Question

Describe an alternative pricing mechanism that exists within the healthcare industry or by a specific healthcare firm that deviates from the traditional market equilibrium pricing process (i.e. price discrimination, price leadership models, cost-plus pricing, incremental pricing, multiproduct pricing, transfer pricing, price skimming, prestige pricing, penetration pricing, predatory pricing, prestige pricing or psychological pricing). What type of market conditions exist that allows the unorthodox pricing procedure to exist?

Answer 1

Healthcare is classified as a merit good. Consuming healthcare provides benefits to public at large as well as to the individual consumer. For example, while inoculation against a contagious disease say COVID -19 generates a private benefit to those inoculated as well as others who are not bearing the direct costs associated with such inoculation.

(A) Alternative pricing mechanism that exists in healthcare industry consisting different healthcare firms

1. Individual negotiations between providers and payers.

2. Negotiation between associations of providers and payers.

3. Unilateral administrative price setting

4. Bundled pricing strategies and price variations

We will discuss each of the above one by one as follows

1. Individual negotiations between providers and payers.

Under individual negotiations, prices are agreed upon through negotiations between individual health insurers or self-paying patients and individual providers of health care services. Transaction prices are the result of many discrete negotiations often unknown to final consumers and to the public.

There are several key features of individual negotiations. Under individual negotiations, a concentration of purchasers and providers will have stronger bargaining power, like the negotiation of any normal good, where prices reflect the parties’ respective bargaining positions. Those parties with stronger market power, for example, will have stronger bargaining power.

In theory, if an insurer covers a large share of the population, beneficiaries can be guided to use “in-network” providers with which it contracts. Under such a system, providers may agree to accept relatively lower rates from the insurer to ensure patient volume and capture guaranteed revenue.However, in practice, providers with good reputations or brands, specialized services, or those representing the largest or sole provider or monopolistic power in the region have strong leverage to demand higher rates from insurers and can control price changes over time.

Under individual negotiations, there will be price discrimination, in which identical/same services can be purchased by different payers at different prices. The US private health care market commonly reports variations in prices for the same services that bear little relation to the cost of providing services, its quality or patient severity.

2.  Negotiation between associations of providers and payers/ Collective negotiations

Under collective negotiations, associations of payers (i.e.,health insurers) negotiate with associations of hospitals doctors or other health providers. The outcome of these negotiations would typically be a uniform fee schedule that would apply to all payers and providers.

There are wide differences in the objects and levels of negotiation. Frequently negotiations take place when determining payment levels to health care professionals, where the objective is to ensure an optimum income.

There are several key features of collective negotiations. Price discrimination present in individual negotiations is eliminated, given that an identical service is purchased at the same price. Collective negotiations also face much lower administrative costs in comparison with individual negotiations, given that substantially fewer resources must be dedicated to billing and marketing. At the same time, the level of conflict among the different stakeholder groups participating in the negotiation may increase as the space and the scope of negotiations widens.

3. Unilateral administrative price setting

The third method of determining price levels is unilateral administrative price setting by a regulator / Governmental body. When prices are administered, a form of non-price yardstick competition rewards a given firm depending on its standing vis-a-vis benchmarking. The key characteristics of this approach is as under

Setting uniform national prices based on average costs through yardstick competition gives incentives to higher-cost providers to improve efficiency and reduce costs. Providers with below-average costs have incentives to keep prices below the average to retain the marginal difference.

Like collective negotiations, the unilateral administrative method eliminates price discrimination, given that a fixed price is established. In comparison with individual negotiations, unilateral administrative price setting incurs lower administrative costs by insurers and health systems, but additional relatively smaller regulatory expenses may apply

Prices for hospital services are often set unilaterally and may include add-on payments to ensure broader public health goals such as equity and access. A unilateral, administrative price-setting system requires information including cost, volume, and outcome given that prices are usually cost-based (average, marginal) or normative (efficient). Adjustment factors are used by the provider or by service to account for features that impact the cost of production.

4. Bundled pricing strategies and price variations

In a bundle pricing, companies sell a package or set of goods or services for a lower price than they would charge if the customer bought all of them separately. Pursuing a bundle pricing strategy allows you to increase your profit by giving customers a discount. In health care industry, procedures such as an MRI or -a joint replacement can be priced at a flat "bundled" rate.

In US, states such as Arkansas and Tennessee have implemented bundled payments within their Medicaid programs for specific episodes of care that have high costs and price variability. Several hospital systems have also entered into bundled payment programs with some of the nation's largest self-insured employers, such as Walmart, Lowe's and McKesson.

(B) Market conditions that allows the unorthodox pricing procedure to exist in Healthcare Industry

1. Health-care markets lack the characteristics needed to determine a "market" price

Health-care markets lack the characteristics needed to determine a "market" price that reflects the economic value of resources used. Therefore due to absence of these characteristics, market price can not be arrived and resultantly unconventional pricing methodologies exists where pricing depends on case to case basis and economic variables of particular practical problem.

2. Complex nature of health care as a service or product

The market conditions existing in healthcare industry is such that they contribute to complexity to health care whether as a service or a product. Health care is not an item that is pulled off a store shelf, placed in a shopping cart, and paid for at the cash register. The desired result cannot be guaranteed and depends on various factors, many of which are beyond the control of the health-care provider.

3. Health care is a heterogeneous product

Heterogeneous products are products with attributes that are significantly different from each other, which makes it difficult to substitute one product for another. Health care is a heterogeneous product as the patient can experience a range of outcomes.

4. Imperfect Competitive Market

Market characteristics of healthcare industry differ from those in a perfectly competitive market. The market for health-care services is considered an imperfect market because health care is a heterogeneous product, as the patient can experience a range of outcomes. Patients who are insured have third-party payers covering their direct medical expenses; and A "market price" is lacking, i.e., no feedback mechanism exists that reflects the value of the resources used in health care.

5. The Nature of Commodity/ Service

The nature of service Healthcare industry is such that there is no possibility of transference from one market to another as sale of direct personal services of surgeon etc. is involved which leads to price discrimination.

6. Legal Sanctions and entry barriers

Legal Sanctions prevailing in the nation endues the market to allow the unorthodox pricing methodologies to exist. Further large entry barriers such as holding of valid licenses, permits etc, prevailing in Pharma or healthcare industry leads to such unconventional pricing

7. Imperfect Information

The buyers in the healthcare markets are not fully aware of costing and pricings of particular healthcare product. Due to asymmetric information about quality and pricing of services, market failure occurs. The producers and consumers are not fully informed about market conditions and economic actions.

As discussed above due to nature of the product for sale and the structure of health care markets, most of these markets do not meet the ideal perfect market conditions that facilitate efficient resource allocation and orthodox pricing strategies.