Dentist's Compensation: Taking your finances to the 'tipping point'

In his book, The Tipping Point, Malcolm Gladwell examined what causes dramatic social change. Examples he cites of such change include the sudden drop in crime rate in New York in the mid-1990s and an unknown novelist's rise to best-selling author. These changes can spread as quickly as an epidemic. Described in quantitative terms, dramatic change seems to be as different from normal change as multiplication is from addition. Dramatic change seems to have an "exponential," rather than a "linear," progression.
An example of a linear progression may be 1+2+3+4+5=15, whereas an exponential progression may be 1x2x3x4x5=120, with the latter growing far more rapidly. The moment when these social epidemics take off, departing from a linear-type progression to an exponential one, is called the "tipping point."

In our experience working with dentists for more than 20 years, we have discovered that the way in which they run their practices can either lead to an accumulation of wealth that is slow and modest — i.e., linear — or one that is rapid and substantial — i.e., exponential. Most doctors are unable to bring about dramatic changes to their financial lives because they are focused on the wrong things. How does one bring about dramatic financial change and thereby create an exponential accumulation of wealth?

Our firms have been keeping statistics on hundreds of dentists' financial lives over the past six years to try to determine what causes some dentists to barely get by financially, and others to accumulate wealth in an exponential fashion. We have discovered factors that determine whether a practice will reach the tipping point and grow exponentially. In this article, we will share our discoveries with you.

First, let's examine revenue and expense so that we can compare the statistics of a dental practice with linear wealth accumulation vs. a practice with exponential wealth accumulation.

The linear practice has earnings of 32 percent of gross production; the exponential model, 40.1 percent. Three primary factors differentiate an exponential practice from a linear one and allow for the rapid accumulation of wealth: 1) production per hour, 2) restructuring of debt, and 3) retirement savings.

Production per hour
The first and most important issue relates to production. Our research shows that the exponential practice is 20 percent more productive for the same hours worked than the linear practice. In Table 1, the linear practice produces $500,000 in annual production; the exponential model, $600,000. Later in the article, we will explain how to raise production per hour, which is critical to developing exponential financial growth.

For an exponential practice with a gross production of $600,000 per year, this 20 percent increase in productivity is created from additional production of approximately $68 per hour. We are assuming the dentist is working four days per week, multiplied by eight hours per day, multiplied by 46 weeks per year, for a total of 1,472 clinical hours per year.

In the linear practice, $500,000 divided by 1,472 hours equals a production of $340 per hour. In the exponential practice, $600,000 divided by the same 1,472 hours worked equals a production of $408. When you understand the profound effect on your personal wealth accumulation that is possible in the exponential practice — and the many tools at your disposal for increasing production even more than 20 percent — you will see that $68 per hour is a very "do-able" production increase to strive for. Indeed, in many practices, far greater production increases per hour have been achieved.

Restructuring of debt
The second issue relates to using the proper planning techniques (capital budgeting) for equipment and debt. The linear practice model has 6 percent per year of gross production allocated to practice loans and leases (4 percent) and equipment purchases (2 percent). The exponential model reflects a practice with the same equipment outlay, but one that uses the proper structure of previously existing debt.

By effectively structuring existing debt, the exponential model drops the percentage to only 1.2 percent for the payment of practice loans and leases. Note that the exponential practice does not achieve better numbers by skimping on equipment. It makes the same cash outlay for equipment as the linear practice ($10,200), but with the 20 percent production increase, the percentage of those purchases drops to 1.7 percent per year.

Retirement savings
Finally, the linear practice only contributes minimally to retirement savings for the doctor. In this case, only 2 percent of gross production is allocated to retirement savings. Typically, a linear practice has IRA-based plans, such as SEP-IRAs or SIMPLE plans, which do not allow the maximum retirement savings.

The exponential practice uses a qualified retirement plan which allows a much larger percentage of earnings to be contributed on a tax-deductible basis to retirement savings. In the exponential case, the doctor will contribute $40,000 to a qualified retirement plan in 2002. This compares to an average of retirement savings of only $10,000 for the linear practice.

Finally, let's compare the percentage of spending on lifestyle between the linear model and the exponential model (see Table 2). For lifestyle spending, note that the exponential model does not contain any reduction in actual living expenses. This means that dentists can save substantially more without diminishing their lifestyles — a concept many don't believe — but here it is in black and white! Indeed, the exponential dentist can afford to live in a nicer house and make additional mortgage payments of $10,000 per year. The only lower spending in the exponential practice involves eliminating automobile and consumer debt through a proper structure of personal debt.

Making the pie 20 percent larger in the exponential practice, by increasing production per hour by $68, allows the same or a better lifestyle at a lower percentage of spending. This is very important! Many doctors try to increase savings by being very frugal with their lifestyle. However, when one examines lifestyle spending, perhaps as much as 75 percent of earnings is allocated to federal and state income taxes and housing and automobile expenses. These are fixed expenses that are very difficult to change. The variable expenses which can be reduced, such as clothing, entertainment, contributions, and food are cut only with a significant reduction in quality of life. As the table clearly shows, you do not need to live in a dilapidated home or wear tattered clothing in order to accumulate wealth exponentially.

The difference in wealth accumulation in the linear model, compared to the exponential model, is dramatic. Now that we have demonstrated an equivalence in lifestyle spending for the linear and exponential models, let's look back to Table 1 (Comparison of Annual Revenue and Expenses) to see the wealth accumulated. Not only does the exponential practice yield $190,300 in available owner's compensation — as opposed to only $140,000 for the linear model — but the exponential model also contributes $40,000 to the dentist's retirement plan, instead of $10,000 in the linear practice.

In Table 2 (Comparison of Annual Lifestyle Expenses), we see that for the $500,000 linear practice with retirement savings of $10,000, there is available personal savings of only $3,000 for a total savings of $13,000 per year. The exponential model exhibits $40,000 of retirement savings, with $37,535 of personal savings available, for a total of $77,535 per year. If this amount is saved at an 8 percent annual return, it will amount to $3,548,153 in a 20-year career in dentistry! If the doctor only has 10 years left to practice, he or she can accumulate $1,123,216 at an 8 percent return by switching from a linear to an exponential model. Benefiting from the exponential model for only five years before retirement will provide a return of $454,867. That's why it's never too late to switch to the exponential practice.

The exponential practice more productive
An exponential practice achieves greater production per hour through proven management techniques that result in an exquisitely run operation. The essential navigational tool that steers the practice to higher production is the development of an annual plan, carefully calculated to set challenging — but achievable — production and other goals. The practice achieves its goals through improvements that raise production per hour by working smarter, not harder.

Some of these improvements include: (1) scientific scheduling, (2) enhanced communications with the staff through morning huddles and weekly staff meetings, and (3) control of managed care.

Scheduling
Scientific scheduling, as opposed to haphazard scheduling, brings many advantages to doctor, patients, and staff. It makes the difference between an exponential use of the doctor's time, as compared to a linear use. Our research shows that proper scheduling by itself — along with the morning huddles and staff meetings to support the staff in fulfilling the more ambitious schedule — will usually bring about the 20 percent increase in production with virtually no other practice-management improvements, such as better case presentation or marketing.

The reason for this is that there is usually sufficient diagnosed treatment sitting in the charts. Establishing production goals, along with training the staff to meet them, brings this treatment into the operatory. To paraphrase Gordon Christensen: In every dental practice, there is another two-thirds of a practice in treatment not done due to insurance problems and other obstacles. There is a prevalent problem of undertreatment in our profession today, and proper scheduling helps solve that to the benefit of the dentist and patient.

Exponential scheduling includes preblocking (or reserving) a calculated number of appointment slots to fill with significant procedures, focusing on comprehensive care and quadrant dentistry, performing multiple procedures when possible, and overlapping and comfortably compacting the doctor's schedule. Hygiene production can contribute to the overall increase in production per hour through timeliness of periodic radiographs, honing communication and relationship skills to influence patients to meet their maintenance schedules, and instituting a soft-tissue management program to provide additional quality care. Remember, as illustrated in our table, it only takes a $68 increase in total production per hour to move from the linear to the exponential practice.

Morning huddles and staff meetings
Many doctors think morning huddles and staff meetings are a waste of time because they have not utilized these sessions to achieve the goals of the practice — i.e., to communicate the goals, to strategize on how to reach them, and to measure the team's success. Morning huddles are indispensable in targeting the staff to fill open, preblocked appointment slots to meet production goals.

Will the preblocked appointments be filled with new patients targeted for comprehensive exams, hygiene patients with diagnosed dentistry in the charts, or delayed treatment cases? This is for the team to strategize daily. The huddle focuses team members on this important task. Staff meetings enhance the team's skills, measure their progress, adjust to changing conditions — all so that the goals are met. Dentistry, like football, needs huddles and team meetings to reach the goal line.

Managed care
Many doctors do not realize the deadly effect of reduced fees on their earnings per hour. For example, let's say you charge $700 for a crown and it takes 1.75 hours of your time for preparation and cementation. Let's also say you have expenses of $160 for lab, $44 for supplies, plus $299 for fixed expenses (the total facility, staff, promotion and other fixed expenses of running the practice, calculated for the fraction of total clinical time used to do the crown procedure). That means you have pretax earnings from that procedure of the fee minus expenses (or $700-$503), that equals $197. Divided by 1.75 hours, your earnings per hour for the crown are $112.57.

What happens if you accept a reduced fee of 20 percent, or $560, for the crown, instead of your UCR fee of $700? Your lab, supplies and fixed expenses remain the same ($503). But reducing the fee to $560 will give you a pr-tax profit of only $57, instead of $197 ($560 reduced fee minus $503). Dividing your reduced earnings of $57 by 1.75 hours to perform the procedure brings your earnings per hour down from $112.57 to $32.57, which is only 29 percent of your earnings on the $700 full-fee crown. Thus, a 20 percent reduction in your fee yields a 71 percent reduction in your earnings per hour! This is why you need to evaluate the role of managed care in your practice. You may not need to eliminate it, but you may indeed need to limit and control it.

Reaching the 'tipping point'
After analyzing the data in these tables, we think you will come to the conclusion — as many dentists have — that it's quite "do-able" to save 10 percent or more of gross production each year. If you are not now doing this — and most dentists are not — perhaps you need to bring your practice and personal finances to a "tipping point." There is no better time than now to restructure your debt and increase your production per hour so that you can enjoy the same lifestyle, while accumulating wealth exponentially. In effect, for those of you who have not thought seriously about these financial realities — i.e., the majority of dentists — you are at a crossroads. One fork leads to continued linear wealth, small returns over many struggling years, and no option for early retirement. The other fork leads to exponential wealth, the option of early retirement, and the continued enjoyment of your accustomed lifestyle for all the years of your life. The future is up to you.

James R. Pride, DDS, and Brian C. Hufford, CPA, CFP

Originally published in Dental Economics, February 2002