Managing Gross Profit Margins: Negotiating Wholesale Hearing Aid Prices



Author: Brian Taylor, Au.D.

Wholesale price is best defined as the price the clinic pays directly to the hearing aid manufacturer for each device that is then, in-turn, resold to a patient. Perhaps more than other business metrics associated with hearing aids, wholesale price, commonly known as cost-of-goods or COGs, is a mandatory calculation for all business managers and effectively managing it contributes significantly to profitability of the clinic.

As a strategic imperative, business managers are often tasked with optimizing the wholesale price their clinic pays for hearing aids from manufacturers. Essentially, optimizing wholesale price or COGs is equated with receiving the lowest possible price from the hearing aid manufacturer or vendor. However, it is not this simple and the process of optimizing cost of goods within a clinic can be fraught with several challenges: Each audiologist is apt to have a preferred hearing aid brand. Hearing aid manufacturers may also entice audiologists to recommend their hearing aids by providing an incredibly low introductory price for a brief time frame. Further, audiologists, who usually have little formal business training, are not attuned to the impact COGs have on profitability. In a clinic with several providers, as these challenges intensify, the overall cost of goods for the entire clinic can be difficult to manage and it often rises, thus affecting profitability.

For these reasons, the business manager must work closely with the clinicians in the practice to ensure they are optimizing their cost of goods without compromising the quality of care. The objective of this case study is to outline how one large practice better managed the factors associated with optimizing a clinic’s cost of goods, and the effect the execution of a sensible strategy had lowering COGs and increasing profitability.

Scope of Challenge
Cost of goods (COGs), which is the money paid directly to the manufacturer for each hearing aid, typically represents, along with the cost of labor, the largest expense in a clinic. Survey data suggest the average COG for hearing aids range from 40 to 45%. (This calculation means that 40 to 45% of the retail cost is comprised of the wholesale cost, or stated differently, the wholesale cost of the hearing aid is marked up by a factor of about 2.25 or 2.5.) Contrast the relative high COGs of 40 to 45% with more efficient practices that operate with COGS of between 25 and 30%. If the cost of goods can be lowered by, say, $150, that can save the practice thousands of dollars in expenses over the course of an entire year when factored across hundreds of hearing aids dispensed in a given year.

Given the impact a high COGs have on overall clinical profitability, practices can lower them through effective negotiating tactics with their vendors and changes in clinician behavior toward the dispensing of hearing aids. However, simply asking the hearing aid vendor for a discount is an ineffective strategy. To even consider a significant discount of 10% or higher, the hearing aid vendor is likely going to ask for an additional unit commitment. Considering the number of hearing aids dispensed in a year is relatively fixed (even the most productive full-time provider has time limitations that keep this number fixed), negotiating a lower COGs with a hearing aid vendor requires the clinic to make some tough choices about product lines and technology tiers they routinely fit.

Compounding the challenge of lowering COGs are the attitudes and behaviors of audiologists. For various reasons, many audiologists are loyal to a specific hearing aid brand, and like any brand loyalist, there is often an emotional attachment to the brand that must be acknowledged and respected. However, the manager, through effective communication, has the opportunity to use data to sway the opinions of even the most avid brand loyalist.
Project Description
Clinic X employs five full-time audiologists. The clinic operates an active, commercially-based hearing aid dispensary. Although the practice often dispenses more than 1,000 hearing aids per year, which yields approximately $2 million in annual revenue, the new business manager has been tasked with increasing hearing aid profits without compromising quality of care or clinical efficiency. Specifically, the manager has been asked by the owner of the clinic to increase profitability without raising retail prices of hearing aids.

Given the goal set by the owner, the first task of the business manager was to review the prior year’s unit sales, how they are distributed across both provider and manufacturer, and to examine the wholesale pricing across product lines and technology tiers. This distribution is shown in Tables 1 and 2.

After reviewing this data with the five audiologists, the clinic created a plan to lower cost of goods and improve profitability. After the staff agreed upon a plan to lower cost of goods, they were expected to execute the plan over the next year, carefully monitoring progress along the way. The expectation being that a lower cost of goods yields more profits that can be re-invested back into the practice.
Methods and Results
Table 1 shows a distribution of hearing aid sales for this large medical practice that employs five full-time audiologists. According to the distribution, 1,000 units were dispensed from seven different hearing aid manufacturers. The total number of units equates to an average of 20 hearing aids dispensed per month for each audiologist. Further, Table 1 shows the average wholesale cost per unit (rounded to the nearest $50) across three levels of hearing aid technology.

Table 2 shows the total dollar value, for each of the three technology levels, from each of the seven manufacturers used by the clinic. The total wholesale cost of hearing aids for this clinic for one year was $948,750. This wholesale figure generated $2,087,000 in hearing aid sales for the practice for the one-year period. Table 3 provides a breakdown in the financial figures for one full year.
Table 1. An analysis of wholesale prices from 7 hearing aid manufacturers. The number of units dispensed for one calendar year per each level of technology is listed.
  Basic Mid-level Premium Total Units Per Manufacturer
Manufacturer 1 $400 26 units $800 74 units $1350 20 units 120
Manufacturer 2 $450 24 units $850 56 units $1200 18 units 98
Manufacturer 3 $450 26 units $750 159 units $1000 82 units 267
Manufacturer 4 $450 30 units $750 168 units $1350 15 units 213
Manufacturer 5 $400 36 units $800 95 units $1400 18 units 149
Manufacturer 6 $550 10 units $950 26 units $1600 14 units 50
Manufacturer 7 $400 46 units $700 22 units $1350 43 units 112
 
Table 2. The total wholesale costs per technology level for hearing aids dispensed from 7 manufacturers over the course of one calendar year.
Table 2 revenue corresponds to the unit totals in Table 1.
  Basic Mid-level Premium Total Cost Per Manufacturer
Manufacturer 1 $10,400 $59,200 $27,000 $96,600
Manufacturer 2 $10,800 $47,600 $21,600 $80,000
Manufacturer 3 $11,700 $119,250 $82,000 $212,950
Manufacturer 4 $13,500 $126,000 $20,250 $159,750
Manufacturer 5 $14,400 $76,000 $25,200 $115,600
Manufacturer 6 $5,500 $24,700 $22,400 $52,600
Manufacturer 7 $19,200 $15,400 $58,050 $92,650
Total Wholesale Cost $85,500 $606,750 $256,500 $948,750
 
Gross margin is calculated by subtracting the cost of goods (wholesale price) from the gross hearing aid revenue. The gross margin is the amount of “profit” generated from the sale of hearing aids before all other clinical expenses are calculated. Note in the previous sentence that profit is in quotation marks because the gross margin is not really profit because several other expenses, like payroll, rent, utilities and marketing have not been deducted from it. However, since gross margin is the difference between what the clinic pays the manufacturer for each hearing aid and what the patient pays the clinic for the hearing aid, gross margin is one type of profit. This case study assumes a traditional bundled pricing model in which clinical services are not charged separately.
Table 3. Cumulative key totals for one year
Gross Hearing Aid Revenue Cost of Goods Gross Margin Cost of Goods as % of Gross Hearing Aid Revenue
$2,087,000 $948,750 $1,138,250 45%
 
The financial calculations shown in Table 3 indicate there is an opportunity to improve profitability by lowering the cost of goods or increasing retail prices. Now is an appropriate time to pause and consider the options of the manager. Given that the COG's percentage is in alignment with industry norms, a COG of 45% is customary per industry survey data, the manager could decide to leave this variable alone and raise retail prices. However, if the average retail price of hearing aids in the practice is $1750 each, even a modest 5% increase in retail price adds over $150 to a pair of newly purchased hearing aids. This is costly to patients and challenging for clinicians who may have to explain why costs are increasing. Before deciding to make a snap decision to raise retail prices, the manager takes a closer look at the expenses related to wholesale hearing aid purchases made by the clinic. After all, money saved on cost of goods might be used for other items that could benefit the practice. For example, it is money that could be used to invest in new equipment, new office furniture or to increase the pay of staff –all things that maintain or create competitive advantages. And, saving money, rather than raising prices, is sure to keep patients and clinicians happy.

Table 4 is a rough calculation the manager made to see approximately how much money the practice could save by doing nothing more than lowering the price they pay the hearing aid manufacturer for hearing aids.
Table 4. A breakdown of potential savings by lowering the cost of goods at three different discount rates.
Annual Cost of Goods = $948,750 Money Saved
10% reduction $94,875
15% reduction $142,313
20% reduction $189,750
Discussion of Tactics
Armed with the information in the three Tables above, the manager worked directly with the clinicians to formulate a strategy to strategically lower the cost of goods for the entire organization. This process began during a monthly staff meeting when this information was shared with the staff. At the same time, the staff, led by the manager, discussed why lowering COGs would be beneficial to the practice. This discussion included an overview of the amount of potential money saved by the practice per Table 4 and how the money could be used to benefit the practice. Also, it was emphasized that retail prices would not be increased, and quality of care could not suffer because of the lowering of COGs. After reviewing the COGs data as a group and allowing for questions, the manager explained that the primary approach to lowering COGs would be to try and whittle the number of vendors from seven to two or three primary vendors. As the manager explained, if the objective was to lower COGs, then the clinicians had to come to some agreement on their primary vendors. By narrowing their primary vendors to two or three, the manager informed the clinicians, they could negotiate a more favorable wholesale price because they would be able to commit to more units, spread over a smaller number of manufacturers. At the meeting, the manager calculated the percentage of units for each of the seven manufacturers used by the clinic. This information is depicted in Table 5.
Table 5.
Total Units Per Manufacturer Percentage
of Business
(By Unit)
120 12%
98 10%
267 27%
213 21%
149 15%
50 5%
112 11%


At the end of the meeting, the clinicians were asked to come to an agreement within the next two weeks on the three primary manufacturers in which they could commit 90% or more of their business. The clinicians were informed that whatever three manufacturers they agreed to be their primary suppliers, the manager would negotiate directly with the vendor to get a lower COG in exchange for a larger monthly unit commitment with each of the primary hearing aid manufacturers. Also, it was acknowledged by the manager that reducing the number of vendors would be a challenging project and some difficult choices and compromises would need to be made, but the staff had the ability to choose their primary vendors and agree to use them for 90% of their business.

Within the next few days, the lead clinician, with the help of the staff, created a list of the characteristics or features the staff believed were needed from their primary hearing aid suppliers. The clinicians were asked to keep their list to items that benefited the patient or the patient-clinician relationship, not just the clinician. The condensed list, which also shows the manufacturers the clinicians believe represent each trait, is shown in Table 6. It is important to note that this list generated some contentious debate among the staff, as most had rather strong opinions about their favorite suppliers. After some heated debate the majority of the staff came to an agreement on three top choices.
Table 6.
Feature or Characteristics Supplier
Full line of products for all hearing losses 2,3,4,6,7
Customer service 1,3,4,7
Technical support 1,2,4,5,7
Quality of fit 1,2,3,4,6,7
Software 2,3,4,
Track record/Patient results 1,3,4,5,6
Most current or modern technology 3,4,5,7
 

Based on the information in Table 6, the manager, who now has the support of the clinicians, plans to approach Manufacturer 4, Manufacturer 5 and Manufacturer 7 and re-negotiate terms for wholesale pricing. During a phone call with the director of sales with each of the three manufacturers, the manager explained the practice’s goal of lowering their COGs and how the staff gained an agreement on their top manufacturers. The manager then asked for a 20% reduction in their wholesale price in exchange for a commitment of 300 hearing aid units for the entire year from the practice. The director of sales for each manufacturer agreed to consider the proposal.

Within a week, the manager heard from each of the three manufacturers. Manufacturer 4 made a counter proposal of a 15% reduction in their current price, while Manufacturers 5 and 7 both agreed to the 20% discount in exchange for the 300-unit commitment. The clinic manager agreed to the updated terms from all three manufacturer partners and asked that each commit to a 3-hour staff training to ensure that all clinicians and staff, especially those somewhat unfamiliar with the products and software, receive the proper training and support.

(Note: An alternative negotiating strategy, not employed here, would have been to approach all seven vendors asking for a competitive bid in exchange for a greater unit commitment. Additionally, the managers could have delineated by technology tier and asked vendors for steeper discounts for greater unit commitment for specific technology tiers. Readers should think about the advantages and limitations of these alternative negotiating tactics relative to the actual tactic employed above.)
Outcomes
Table 7 shows the new wholesale pricing for the three primary manufacturers used by Clinic X. The new prices here can be compared to the previous wholesale prices shown in Table 1. Note that for the non-preferred vendors, wholesale prices did not change.
Table 7.
  Discount Level Basic Mid-Level Premium Annual Unit Commitment
Manufacturer 4 15% $382 $638 $1148 300
Manufacturer 5 20% $320 $640 $1120 300
Manufacturer 7 20% $320 $560 $1080 300


Following staff training by the three vendors, the expectation set by the manager was that 90% or more of all hearing aids would be ordered from one of the three primary partners. The updated wholesale pricing plan was now fully implemented.

Table 8 shows the breakdown of units for all seven vendors, one year after their plan was fully implemented with new prices from the three primary partners.
Table 8.
Manufacturer 1 26 units
Manufacturer 2 0 units
Manufacturer 3 88 units
Manufacturer 4 278 units
Manufacturer 5 372 units
Manufacturer 6 0 units
Manufacturer 7 322 units
  1,096 total units
 
Following one year of implementation of the new pricing strategy, there are a few consequences of the decision to narrow the number of vendors to improve COGs that readers should consider. One, the 300-unit commitment for one full year was met for two of the three primary vendors. Failing to meet just a single unit commitment could be cause for some concern, as the clinic could lose their discount. Two, Manufacturer 1 and Manufacturer 3 still received some units, mainly from one audiologist who was insistent on sticking with those vendors for most of her hearing aid recommendations. This could be a concern for the manager, but since the audiologist is experienced and well-liked by patients, the manager decided not to intervene in her recommendation process now. Three, largely due to training and support from other staff, two of the audiologists successfully shifted their recommended hearing aid from Manufacturer 3 to Manufacturer 7. This resulted in substantial savings to the clinic in COGs and patient satisfaction was not affected.

Finally, although the practice dispensed almost 100 additional units in the second year, by negotiating more favorable terms with three vendors, and strategically bringing more than 90% of unit sales to those three companies, the clinic was able to save more than $300,000 in COGs in the second year. Table 9 shows the breakdown of units per technology level for the seven vendors. Notice that two of the vendors did not receive any business in Year 2, which is a by-product of effective communication and training on the part of the staff. Table 10 shows the cumulative wholesale prices paid to the vendors. These numbers can be compared to Table 2 from Year 1 to gauge the level of improvement in COGs and profit that was generated through strategic renegotiation.
Table 9.
  Basic Mid-level Premium Total Units Per
Manufacturer
Manufacturer 1 $400 8 units $800 10 units $1350 8 units 26
Manufacturer 2 $450 $850 $1200 0
Manufacturer 3 $450 14 units $750 62 units $1000 12 units 88
Manufacturer 4 $382 0 units $638 168 units $1158 20 units 288
Manufacturer 5 $320 206 units $640 95 units $1120 71 units 372
Manufacturer 6 $550 $950 $1600 0
Manufacturer 7 $320 148 units $560 102 units $1080 72 units 322
Table 10.
  Basic Mid-level Premium Total Cost Per Manufacturer
Manufacturer 1 $3,200 $8,000 $10,800 $22,000
Manufacturer 2 0 0 0 0
Manufacturer 3 $6,300 $46,500 $12,000 $64,800
Manufacturer 4 0 $107,184 $23,160 $130,344
Manufacturer 5 $65,920 $60,800 $79,520 $205,840
Manufacturer 6 0 0 0 0
Manufacturer 7 $47,360 $57,120 $77,760 $182,240
Total Wholesale Cost $122,480 $279,604 $203,240 $605,324


Although Clinic X was able to save more than $340,000 in cost of goods through a strategic negotiation process, the financial contribution to the bottom line of the practice is remarkable. Because the clinic also dispensed 96 more hearing aids in Year 2 at a much lower cost of goods, the gross margin in Year 2 increased by nearly $500,000, as summarized in Table 12. Importantly, this gross margin improvement occurred without raising retail prices on hearing aids, increasing staff headcount or adding more appointment slots to the already busy schedules of the audiologists. These stellar financial results transpired through deliberate negotiating tactics, as well as effective communication and management skills in which the clinic and three of its vendors all benefited.
Table 11.
Gross Hearing Aid Revenue Cost of Goods Gross Margin Cost of Goods as % of Gross Hearing Aid Revenue
$2,231,000 $605,325 $1,625,675 27%
Considerations
There are several lessons from this case study that can be applied to any audiology practice engaged in the commercial sale of hearing aids.
  1. Be inclusive. By involving the staff from the beginning on the decision-making process, the buy-in from most clinicians was excellent and likely contributed to better execution of the strategic plan.
  2. Use data in the decision-making process. Rather than making a knee-jerk decision to raise retail prices, which would undoubtedly have unintended consequences, the manager systematically looked at the prior year’s financial data and decided to deliberately target COGs as an area of improvement.
  3. Be willing to make trade-offs. The manager understood that the negotiation process had to be a win-win for all parties. Thus, the manager targeted a select few manufacturers that the clinicians had gained an agreement on and approached them with a specific plan. When asking for a discount in their wholesale price, he agreed to commit more business to each of their preferred vendors.
  4. Be flexible. Although buy-in from staff on the narrowing of vendors was generally good, there was one hold out. Since
    this clinician was an experienced and valued member of the staff, the manager tolerated her hearing aid selection approach.
  5. The power of compound numbers is astonishing. Given the substantial reduction in wholesale price when this discount is spread over more than a thousand in unit sales for the year, combined with the slight uptick in total business, the practice was able to generate an additional one-half million dollars in gross margin from their hearing aid business. This case study is a good example of how one strategic decision – reducing COGs – that is systematically executed by the entire staff can have a profound impact on overall profitability and growth.