Disintermediation of the Doggy-Doctor Relationship: Following the Puppy Profit

Graphic Designed by: Rose Lee

The BRB Bottomline: The business of selling things for pets has always been that of selling things to people. In the U.S., money spent on pets has more than doubled in the past decade, and these increases have spurred new products, services, and business models. Many innovative—many more wonky. But the story doesn’t end there. Internet retailers and innovations in supply chain management are disintermediating the before-sacred, doggy-doctor relationship. With in-practice sales of medications and supplies accounting for 20% of veterinary practice sales and more than 50% of operating profits, veterinarians could see their livelihoods at stake.   

The business of selling things to pets has always been that of selling things to people. As human standards of living improve, pet spending in the U.S., as reported by the American Veterinary Medical Association (AMVA), has hit an all-time high, suggesting people desire similar improvements in the lives of their furry friends. 

Money spent on pets has more than doubled in the decade, and those increases have spurred new products, services, and business models. Many innovative—many more wonky. Entrepreneurs and charlatans have been listening closely with their floppy ears pressed firmly against the door. 

But that’s not even the big story. Internet retailers and innovations in supply chain management are disintermediating the before-sacred, doggy-doctor relationship. The industry calls this the VCPR (Veterinarian Client Patient Relationship), and recent measures taken by drug manufacturers and legislators in light of new competition is changing the way prescription drugs, pet foods and supplies will be distributed in the future. With these in-practice sales accounting for about 20% of veterinary practice sales and more than 50% of operating profits, veterinarians are taking drastic measures to survive.

But, before we get to the serious stuff, I want to spend the next two sections surveying the current state of the pet industry. Perhaps it’ll seem unnecessary. At the very least, I hope it’s entertaining. Nevertheless, I think it’s important to pay lip service to what currently holds the attention of the pet industry in order to then direct the reader’s attention to the graver story that few people are talking about but for which every veterinarian, pet drug manufacturer, and retailer is positioning. 

That Pampered Pet Lifestyle

Pet owners will do seemingly anything for their animal mascots—meal-delivery kits for dogs, spa days for cats, cancer treatments that average $40,000 a procedure, health insurance that rivals the cost and coverage of human health insurance, etc. 

The biggest way pet parents lavish on their animals is in the kitchen. Spending on pet food in the United States has grown 6.0% compounded annually over the past eight years and will reach almost $32 billion in 2019, according to the American Pet Products Association (APPA). The number of domesticated dogs and cats in the U.S. has only grown at just over one percent per year in the same period, according to the Insurance Information Association (III)

This means that spending per pet has increased over the same time period. Using statistics reported by APPA and III, we estimate annual food costs per pet have increased to over $170, growing at a 4.5 percent CAGR over the past eight years. That doesn’t even include treats, which typically cost around $40 per pet per year. The average will be much different from reality, which varies widely depending on breed and weight. 

The culprit is not pets eating more—although Nationwide estimates that pet obesity has increased every year for the past eight years—but rather pets eating better. According to APPA, “[P]remium dog food account[s] for the most frequent type of food purchased, followed by generic and natural food.” 

Locally-sourced ingredients cooked in human-grade kitchens, kept fresh by refrigeration instead of preservatives, even put some human diets to shame. Moreover, the pet industry has fashioned its own subscription meal delivery modalities similar to the likes of Blue Apron and Plated. Here are some of the more popular ones and their salient features. Commonality: expensive. 

Source: The Farmer’s Dog

The Farmer’s Dog is a meal delivery service for dogs that can cost “as low as $3 a day,” which adds up to approximately five times the cost of the 2018 average. The company is betting that dog owners will pay up for quality and convenience. The Farmer’s Dog claims that its recipes are developed by board-certified veterinary nutritionists and comply with AAFCO (Association of American Feed Control Officials) standards. “Ingredients are human-grade and unprocessed—all food is cooked within days of shipping,” according to the company’s website. 

Some of the things people eat aren’t even prepared in “human-grade” kitchens.

We Feed Raw is one of the oldest pet food companies and has been around for a decade. It’s not so much a meal delivery company as it is a raw meat distribution company marketed and sold to pet owners. Whether it’s because of low volumes or marketing upsell, even buying raw, unportioned, ground meat will cost pet owners a premium.

Ten pounds of We Feed Raw ground chicken (80% meat and fat, 10% organ, 10% edible bone), human-grade, not portioned, will cost $4.65 per pound, which is almost double the cost of chicken thighs you would buy for yourself at the grocery store and about the cost of the highest-grade, organic chicken breast in the supermarket. 

Perhaps the two most recognizable faces in the pet meal delivery industry are PetPlate and Ollie. A Business Insider staffer did a review of the two services and had this to say, 

“Ollie offers the same protein options as PetPlate but gives them fancier names: Healthy Turkey Feast, Hearty Beef Eats, Chicken Goodness, and Tasty Lamb Fare…Winner: Based purely on subjective appearance, I would say that PetPlate looked consistently more appetizing and therefore of a better quality, but Ned [the staffer’s dog] didn’t seem to have a favorite. With Ollie, there was one delivery that appeared to be a little less appetizing than the others. Instead of having vegetable bits mixed in with the grayish protein-like mush, the contents of the tray appeared to be uniformly grey, though there was clearly vegetable matter in there as well. Ned chowed down all the same.” – Business Insider, emphasis added

The cost of both services for a medium-sized dog (55 pounds) is almost three times the cheapest option for The Farmer’s Dog, which we already know is five times the amount the average American spends on their pet’s food. That means the most popular meal delivery service for a medium-sized dog will cost about 15 times the cost of the nationwide average. That’s a lot of extra money being thrown at a meal for a dog that “chow[s] down all the same.”

Pet food is the classic example for marketing students on identifying the correct Who in your positioning statement. Pets don’t buy pet food. People buy pet food. Ned, the Business Insider staffer’s dog, clearly doesn’t have a favorite. 

Another lesson to take away. “Pet food trends tail human ones. When gravy was popular in the 1950s, Gravy Train dog food appeared. In the 1980s, Fancy Feast cat food mirrored a growing interest in gourmet food,” wrote a staffer at the Chicago Tribune. Now, raw and organic diets are de moda.  

Source: NomNomNow, another pet food delivery company

As much as I’ve framed pet food delivery companies in a negative light, their intentions come from a genuine place to treat animals better. Moreover, demand in the market is growing, and entrepreneurs should follow their capitalist senses. According to Nielsen data, U.S. sales of fresh pet food in grocery and pet stores jumped 70 percent to more than $546 million between 2015 and 2018. For example, pet food products claiming to be free from wheat represented $4.9 billion in sales in 2018, an increase of $331.7 million dollars from the year before. 

Pet Tech: All the Rage

Pet-focused entrepreneurs have also started peddling so-called intelligent pet products, such as “app-controlled pet food containers and feeders, pet water containers and dispensers, and smart pet toys,” according to the Securities and Exchange Commission filings of this Chinese company with the delightful stock ticker, DOGZ. 

Perhaps, as is the case in the pet food business, many of these entrepreneurs are driven by a genuine desire to improve the lives of pets. Other entrepreneurs are less scrupulous. 

One company called ZenCrate sells $1,000 dog crates that claim to be research-backed and engineered to reduce pet-anxiety. In reality, the company’s flagship product is a vaulted box with speakers. It touts eight “innovate” features.

ZenCrate claims to be sound-dampening, but that’s just because it drowns out any external noise with meditation music. It senses motion and has a battery backup, but it doesn’t have an on/off switch, so how else would you turn off the babbling brook once the dog leaves its box. It has one opening, which the company claims is part of its design to be noise proof; one opening seems natural given that it’s a dog crate. The interior is dark, which the company claims is engineered for light-sensitivity; again, seems like a natural phenomenon given that a dog crate is typically surrounded by three opaque walls. 

The only innovation seems to be the shock-absorptive legs, which honestly just makes this “smart” dog crate into a dumb dog crate on stilts.

Source: ZenCrate

Pet Loves Best, a pet product review site, quickly retracted its glowing review of the ZenCrate after it “tried to contact them multiple times” but to no avail.  I tried to contact the company from the phone number on its website but got routed to the line of an environmental consulting company. A ZenCrate customer had this to say of the product: “It[‘]s a huge waste of money and the fact that they do not accept returns should tell you something. Wish I never spent the $1,000.”

Rapid growth in U.S. pet spend has defined an industry of fertile financing and revolving new faces. Many of the new faces garnering attention have been in the premium puppy segment—meal delivery services for pets and pet tech gadgets. But there are graver changes coming to the pet industry to which few mainstream media have given sufficient attention.   

Disintermediation of the Doggy-Doctor Relationship

Financing for luxury pet services, like Ollie and PetPlate, and pet tech gadgets, like FitBark and ZenCrate, garner plenty of media attention. But much of this is just sizzle. A much more frantic pace of investment is afoot in veterinarian offices across the nation as an industry tries to defend itself against new distribution models that threaten to dismantle its tacit and once-sacred mode of operations. 

According to a 2015 FTC report on competition in the pet industry, “Historically, nearly all major manufacturers of pet medications distributed their products only to licensed veterinarians or to authorized distributors that sold only to veterinarians.”

With the increased presence of non-veterinary retailers, manufacturers have shifted away from the veterinarian-only distribution paradigm and now supply both veterinarians and non-veterinary retailers with prescription and over-the-counter medications. According to Today’s Veterinary Business, mass market retailers like Costco, WalMart, and Target accounted for 20 percent of retail sales of pet medications in 2017, which is in addition to the 12 percent market share going to the internet businesses of those traditional retailers and other ecommerce retailers like Amazon and Chewy.

This is a problem for veterinary practices who have historically generated 20 percent of their sales from high-margin, in-practice sales of over-the-counter and prescription drugs, as well as pet food and supplies. Listen to one veterinarian describe how the sales process used to work:

“Historically, selling these products has been a relatively passive revenue source. You decide which drugs you want to inventory, apply a markup (typically 100 percent), and add a dispensing fee of $5 to $15. Then you dispense the product as indicated and restock.” 

While only 20 percent of sales, those high-margin sales might generate around 50% of operating profits, according to P/L figures provided by Live Oak Bank, a financier of over 500 veterinary practices. And that’s only for the “good practices.” Live Oak Bank says that, “‘well-managed’ practices derive less than 33% of gross revenue from the sale of medical products, over the counter products, pet diets, preventatives and boarding and grooming services.” If a veterinary practice derives more than 20 percent of its gross sales from medical products, it could potentially lose more than half or even all of its profits if clients choose to take their business out of the practice.

The Drivers of Disintermediation

In the veterinary practice business, “many veterinary clinic owners and managers complain about how the internet and big-box stores are taking over their prescription business and cutting into their profits,” according to Brian Conrad, CVPM

His advice to veterinary practices isn’t to whine. This is the paradigm of the world in which we live. “[A] lot of the same practice owners and managers who cry about the prescription marketplace are buying their eye glasses at national discount outlets, their groceries at Sam’s Club and Costco, and playing veterinary distributors against each other for the best deals for products and supplies to stock their clinics.” 

And it’s not just the advent of ecommerce that is stealing market share away from veterinary practices. In March 2019, the bipartisan Fairness to Pet Owners Act of 2019 was introduced in the House Committee on Energy and Commerce to require veterinarians to write portable prescriptions for pet medications. This act seeks to curb the sometimes unscrupulous habit of veterinarians to push pet owners to buy medications at the practice without informing them that they have the right to fill their pet’s prescription wherever it is the cheapest. In fact, federal legislation was introduced as early as 2011 to require veterinarians in all states to provide portable prescriptions for every medication they prescribe, regardless of whether the client requests it.

Obviously, the AVMA came out against such bills arguing that it “interferes in the veterinarian-client-patient relationship and creates an unnecessary regulatory burden in an area already effectively regulated by states through their oversight of the veterinary profession.”

The opinion of the executive branch of government, as represented by the FTC’s report on competition in the industry, is that such legislation would increase competition in the pet medication and supplies business and lower rising costs for animal health. 

In many ways, bills like the Fairness to Pet Owners Act serve as a microcosm of the type of regulatory solutions and industry backlash that characterize the challenges in reducing human healthcare costs. The whole healthcare system has been set up to enrich licensed professionals and businessmen with exclusive distribution rights under the pretext of what’s right for the patient. 



Veterinary Practices Are Trying Everything to Survive

If you can’t compete, get out of the way. That’s the message veterinary practice owners are hearing from private equity looking to consolidate players in the veterinary practice management (VPM) space. In 2014, Ares purchased National Veterinary Associates, which owns 240 companion animal veterinary hospitals across 39 states, for $920 million. In 2017, Mars Incorporated purchased VCA, the owner of 800 pet hospitals, for $9.1 billion. See Joseph Ng and Shivani Kaeley’s BRB article on conglomerates for part of that story. 

Private equity companies, like Ares Management and KKR have made big bets on VPMs in the past couple of years. The reason being, veterinary practices were down merely 1% in sales during the last recession, which compares with 10-50% drawdowns for other businesses during the same period. 

That data, however, comes from a time before legislation like Fairness to Pet Owners Act, and competition from online and mass market retailers. The additional scrutiny and price competition is surely eating into the returns private equity once saw in the business. Consolidation will only get you so far in reducing fixed costs. If veterinary practices can’t figure out how to keep their high-margin medication sales, they’ll have to compensate for it in higher medical and surgical fees, which could drive away pet owners. 

Some veterinary practice managers don’t want to give up. They know their community. They have an obligation to the veterinarians and employees in the practice to keep the doors open. 

The message that companies like Covetrus, a provider of Product Information Management (PIM) software, have been telling veterinary practice managers is to join the game. 

Covetrus helps veterinarians set up their own ecommerce stores from which patients can buy medications. Covetrus collects a percentage of each transaction as well as a service fee. Through its Vets First Choice customizable platform, Covetrus provides veterinarians the ability to sell pet owners medications at the practice, so vets can stem lost sales from not having product available. 

Nevertheless, having an online store doesn’t mean vets will be able to compete on price, convenience, and delivery. As unilateral support from drug manufacturers begins to wane, the once-impenetrable VCPR is now exposed to the sharp teeth of competition. 

It may just be a matter of time before vets throw in the towel, and practices start shutting down. 

Take Home Points

Veterinarians once enjoyed a monopoly on pet medication sales. That high-margin business is now under siege by a cocktail of ecommerce companies, mass market retailers, politicians, and drug manufacturers. While veterinary practice managers have benefited from the steady climb in U.S. pet spending, in-practice sales of high-margin medications are on a knife’s edge. If veterinary practice managers do not figure out how to effectively compete, ecommerce and mass market retailers will force thousands of veterinary practices to close. What once was a stable, no-brainer business might get left behind in the rapidly evolving pet industry.

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