Building a Healthcare System from Scratch, Part 4: Levers that Determine Profit

In parts 1, 2, and 3, we looked at what we want a healthcare system to do for us (the “jobs”), we figured out which parties in a healthcare system have an incentive to perform those jobs, and then we discussed that, for those parties to have an incentive to maximize value while performing those jobs, they need to make more profit when they deliver higher value.

The next part of the Healthcare Incentives Framework takes a look at the different levers that affect profit to see which can be used to reward higher-value parties with more profit.

Let’s review how profit is calculated:

Profit = Revenues – Costs

Profit = (Price x Quantity Sold) – Costs

And since most companies sell more than one product or service, . . .

Profit = ∑((Price x Quantity Sold) – Total Costs)

These are the only four factors that determine a company’s profit: service mix, price, quantity sold, and total costs. So, which can be used to reward higher-value parties with more profit?

Service mix: Companies in healthcare already generally have the freedom to dedicate their resources in ways that maximize the amount of higher-profit services they deliver (why do you think my hospital renovated the orthopedics floor first?), so I won’t go into depth on this one other than to say that we need to allow them to continue doing that.

Price: Could we use prices somehow to reward higher-value parties with more profit? How about we try giving bonuses to higher-value providers? Those bonuses would essentially raise their prices, which actually lowers their value (remember, Value = Quality/Price). Sure, other providers would be motivated to raise their quality to get the higher prices too, but all we’d end up with is a little better quality at a little higher price, with no clear path to much else. Therefore, this approach doesn’t do a very good job of accomplishing the core goal of rewarding higher value with more profit. It’s not the lever we are looking for. But, while we’re talking about prices, there’s one crucial aspect of price that we need to include in our optimal healthcare system: providers and insurers need the freedom to set their prices themselves. The reasons for this will become clearer in subsequent posts.

Costs: Finding a way to lower the costs of higher-value providers is basically the same as raising their price–either way, more money is given to them, which raises their profit but lowers the value people obtain from them. So, the same problems exist with using costs as a lever to reward value with profit.

Quantity Sold: We’re left with one last lever, and I saved it for last on purpose. What would happen if higher-value insurers or providers all of a sudden were getting more patients flocking to them? They would certainly get more profit (assuming they have the capacity to take on more patients/subscribers). And the patients are happy because more of them are getting higher-value services. Now think beyond that static world. Over time, higher-value parties would continue to make more money and expand, and lower-value parties would be forced to improve their value or just go out of business. Parties would have an incentive to take big risks on innovations that improve value because they would know that, if the innovation ends up improving value for people (lower price, higher quality, or both), it will be rewarded handsomely with profits.

In summary, the best way to reward higher value with more profit is to get more patients to flow to them. This is how to permanently “bend the cost curve” and weed out low-quality options.

In Part 5, I will enumerate the core elements required for people to do that.