Healthcare competition – Clear Thinking on Healthcare

What Is “Competition” Anyway?

You know the word “travesty”? People who want to sound smart sometimes use it instead of tragedy, as if it’s the smart person’s version of tragedy. But it’s not. They use the word even though they don’t know what it actually means.

People do the same thing with “competition.” Many think it’s either the solution to everything or the cause of all evil . . . even though they don’t seem to know clearly what it means.

It turns out, I can’t fault them. This is a longstanding issue. Maybe I’m just ignorant of some classic economics textbook that has the grand master definition in it (you’d think they would have covered it in the econ classes I took), but man is it hard to find a definition of this word! I was especially hoping to find one from at least one of the classic economic thinkers. This is the best I could come up with . . .

Adam Smith didn’t use the word very much. Here’s the main example of how he thought of it, taken from The Wealth of Nations, Book IV: “The competition of producers who, in order to undersell one another, have recourse to new divisions of labour, and new improvements of art, which might never otherwise have been thought of.” So, in his mind, competition was simply improving manufacturing processes to undersell competitors?

And Joseph Schumpeter, who even still has a type of competition named after him (“Schumpeterian competition”), didn’t offer up a definition that I could find either. The closest thing is what he wrote in Capitalism, Socialism, and Democracy: “But in capitalist reality as distinguished from its textbook picture, it is not that kind of competition which counts but the competition from the new commodity, the new technology, the new source of supply, the new type of organization (the largest-scale unit of control for instance)—competition which commands a decisive cost or quality advantage and which strikes not at the margins of the profits and the outputs of the existing firms but at their foundations and their very lives.” He’s taking the term as a given and focusing on a specific type of it–the type related to how new innovations impact competition.

Even Michael Porter, in his book Redefining Healthcare, never provides a definition. He says things like this though: “The way to transform health care is to realign competition with value for patients. Value in health care is the health outcome per dollar of cost expended. If all system participants have to compete on value, value will improve dramatically.” He felt the need to define value, but never competition, and, like the others, took the term as a given.

And I’m completely skipping over all the definitions of “perfect competition,” which describes everything around a special case of competition without actually defining it either.

How about Wikipedia? It at least offered a definition! In the article Competition (economics), it says, “Competition is a scenario where different economic firms are in contention to obtain goods that are limited by varying the elements of the marketing mix: price, product, promotion and place.”

Competition is a scenario? And the main focus is that firms are trying to obtain goods? This one sounds really smart, but I disagree with it. I also believe it doesn’t facilitate a clear understanding of the concept.

So it’s time I offer up my own definition. Maybe I’ll change it over time as I learn more. But for now, this is what I’ve got:

Competition is a state in a market where there are multiple companies trying to win more profit by convincing potential customers to choose their product or service because it will meet their needs in a higher-quality and/or lower-priced (i.e., higher-value) way than other companies’ offerings.

I’ll unpack that.

First, it’s a state of being. Markets can exist in a state of competition or not. Really, it’s a continuum from no competition at one end to perfect competition at the other end. But the bare minimum needed for it to exist is for there to be multiple companies fighting for limited profits, which are the prize. If this is a non-profit environment, then we’ll call profits “surpluses.” Same idea. And to win those profits, they need to convince potential customers to choose them over their competitors. There’s always a mix of strategies–high-profit low-quantity vs. low-profit high-quantity–but the end goal with all of them is to win the most profit. I recognize that more and more companies are “mission driven” rather than “profit driven.” That’s great and all–I guess they’re willing to give up some profit to achieve their mission. But the stark reality is that they need to earn enough money to continue achieving their mission, which means they still have a strong profit motive if they want to sustain and grow.

I’m deliberately not defining which companies count as being in a market because it depends on the needs of people. For example, Ford’s new F-150 Lightning (an electric vehicle that can even use its battery to power your house) technically is filling the same need as people shopping for an emergency back-up generator, which means for that customer segment Ford is competing with generator companies. Competition often spans the traditional boundaries of markets.

And I said “convince” potential customers because people make a purchase decision based on the information they have. It’s not enough to be objectively better in every respect. It only matters if you convince people who are looking for a solution to fill their need. Long-term, yeah, you generally need to actually be higher-value to keep customers, at least if there’s enough information available to potential customers to make the market somewhat transparent.

So there you go. An actual attempt at a definition of competition. And, thinking about it now, isn’t it a wonderfully desirous state to strive for? I hope this definition is useful in helping you think about what you are meaning when you use the word.

Helping Patients Choose Higher-Value Providers

Last week, I wrote about how quality metrics are misused by healthcare reformers. They’re almost exclusively tied to bonuses or penalties from insurers. In other words, they’re used to increase or decrease the price providers get paid. This is a form of administrative pricing, which is a super economically inefficient way to set prices. And I proposed the alternative use of quality metrics–to help patients choose higher-value providers.

We give people quality metrics and they seem to generally do a good job shopping for the best value in pretty much every other industry, which drives competition over value. So why do we fail so miserably in healthcare?

The first problem is that healthcare is missing the thing that motives people to shop around for the best value: their money is on the line. I wrote about this a couple weeks ago. We need people to pay a little more if they choose a higher-priced provider. But when prices are opaque or unknowable beforehand, or when their insurance plan makes them pay the same regardless of the provider’s price (or if the insurance plan is complex enough that the patient doesn’t understand that they’ll have to pay more if they choose a higher-priced provider), people don’t perceive that their money is on the line. In that last sentence, I just listed four issues preventing people from actually caring what the price is!

And then there are the issues of having only one option (like in a rural area) and non-shoppable services (like during emergencies) and non-shopping-when-you’re-already-established-with-a-provider. Yeah, there are a lot of reasons people don’t shop for prices in healthcare! But in spite of all that, there are some good studies that show that people will actually shop for services when all the stars align.

I know that even if people have a hard time knowing prices beforehand, they theoretically could still shop just as vigorously for the highest quality.

But I think there’s something that happens when people can’t shop for price that sorta stops them from thinking about shopping for quality too. I haven’t seen any studies that prove this, but I suspect it’s a thing.

So let’s talk about the people who say, “Well if I don’t know what I’m going to pay, I might as well try to find the best quality option.” They use a variety of sources since there isn’t one single well-known and useful quality source out there. Usually they rely on recommendations from their doctor or their friends and family. If that person had a good experience, that’s a reliable indicator of quality, right?

Or maybe they decide to be brave and try Googling quality metrics. They’ll find something, certainly. But chances are they’ll find quality metrics that aren’t super relevant to what they actually care about. For example, maybe they’ll discover Medicare’s Care Compare website. What does 3 stars even mean? Even drilling down, how useful is it to know that a hospital’s safety is “below the national average” in 2 out of 8 metrics? How does that get weighed against a high recommendation of the hospital from a family member? Or, is that quality rating ignored because the hospital’s lobby is spacious and it advertises meals prepared by well-known chefs?

Compare the relative uselessness of those quality metrics to the example of Seattle’s Virginia Mason Health System when they were redesigning their low-back pain care pathway. They figured out that people care most about how soon they can get back to work (it’s expensive to live in Seattle, if you didn’t know) and, among other changes, made same-day appointments available. This was the quality metric people cared about, and their low-back-pain market share doubled.

After reading all these barriers to people shopping for the best value in healthcare, I hope you can see that (1) this problem is perfectly explainable and (2) it’s totally fixable. Can someone please tell the Medicare administrators that most of their current efforts at “value-based purchasing” are going to be close to useless? And tell them to look at getting rid of some of these barriers to patients choosing high-value providers instead.

The True Usefulness of Cost Sharing Is Misunderstood

Photo by Karolina Grabowska on Pexels.com

“Cost sharing” refers to people paying money out of their own pocket to receive healthcare services. There are lots of forms of cost sharing—the most common ones are deductibles, copays, and coinsurance.

When healthcare reformers talk about cost sharing, they are often arguing that we should increase cost sharing so that people will stop overutilizing health services (especially low value ones). They call it getting consumers to have some “skin in the game.” The Rand Health Insurance Experiment found that this works, although people decrease their utilization of high-value services as well.

But this isn’t the thing we need cost sharing to do for us. What we need it to do is get people to start considering prices when they choose where to get care.

If people don’t care what the price of a procedure is, there’s no reason they would go out of their way to find one that is less expensive (while being of at least equivalent quality). In fact, they probably wouldn’t bother checking prices at all.

But when they are forced to pay at least some part of the price, they will start asking questions to find out the price of their options. Not everyone will, of course. But some will start doing that, especially when they discover that they could potentially pay thousands of dollars less for no worse quality.

Trying to find prices is a frustrating endeavor in our healthcare system because prices are still hard to come by. And often even the quoted price is an estimation, or it doesn’t include the same bundle of services as another provider’s quoted price.

But if people can successfully find prices and choose ones that are lower priced, do you know what happens? Providers start to see that their prices actually do impact how many patients choose to receive care from them. And then the market actually starts to function because competition (at least over prices) has begun.

To summarize, we don’t need cost sharing for the sake of skin in the game; we need it so patients can be put to work searching for the best deals (trying to save their hard-earned money) because this searching effort is the main prerequisite for competition.

By the way, I am not saying people need to pay the full price of every service. The key is that they pay at least some amount of the price differential between options. So if one provider quotes $4,000 and another quotes $5,000, all we need is for them to pay is a little more if they choose the $5,000 one. This could be through reference pricing, where they pay the full $1,000 difference. Or through other methods that only have them pay part of that $1,000, such as high coinsurance or tiered networks. There are many ways to achieve this.

Maybe This Is How PBMs Started Getting Kickbacks?

In case you haven’t been following all the riveting posts I’ve been writing lately about pharmacy benefit managers (PBMs), here are the main ones:

Pharmacy Benefit Managers: Kind of a Mystery to Me

I’m Still Confused by PBMs But Trying to Fix That

Why Does GoodRx Exist, and How Does It Work

In the “I’m still Confused by PBMs” article, I went through the step by step process of PBMs coming into existence, which they did by filling a need in the market for companies to help consumers pay the correct copay right up front when they buy a medicine.

This time, I want to think more about how they went from that simple software solution (integrating an insurer’s formulary into the pharmacy’s software system so that it can spit out the right out-of-pocket price on the cash register when a patient buys a medicine) to being seen by many as the “shady middlemen.”

The starting point is the position they found themselves in the market. They were responsible for creating formularies for several different insurers. Their goal, assuming the PBM industry is competitive, is to help insurers have the most generous formulary for the cheapest.

I bet at some point, some young upstart working for a PBM had an idea . . .

Young upstart: “If we want to offer a cheaper formulary than our competitor, why don’t we try to negotiate directly with drug manufacturers to lower the costs of the drugs?”

Old manager, feeling superior: “But how are we going to do that? You don’t understand that drug manufacturers only negotiate with pharmacy wholesalers. The wholesalers are the only party to which manufacturers sell their drugs. Nobody else buys directly from the manufacturers, so no one else can negotiate with manufacturers.” And then, with a taunting eyebrow raise, “Unless you are suggesting something radical, like that we start backward integrating to act as drug wholesalers as well?”

Young upstart, undaunted: “Not at all. How about this. Why don’t we pay a visit to a drug manufacturer that is selling a medication that has several competitors in the same drug category and make them an offer they can’t refuse. We could tell them we’ll put their medication in the lowest copay tier and all the other medications in that same category will still be in the middle copay tier. They will sell way more of their medicine and make a lot more money. But, in return, they have to pay us a “rebate” for every transaction of their medication that we process. They still make more money because they’re selling so much more of their medication, and we get some of it.”

Old manager, interest piqued: “And how is this going to allow us to offer a cheaper formulary than our competitors?”

Young upstart, gaining momentum: “We’ll simply charge less for insurers to use our formulary. Sure, they’ll have to pay a slightly larger share of the total cost of that specific medicine, but the lower price we offer them will more than make up for that. And the best part is, everyone wins! The drug manufacturer wins by increasing profit, the patient wins by paying a lower copay, the insurer wins by getting a cheaper overall formulary, and we win because we keep some of the rebate!”

Old manager, ever skeptical: “If everyone wins, then where is the money coming from?”

Young upstart: “The money comes from the other drug manufacturers, whose market share goes down. That profit that they’re losing is being divvied up among (1) us, (2) the drug manufacturer we’re contracting with, and (3) the insurers using our cheaper formularies, some of which will be passed on to patients.”

Old manager: “Ok, that makes sense, but this sounds too good to be true. You haven’t mentioned pharmacies yet–how would this impact them?”

Young upstart: “I was hoping you’d ask. This won’t impact pharmacies at all. They won’t even know about this transaction between us and the drug manufacturer. As far as they’re concerned, all they see is that they’re still getting paid the negotiated price for the medication, it’s just that patients are paying less and the insurer is paying more.”

Old manager, nodding: “So the patient pays less but the insurer pays more. Yet the insurer is saving money overall because our formulary is cheaper enough to more than compensate for that.”

Young upstart: “Exactly.”

And that is what I imagine to be the start of PBMs negotiating “kickbacks” with drug manufacturers. It was all in the name of PBMs being able to offer lower-priced formularies to insurers by orchestrating a way to help some drug manufacturers sell more drugs and get rebates/kickbacks/volume discounts in return.

This surely boosted the profitability of the PBMs that started doing it, which, when others heard about it, started doing the same thing.

Eventually, every drug manufacturer started paying some kind of rebate to PBMs, which means it became a zero sum endeavor overall for manufacturers because the net effect of having a higher market share through a specific PBM but a lower market through the others that made deals with their competitors means that they end up with essentially the same market share, the only difference being that now they are paying money to PBMs to avoid losing that market share.

Shady middlemen indeed. But I can’t blame them for doing it–this is what capitalism and competition is all about. It’s just a market failure that this specific strategy turns out to be a cost-increaser in the market.

NEJM’s Fundamentals of U.S. Health Policy, Part 7b: My Commentary on Creating a More Efficient Delivery System

In last week’s post, I summarized this article, which is the last in the Fundamentals of U.S. Health Policy series published by The New England Journal of Medicine. The article was written by Michael Chernew, Ph.D., and discusses the role of market forces (more specifically, competition) in improving our healthcare delivery system.

I’m heavily biased toward using competition inasmuch as it is possible (for good reason), but that doesn’t mean I’m blind to our failed attempts at improving competition in healthcare. And Dr. Chernew does a great job summarizing many of those failed attempts while remaining optimistic that competition still has a role in improving our healthcare delivery system.

I completely agree with his conclusion that where the market fails, we need government involvement. It’s a conclusion that is commonly agreed upon amongst researchers in this field.

But the difference between me and most other health policy researchers is this: I believe the market will work to a much greater degree than others do. Maybe this is because my original bias toward decentralized decisions and efficiency led me to question harder why all those supposedly market-improving reforms failed.

Others may say, “Well, all these reforms failed, so I guess the market just won’t work in healthcare, so let’s see what the government can do to fix this mess instead.” But I say, “Let’s figure out why they failed. And if the reason they failed is because markets just won’t work in healthcare, great! Let’s turn to the government for help.”

The answers I’ve found over the last several years about why all those competition-improving efforts have failed tell me that markets can work to an extensive degree in healthcare, we’ve just never created the environment for it to happen.

I’m passionate about this because if we don’t understand that environment and then create it, the future fiscal health of most countries will sooner or later be ruined because the non-market government solutions they’ve come up with so far are insufficient at stimulating the cost-reducing innovation necessary to make healthcare systems sustainable.

My concerns with Dr. Chernew’s paper are in the section where he lists all the ways transparency efforts and benefit design change efforts have failed and then gives as the explanation for these failures that, “The core problem is that for markets to work, patients must face the economic consequences of their choices, but labor-market concerns dampen employers’ enthusiasm for adopting plans that impose such consequences.”

Translation: Employers don’t want to force employees to face big out-of-pocket spending in the plans they offer them because that’s not popular among employees, which will lead to employee dissatisfaction and possibly even lead to the best recruits choosing other jobs. And so employers are unwilling to adopt the insurance plan benefit designs that are necessary to make competition work in healthcare.

I disagree for a few reasons. First, an insurance plan does not have to make the patient pay the entire price out of pocket for them to be price sensitive. They only have to make the patient pay some of the price difference between their provider options. Second, employers can offer a few plan options to employees, only one of which would impose such requirements. Third, if there were multiple plan options to choose from, the one with such requirements would likely be fairly popular because the premium would be much lower on account of all the savings generated by those requirements leading enrollees to choose lower-priced providers.

The main potential limiter to the popularity of such a plan would probably be in its implementation. Is there an app that the patient can use that would easily tell them the provider options in their region and what their out-of-pocket cost would be for each one? Better yet, does that app also integrate patient-relevant quality information? Such apps are out there. And providing an explanation about the benefit design purpose and the accompanying app in the plan’s description would probably overcome a big chunk of the issues causing people not to use transparency information.

So I disagree with Dr. Chernew’s implication that competition in healthcare is going to be fairly limited because employers are unwilling to implement such plans. I actually wonder if there aren’t already groups of large employers banding together in different regions of this country making plans to all make such benefit designs available to their employees at the same time in an effort to get so many people in the region choosing based on quality and price that the providers are forced to respond in value-improving ways. (If any employers are out there considering such an attempt, I am happy to advise!)

But I do think that this last topic was the perfect one to end the series with, and Dr. Chernew was one of the best people they could have chosen to address the topic so effectively. How to increase the efficiency of the delivery system is the big challenge that neither the Republicans nor the Democrats seem to have an answer to, but it’s the issues that is going to loom larger in the future, especially if we turn to more administrative pricing and quickly discover that the price floor (the point at which the price is too low because it makes providers unprofitable) is actually incredibly high.

Well, that wraps it up for this series. I learned a ton and I appreciate NEJM’s efforts to educate more people about health policy!

NEJM’s Fundamentals of U.S. Health Policy, Part 7a: Creating a More Efficient Delivery System

It’s a market. Photo by Mark Stebnicki on Pexels.com

This is the last part of the Fundamentals of U.S. Health Policy series! And it’s a super interesting one. Michael Chernew, Ph.D., wrote about the role of market forces in U.S. health care. Since this is squarely in my area of focus, I have a lot of thoughts. Thus, this week I’ll stick to summarizing Dr. Chernew’s article, and then next week I’ll provide some commentary.

Forewarning, I’m following the paper’s logic flow, which, to my brain, is a little meandering, so it’s easy to lose one’s place, but I’ll clarify as much as I can now and then attempt to provide additional insight next week.

Remember how Total Healthcare Spending = Price x Quantity? (Well, actually, it’s the sum of the price x quantity of all the different services being provided in our healthcare system.) Dr. Chernew is basically using that equation when he starts out by saying that our challenge is to reduce the quantity of low-value services provided and to lower prices.

And then the big question . . .

What role should markets play in doing that?

He finally gets to the answer at the end, which is that markets and government should both be used to complement each other. Markets can be leveraged inasmuch as they will help, and this should be paired with the government regulations needed to help them work as well as they can.

I won’t list his specific recommendations quite yet about how we could do that because first I need to review what he says in the rest of the article about markets and how they work.

First, he says that markets are the “foundation of our economy,” and they promote efficient production and cost-reducing innovation. He doesn’t exactly give the step-by-step explanation of how they do that, but you can gather it from his next several paragraphs. Markets create competition, which is when consumers (in this case, patients) have “the ability and incentives . . . to seek low-price, high-quality providers. . . .” And because of that competitive pressure to win consumers, the players in a market are forced to innovate in ways that make production more efficient.

Great, so a good healthcare market will help patients choose low-price, high-quality providers. Unfortunately, healthcare markets are more imperfect than other markets. Want a big piece of evidence for this? Look at the extent of unwarranted price variations that exist in healthcare. It’s way more than in other markets.

But why is the healthcare market so bad?

“Competition in health care fails for several fundamental reasons. First, patients often lack the information needed to assess both their care needs and the quality of their care. Second, illness and health care needs are inherently difficult to predict, exposing people to financial risks that they must insure against. This risk gives rise to an insurance system that shields patients from the price of care, dampening their incentive to use care judiciously and to seek care from providers offering high-quality care at affordable prices. The information problem, amplified by insurance, reduces the ability and incentives for patients to seek low-price, high-quality providers and impedes well-functioning markets. This problem has been magnified lately by consolidation of health care providers.”

So, basically, it’s difficult for patients to really know what care they need, they have a hard time assessing quality of care, they’re shielded from prices because of insurance, and consolidation has limited their options. The result of all that is they have neither the ability nor the incentives to choose low-price, high-quality providers.

This, by the way, sounds almost exactly like what I’ve written (or linked to) a thousand times before, which is that patients need to start making value-sensitive decisions, and to do that they need (1) multiple options, (2) the ability to identify the value of each option, and (3) the incentive to choose the highest-value option.

Regarding consolidation, he gives some interesting data, which show that only 51% of markets have 3 or more hospital systems.

Based on all of that, many would conclude that we should abandon markets altogether in healthcare. But he says, “The weaknesses associated with market-based health care systems are severe, but that does not mean the market should be abandoned.”

And then he proceeds to give a few examples of beneficial things that have come from markets already, such as new payment models, telemedicine, a shift from inpatient to outpatient care, and narrow networks (which allows for lower prices).

Those, however, end up being overshadowed by the list of ways we’ve tried and failed to bolster market function by providing patients with better information about quality and prices and by changing insurance benefit designs.

The summary of this section of the paper is that giving patients better information about quality and prices have had very little success because . . .

Patients rarely use price- and quality-transparency tools
These sorts of decisions are complex
Patients fear disrupting their relationships with their physicians

Changing benefit designs to get patients to directly pay for more of their care (e.g., implementing high deductibles) has had a larger effect on utilization, but it hasn’t significantly impacted the market because . . .

What tends to happen is higher-value and lower-value care both decrease
Not enough patients end up getting steered toward higher-value providers to actually impact market prices.

He provides his explanation for all these failures: “The core problem is that for markets to work, patients must face the economic consequences of their choices, but labor-market concerns dampen employers’ enthusiasm for adopting plans that impose such consequences.”

In the realm of getting patients to choose higher-value insurance plans, there’s been a little bit of headway with insurance exchanges, although there are many drawbacks to those, too . . .

Beneficiaries make poor plan choices
Insurance exchanges induce more price sensitivity, which leads people to choose lower-premium plans that impose greater financial risk on them, which they often cannot bear

And, to make things worse, many of the downsides of insurance exchanges can worsen inequity.

Dr. Chernew is not exactly giving a glowing review of market-based reform attempts, is he? His comments are all accurate though.

Next, though, he says that “in evaluating their merits, we need to compare them with other systems, such as government-run models.” And government-run models have their own set of limitations.

Luckily, we are not facing an either-or decision. The important question is how government and markets can complement one another. “We do not need to abandon markets–we can make them better.”

Finally, getting to his recommendations about how to use markets and government to complement each other, he says we could work to increase the effectiveness of transparency initiatives, limit provider consolidation, and impose gentle regulations to prevent the most severe market failures (like limits on surprise billing and instituting price caps on the most excessive prices).

Dr. Chernew’s conclusion is that, “If we fail to improve market functioning, stronger government involvement will most likely be needed.” Agreed.

Next week, I’ll give my thoughts on all this!

Healthcare Experts Often Support Good Healthcare Reforms for the Wrong Reasons

This week’s post is a little later than usual, but next week will be back on track with a Tuesday post about Hayek’s book about socialism, The Road to Serfdom, and how it fits into my framework for categorizing governments.

Something I have noticed for many years now is that many good and important healthcare reforms are touted by experts for the wrong reasons. Supporting a good reform for the wrong reason may seem harmless, but without a clear understanding of the principles behind why the reform is important, the implementation may undermine much of the benefit of the reform, or it may not be evaluated based on the right expected impact (and, therefore, cause the reform to be incorrectly judged as a failure). Either one of these mistakes could ruin the reform.

Example 1 – Quality metrics reporting: This refers to making providers track and report a variety of quality metrics, which are then usually used to give quality-contingent bonuses. These quality metrics are also often reported publicly with hopes that it will add some accountability to providers and motivate the lower-quality ones to improve.

What many experts don’t realize is that quality-contingent bonuses are not going to make a big dent in our healthcare problems. They also don’t realize that the main purpose for quality metrics should be to help people make value-sensitive decisions, which means the tracked and reported metrics need to enable people to do this. Commonly used metrics these days, such as aggregate mortality numbers and overall patient satisfaction scores, aren’t super useful at achieving this goal.

Example 2 – High deductibles: Some experts say that if people have high deductibles, they’ve got some “skin in the game” and will therefore stop being such spendthrifts, which will decrease overutilization and total healthcare spending.

It’s true that a high deductible will reduce healthcare spending;, although, unfortunately, people tend to decrease unnecessary AND necessary care. That’s what the classic Rand Health Insurance Experiment demonstrated. But lowering spending is not the main purpose of high deductibles. The primary benefit of them is that they make people actually consider price when they are choosing where they will get care, which allows people to start preferentially choosing higher-value providers (i.e., make value-sensitive decisions). Of course, this only applies to services that cost less than the deductible.

Example 3 – Bundled payments: These are seen as a way to get providers to integrate more and, through that integration, “trim the fat” (what’s with all the flesh metaphors?). Usually the reduction in total episode costs comes from providers becoming less likely to discharge people to skilled nursing facilities.

Bundled payments do get providers to send fewer patients to nursing facilities and to find other superficial ways to decrease total episode costs, but the primary benefit is that they allow people to compare, apples to apples, the total cost of a care episode. Again, it’s all about removing barriers to value-sensitive decisions. This will lead to complete care process transformations as providers become motivated to improve value relative to competitors and are assured they will win greater profit as a result. So implementing bundled payments with a single provider in a region will likely result in only very modest benefits, which will come from those superficial low-hanging-fruit types of changes.

That’s enough examples for this week! Merry Christmas, and may everyone do good things for the right reasons.

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

lever 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.

valuewithprofit

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.

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

The Three Different Ways We Could Set Prices in Healthcare

Image credit: AP Photo/Damian Dovarganes

Out of the three general ways we could set prices in our healthcare system, one is best. Too bad we’re using the other two.

First, I’ll describe each method:

Administrative pricing: This one is very straightforward. The government says, “For procedure A, healthcare providers will be paid X dollars.” Usually the methods for coming up with that dollar amount are sophisticated and rely on the best available data, but not always because they are subject to various political influences and government budgets.
Bargaining power-based pricing: This one is easiest to explain using an example. Think of a small town with only two family medicine docs. One, Dr. Awesome, treats 90% of the town’s residents; the other, Dr. Mediocre, treats the other 10%. All patients are insured by one of four different private insurers, each of which has approximately equal market share. Now think of Dr. Awesome sitting down at the bargaining table with one of the insurers to decide on prices. He says, “If you don’t pay me at least Medicare rates times 1.4, I won’t accept your insurance. I’m serious, I won’t accept anything less.” And the insurer says, “Hey, that’s a horrible deal, but if we stop covering care you provide then most of our policy holders in your town will just switch to one of our three competitors and we’d lose out on even more profit!” Now think of the conversation between Dr. Mediocre and that same insurer. Dr. Mediocre says, “Pay me Medicare rates times 1.4.” And the insurer responds, “No. We’ll pay you Medicare times 0.8. If you say no and we don’t have you listed as a provider in our network anymore, that’s okay because only a tiny percentage of our policy holders are your patients. And we know that you don’t have many patients, so you can’t afford to risk losing 1/4 of them by saying no to the price we offer.” Relative market share between the two parties is the primary determinant of bargaining power, so a bigger market share means you can get a better price.*
Competitive pricing: This is the method used to determine prices in almost every other industry. Here’s basically how it plays out: Competitor A says, “Everyone knows that our product has similar quality to our competitor’s product, so we can’t price it higher than theirs without sacrificing quite a bit of market share. We could sell it for less than theirs to win more market share, but then the price is perilously close to our costs, so we’ll have to do some math to see what the profit-maximizing price/market share combination is likely to be.” Note the one huge condition that is required for this to work: Potential customers must be able to compare the price and quality of all their options, which is starting to happen more and more as better quality information is starting to become available and as prices are becoming more transparent.

Our healthcare system currently relies primarily on number 1 (think: Medicare and Medicaid) and number 2 (think: private insurers and providers setting prices with each other). But which method is best?

If you want to have the lowest possible prices, administrative pricing is the obvious best choice. But that’s only for the short term (as you’ll see), and it does nothing to encourage quality improvement unless you start getting into the treacherous area of performance incentives.

The only thing I’ll say about bargaining power-based pricing is that I don’t like it. I’d rather not have prices that are totally unrelated to costs or quality and instead are determined by relative market share.

Now let me tell you why I like competitive pricing so much. I want our healthcare system to deliver better value right now (Value = Quality / Price), and even more than that I want that value to go up over time as providers and insurers innovate in ways that allow them to decrease prices, increase quality, or both. Competitive pricing is the only method that provides an incentive for competitors to innovate because it rewards the highest-value offerings with increased market share and profit. The other two options don’t do that, which seems like a pretty big downside, don’t you think? I’d be willing to forgo short-term super-low administratively set prices in favor of stimulating innovation that will improve value way more over the long term.

In my next post, I’ll explain how we can shift from bargaining power-based pricing to competitive pricing.

* Do you ever hear those arguments that if public insurers lower their prices any more, providers will just raise their prices for private insurers? Well, now you know why those arguments are mostly hogwash. Providers are already leveraging their relative market share to get as high prices as possible from private insurers, and getting paid less by public insurers doesn’t change that relative market share.

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