How to Make the Cost of Care Cheaper

I’ve been leading up to this for a long time. Lowering the cost of the actual provision of care is one of the most important things all countries with unsustainable health spending growth need. And, at the outset, I’ll say I don’t have all the answers. But here’s what I’ve got, explained in maybe a roundabout way, but hopefully it makes sense by the end.

Think about providers’ incentive to innovate. Do they have one? Hopefully your initial response is “yes,” because you’d be right (partially). Assuming this is a provider that operates as most in the country do, its prices are determined based on market power, not costs. So, with the assurance that prices will stay the same regardless of costs, providers have a great incentive to lower costs! Any cost decrease will go straight to their bottom line.

At this point, I picture in my head a little map of the United States with a vertical pin sticking out of it for each hospital, with the height of the pin representing that hospital’s costs of delivering care. The taller the pin, the higher the costs. So, the incentive for each hospital is to lower their costs as much as possible in order to maximize profits, and different hospitals succeed to varying degrees. The pins get pushed down with each successful cost-cutting initiative, some more than others.

Now let’s say there is a hospital that finds a really innovative way to deliver care, and their costs are way lower than everyone else’s. They want to get more customers in an effort to continue generating more wealth, but they’re stuck! Why are they stuck? Because even though their costs are so much lower, they don’t really get to set the prices the patients actually pay when choosing which hospital to go to for care. High-value providers can’t expand to new cities because they’d have to set their prices lower than existing providers’ prices, steal a whole bunch of the market share, and most likely force some of the lower-value incumbents out of business. But if they could, do you see what would happen to the pins? The one really low pin would start spreading, making the tallest pins get taken off the map completely with each market that it spreads to. It would be beautiful! Different kinds of cost-saving innovations would be spreading all over the country.

So, to repeat David Cutler’s question, Where are all the healthcare innovators? They’re out there, all over the country, but they’re stuck in their current markets; thus, we don’t see or even hear about most of them.

In summary, think of the two ways a company can make more money:

  1. Sell items at a higher margin
  2. Sell more items

Providers in our healthcare system can only do the first one. The second one is mostly not functioning, and thus we don’t have the harsh (and absolutely crucial) evolutionary force of putting lower-value providers out of business and lowering the cost of healthcare.

I’ll admit, the proliferation of high-deductible plans and new kinds of deals between providers and insurers are starting to overcome this. But there are probably other ways to increase the pace of the elimination of these barriers, and I would think the government should be focused on figuring out what they are if they want to solve this country’s budget problems. Or they could continue to argue over how to how to reduce volume and price while largely ignoring costs.

How to Think About a Healthcare Reform’s Impact on Total Spending

I know I left off my last post with a cliff-hanger about how to lower the cost of delivering care, but I realized I’m explaining this in an out-of-order way, so I’m going to back up a bit and lay the foundation.

I’ve posted before that there are actually three ways to lower health spending. Again, here’s the equation:

Total Spending = Volume x Price

To lower total spending, we could lower volume or lower price. And, again, we can only lower price so much without actually lowering costs of delivering care.

But what about the third way? A more complete equation would look like this:

Total Spending = Volumea x Pricea + Volumeb x Priceb + Volumec x Pricec + . . .

Get it? Our total spending is the total amount we’ve spent on hip replacements and on metformin and on office visits. . . .

So, the third way for us to lower total spending would be to adjust our mix of services so we’re choosing low-cost treatments instead of high-cost ones. Instead of buying brand-name drugs, we’d buy generics. Instead of full knee replacements, we’d opt for physical therapy.

Okay, good. Now, whenever you hear anything about a reform that’s aimed at lowering total health spending, you should be able to easily place it into one of those three categories.

So what about the Affordable Care Act? There are a zillion different provisions, all with different effects on total spending. Increasing insurance coverage = increased volume. Requiring preventive care coverage = changing services mix (more preventive services, fewer preventable complications we have to fix). Insurance exchanges = lower price through increased price competition among insurers. . . . To mention just a few.