Ancillary Return on Investment
The basic formula to determine the return on investment (“ROI”) for an ancillary is to divide the profit from an ancillary by its cost. An ancillary with a cost of $500 a month that generates $600 a month has a profit of $100. The ROI would be 20%, (the profit of $100 divided by the cost of $500). The higher the percentage, the better the investment in the ancillary. An ancillary with an ROI of over 100% is returning at least twice its cost. (In the above example, this would be a profit of $500 on $500 in costs.) An ancillary with an ROI of 500% is generating five times its cost in profit. An ancillary with a negative ROI is losing money.
In considering an ancillary, it is extremely important to understand the all of the costs involved. Costs can be divided into three types of costs:
- Hard costs are the direct costs involved in the ancillary, such as staffing, equipment, supplies, etc. These costs are directly incurred when adding the ancillary.
- Soft costs are the indirect costs involved in the ancillary, such as additional staff, additional supplies, utilities, etc. These costs represent the increase of existing costs when adding the ancillary.
- Opportunity costs represent the lost opportunity by adding the ancillary. These costs require a comparison of the ancillary to alternative uses of the hard and soft costs.
Because hard costs are directly tied to the ancillary, they are the easiest to determine. The equipment can be purchased for this amount or financed for this amount per month. These supplies are needed on a monthly basis. This staff is required to operate the equipment. This space must be rented at this cost. There are some direct costs that can be overlooked, however, like the maintenance of equipment or proprietary supplies.
Soft costs are more difficult to calculate because it is often hard to determine exactly costs like how much time the current staff will spend on the additional tasks of a new ancillary. Some of these costs are sunk costs, meaning that they are already incurred in operating the practice, so they don’t really add to the overall expenses of the practice. If a practice has an extra room in their space that they are already paying for but not using, utilizing this room for a new ancillary service isn’t adding to the practice’s expense, but the practice might allocate part of the rent to the ancillary’s cost to reflect the use of this room.
Opportunity costs require that the practice have or consider alternative uses for resources required of an ancillary. If a new ancillary requires an investment of $2,000 a month, for example, the practice could consider the ROI of the using that money for increased marketing rather than a new ancillary. If the practice has two empty rooms, would the ROI be higher from adding a new provider to utilize those rooms or adding ancillaries? Would the ROI be higher from renting those rooms to subtenants?
In projecting ROI, practices should be conservative estimating revenue and liberal when estimating costs relative to the investment required of an ancillary, meaning that practices need to be more cautious with ancillaries that require a longer time commitment or larger investment. Multiple pro formas should be generated showing projections that are very conservative, expected and optimistic. Finally, an exit strategy should be created before any ancillary is added and adjusted on a regular basis so that the extent of its financial exposure on an ongoing basis.