In my prior career, we used to refer to this fallacy as “sales cover sins” – and it’s seductive. If you’re growing your top line (revenue), let’s hope and pray you’re growing your bottom line (income). If you’re not consistently growing your bottom line, then you’ve got a major problem at hand and could be scaling yourself into ruin.
On the other hand, if you’re growing your revenue and you’re growing your income, but you’re growing them at an equal rate, then what are you truly achieving? I can make a good conceptual case that you’re simply scaling headaches. I can probably also make a good financial case that you’re borrowing money at a rate to scale your business that leaves very little in expanded equity to justify doing it in the first place. Was the risk worth it?
- Increase in Income > Increase in Revenue = Gold Star
- Increase in Income = Increase in Revenue = Scaling Headaches
- Increase in Income < Increase in Revenue = Hamster on a Wheel
Putting Numbers to Concepts
Let’s say that in 2015 your business generated $10,000,000 in revenue and $1,000,000 in EBITDA (so it has an EBITDA margin of 10%). Three years later, you’re at $20,000,000 in revenue and $2,000,000 in EBITDA. Is a $2,000,000 EBITDA business worth more than a $1,000,000 EBITDA business? Of course it is. But your EBITDA margin never moved off of 10%. If I’m the buyer, what does that tell me about you as the operator? And does it justify any premium I might be willing to pay to have you lead the company into the next phase of growth after I buy it?
On the other hand, what if your business today is generating $20,000,000 in revenue and $3,600,000 in EBITDA? That’s a significant EBITDA improvement in both dollars and percentage. What does that say about you as an operator to a prospective buyer? And what would it justify as a potential premium for your business?
There comes a time in every business where you’re going to need to make investments to generate future growth. Don’t shy away from that. However, you need to focus continually on the rate of growth of the top line as well as the rate of growth on the bottom line. You want your bottom line to be growing at a faster rate than your top line far more often than not.
Several “big picture” ways to accomplish this are:
- Continually reduce fixed expenses in times of flat revenues or minimize their rates of growth in support of growing revenues.
- Continually drive more revenue to the top line of the business with incrementally lower inputs required.
- Focus on procedure mix to promote higher margin procedures or expansion of services.
- Focus on reducing variable expenses to expand marginal profitability per procedure.
Knowing Your Number
If you really want to get deep in the weeds, here’s the formula for operating leverage:
- Contribution Margin / Net Operating Income = a number (expressed as a percentage)
If the number turns out to be 1.5, the expressed percentage would be 150% and it would indicate that a 10% increase in sales would yield a 15% increase in NOI – which would be a nice result!
I don’t think you need to know your exact number. What you do need to know, however, is the rate of growth for your top line and your bottom line. And you need to simply compare them period-by-period to see if you’re growing your bottom line at a faster rate than your top line.
If you are, then keep up the good work!
And if you’re not, then it might be time to consider focusing internally on operations instead of externally on acquisitions or startups.
If you’d like our help in this area or to discuss any other topics related to trends in our industry, please feel free to contact me at Perrin@TUSK-Partners.com. TUSK provides industry-leading resources for Group Dental Practices and DSOs. We help our clients START, GROW, and SELL their Group Dental Practice or DSO. For more details, visit our website or feel free to download our Overview of Services.
TUSK will be the featured presenter at the “DSO Foundations” seminar hosted by Patterson Dental Supply in Charlotte, NC on June 1 & 2, 2018 where we will present “Tactics to START, GROW, and SELL your Group Practice or DSO.” You can find more information and register HERE. We hope to see you there as well!
To see where else we’ll be in the near future, please check our calendar for a listing of all seminars, conferences, and presentations.