In this edition of Dental CPAs Q&A, I’m going tackle a difficult topic: labor costs. It’s a sensitive subject to bring up sometimes because most dentists I know think the world of their staff, and want to compensate them accordingly for all the work they do supporting and growing the practice. There are limits to reasonable and even top-tier salary packages, and in this case, it’s giving a potential buyer cause for concern.

Dan* is looking to buy an existing practice with long-term staff in place. This can be a great benefit, because of the relationships these staff have built with the patients could help to decrease patient attrition. The problem is that current labor costs are greater than 45 percent of gross. I did a double take when Dan told me that, because it represents a staff that is so massively overpaid relative to what other area dentists pay, industry averages, and practice overhead percentage. No wonder the staff have been there a long time – where else are they going to get paid as well as they do?

His question to me was what to do in this situation: fire existing staff immediately and rehire new staff with adjusted salaries and benefits; keep things as is and after six months, give them the option of a pay cut or to leave the practice; or just not buy the practice at all because it’s too risky?

There are drawbacks with each option. If Dan immediately fires the existing staff, he risks losing patients too, due to lack of continuity and he’s concerned about the perception of being seen as the “new, greedy dentist.” The second option would leave him strapped for cash in the first six months paying exorbitant labor costs, then risk the same outcome as option one anyway. There is also a concern for lawsuits, especially if a staff member could claim age discrimination or firing without cause. (States do vary in their interpretation of at will employment; check your state labor board for clarification.)

The rest of this dental practice meets all of Dan’s requirements, and otherwise he said it would be a good investment, the practice is located in area where he can continue to grow the patient base, and any updates he would need to make aren’t cost prohibitive.

Labor Costs in Dentistry Explained

The recommended average for labor costs as a percentage of overhead is 27 percent. Depending on how some practices allocate employee expenses and labor, this may or may not include supplemental benefits like retirement plans, bonuses, fringe benefits, or employer-paid healthcare premiums. All of these contribute to overall labor costs, after all.

There are three other common culprits of high labor costs in a dental practice: automatic raises, salaried, not hourly, employees, and employer costs. It is common to see long-term staff, like in this example, have extremely high salaries relative to the market if the current dentist gave them raises every year, no matter what. Rewarding top performance makes sense, but a business savvy dentist should be looking at other alternatives to compensate staff; more on that later.

Salaried employees can also be costing the practice money because they get paid no matter what. This isn’t meant to sound greedy, but salaries mean that employees are paid when they’re not at work, for any number of reasons like vacations, continuing education, or when the practice is closed. Labor costs will go down drastically if employees are only paid when they’re at work. Only about 13 percent of dentists are still paying employees salaried, according to research published in DentistryIQ.

A third reason why labor costs can get out of control for dentists is because they’re paying more than they can manage in staff retirement plan contributions and medical insurance costs. You don’t have to stop offering a retirement benefit but opting for a defined benefit plan over a defined contribution plan will share costs between employer and employee. And regarding medical insurance for employees, passing on more of the cost of monthly premiums to employees is an easy way to cut labor costs.

The Solution?

In Dan’s case, he didn’t mention one possible solution: request that the seller make the pay adjustments now, before he or she leaves the practice. There are a number of ways to do this, and some options he can take care of later after he buys the practice. Requesting that the current dentist get the process started is the best way to go, and ensures he won’t look like the mean, greedy doctor once he comes on board.

In a future blog post, I’ll go into strategies of managing labor costs in more detail. In the meantime, if you have questions about dental practice management, acquisitions, operations, or financials, email me at tlott@dentalcpas.com.

*name changed

ABOUT TIM LOTT

Tim provides consulting services to dental professionals and practices. He provides expertise in start-ups, mergers, transitions, tax and retirement planning, financing assistance and budgeting. Some of the specific areas of consulting are associate, partner, and shareholder arrangements; practice management, practice purchase, sales, buy-ins, and buy-outs and related tax issues.