In our consulting business, we find that when physician practice owners and healthcare executives have concerns about profitability, their first question almost always is something like “are we spending too much?” or “is our overhead too high?” or “are we overstaffed?”
Of course, true overspending might indeed mean generating less profit than the business could—or should. But it’s odd that looking to cut expenses has become so reflexive, considering that increasing revenue is a much more powerful way to strengthen the business. What’s more, efforts to save money may even weaken the business—and, sometimes, those weakening effects can be very hard to spot.
This is the essence of a false economy: an action that feels like a savings, but is actually costly. And the quest to keep expenses in the medical practice as low as possible often leads to these kinds of unfortunate mistakes.
Classic examples of false economies are things like cheap tires and cheap shoes. They cost less out of pocket, but you replace them more often, so the cost over a lifetime of use is actually higher than for better tires that cost more to buy.
Of course, teaching examples like these make spotting false economies sound easy. In the day-to-day reality of running a business, though, it can be more challenging to know what does and doesn’t constitute a genuine savings.
Consider a common decision about staffing. For example, perhaps an employee takes an unexpected or extended leave, and you’re unable to replace her for, say, a month or two. During that time, you find that you’re able to “get by” without that job being filled. Does that mean you’ve been overstaffed? And if the employee ends up departing, should you opt not to replace her?
It may seem like a no-brainer: If you’re getting by without that person, making the change permanent will mean the value of that salary and benefits expense goes right to the bottom line. Instant profit, right?
But that conclusion implies an assumption related to another economic concept: ceteris paribus, or, rather, the fallacy of ceteris paribus—i.e., the assumption that changing one variable will have no effect on anything else. In this case, the assumption is that all other variables affecting your profitability will remain unchanged when you reduce staffing. But staffing cuts that have little noticeable effect in the short term—probably because everyone is stretching a bit to fill the gap—may actually have a negative effect on profitability over time. Here are a few reasons why:
- If physicians are picking up the slack, their productivity will decrease. Even if the decrease is slight, the effect on revenue will add up over time. It doesn’t take much productivity loss to decrease revenue by more than your practice saves by cutting a staff job;
- Having one fewer employee may lead to more overtime—which means paying more for hours that are typically less productive (as other staff stay later and try to fill in the gap);
- Any other stress on the workflow—such as an unexpected absence of a colleague, or a big surge in demand (e.g., a busy flu season)—will be much more taxing for everyone, because there will be one fewer person to help carry the extra load. If the stress becomes too much, staff turnover will increase—which can quickly add costs and cut further into productivity.
Before making any kind of cost-cutting decision, considering whether ceteris paribus really applies and can help avoid a mistake that can be very costly over the long haul. And the same thing applies to everyday business investments, such as upgrading equipment or adding technology. When the out-of-pocket cost is significant, it’s always tempting to “save” by delaying needed spending. But the initial cost mustn’t be the only consideration, because making these improvements can have a significant positive impact on productivity and profitability.