How hospitals fail to use pricing to their advantage, and what to do about it.
This article is the fourth in a series examining the writings of well-known economic thinkers in light of the modern healthcare organization The first article took on Alfred Marshall’s perspective of growth; the second article evaluated Marx’s ideas about capital; the third article described Joseph Schumpeter’s necessity for innovation; and this article explores F.A. Hayek’s ideas on prices.
Are prices necessary? According to Nobel Laureate Economist Friedrich A. Hayek, prices are information — or signals — to both the customer and producer (or provider, in the case of the healthcare industry). Hayek said prices provide the information needed to enable economies to work efficiently and effectively. However, health systems have long existed without clear, transparent prices. Today, consumers are starting to demand information about hospital prices. High prices and/or the lack of price information are causing hospitals to lose customers, threatening the existence of some hospitals. Health systems can improve their competitive standing and grow by making improvements to their pricing systems.
In almost every sector of the economy, price is the first thing consumers analyze to gather information about quality, availability and supply. Yet, healthcare — one of the largest areas of the economy — has been a virtual black hole to patients; consumers have had almost no price information to help them make choices. Previously, pricing information was not entirely necessary for many patients because their insurance policies paid the entire cost of care. Insurance plans are changing quickly, though, becoming more dependent on large deductibles. In fact, last year there was a 17 percent increase in high deductible health plans using health savings accounts — covering more than 13.5 million people. Consumers are demanding price transparency as they shoulder a greater share of the cost of care. If these price-conscious patients find the cost of one hospital too high, they will search out a competitor. As a result, the healthcare sector is rapidly catching up to the rest of the retail economy, which centers on transparent, straightforward pricing for consumers.
Are you able to compete?
Here are three steps to ensure your hospital's pricing strategy aligns with market demands.
1. Develop a system to clearly communicate the out-of-pocket patient cost for a procedure. Healthcare — especially outpatient services — has become more like a retail business: Consumers expect the same straightforward pricing they have come to know in other retail settings. For decades, the average consumer dreaded the car buying process because of the haggling and unclear pricing. It provided an entry point for companies such as CarMax, which offered no-haggle, clear-cut pricing. Get ready for the outpatient "shopper," who expects clear and transparent pricing. If your health system cannot provide meaningful and accurate price information, it is likely you are losing a growing segment of outpatient customers to competitors who can provide straightforward pricing information. Even worse, some of your outpatients may avoid or fear the hospital because costs are unknown. Consider the following as your hospital begins to take steps toward a more transparent pricing strategy:
- Designate one person in the health system to be responsible for the pricing team, communication and strategy. Health systems often make several departments responsible for price information, a practice that sometimes results in inconsistent pricing.
- Install a price estimate system that allows the health system to provide out-of-pocket costs based on the patient's insurance company and plan. Remember, nearly 99 percent of patients do not pay the charge rate. The term "charge" is confusing to patients, and sometimes the charge is offensively high, which has led to many of the recent exposés in Time and The New York Times. It is best to avoid communicating charge rates altogether, and provide out-of-pocket costs instead.
- Ensure prices are consistent across facilities, or at least have justification if otherwise. There are many health systems that have several points of service in a local market, all with different pricing. Just like a retail chain, consumers expect pricing to be consistent in a market.
2. Understand the hospital's local competitive market to develop the pricing strategy. As healthcare becomes more like retail, it's important to realize that patients — like other consumers — are looking for more than just the lowest cost. Like any other retail setting, consumers look for value. Determine how your hospital's prices and ability to communicate cost compare to your competitors. Of the major payers, determine if the prices are at the higher or lower end of the market. Then ask what segment of the market are you targeting? A strategy to capture the entire market rarely works. Walmart does not target high-end consumers and Nordstrom does not target coupon-cutting shoppers. If your prices are high, it doesn't necessarily mean you should lower prices, but you will need to deliver a higher value service than the competition. A segment of the market will pay a premium for good service, high quality and a nice facility. If your hospital is the low-cost provider and it aligns with your strategy, develop a marketing strategy to inform local consumers. And remember that patients aren't the only ones shopping; businesses are also looking closely at pricing, with many moving to self-insured plans. Understand how self-insured companies establish pricing. A New York Times article describes a recent example. More companies are setting procedure price caps for employees, making the patient pay the amount above the cap if the employee chooses to go to a higher-cost facility. Be aware of the changes in this growing market to ensure your prices remain competitive, and work with local employers to negotiate reasonable prices that allow both parties to reach their goals.
3. Create a pricing system that makes sense to consumers and the hospital. A poor pricing strategy allows competitors to take advantage of your hospital's lack of clarity or highly priced service lines. Hospitals often have significant leverage with payers to negotiate extremely high reimbursement for X-ray and MRI procedures, but this doesn't mean it is always the best strategy. Squeezing the insurers for revenue on many outpatient services often opens the door for an entrepreneurial urgent care center or orthopedic group to start their own imaging services. Legendary management consultant Peter Drucker warned about overpricing in his article, "The Five Deadly Sins": "The worship of premium pricing always creates a market for the competitor. And high profit margins do not equal maximum profits."
Healthcare systems must create a pricing system that makes sense internally. Hospital executives and department managers should identify the incremental cost of major services and procedures in the hospital, giving the hospital the ability to determine appropriate prices and margins for services. A more straightforward pricing model will empower service line directors to manage toward profitability, and not exclusively productivity.
Healthcare organizations must provide price and value that is easily understood by patients. As F.A. Hayek believed, price signals will not only allow consumers to make effective decisions, but will also allow providers to understand their own value, strengths and weaknesses in the marketplace. Organizations showing disregard for prices threaten their own existence. Begin today taking steps to improve the pricing system of your organization.
Barrett Clark is the director of strategy and analytics at Ivy Ventures, LLC, a consulting firm that helps hospitals grow outpatient service lines. His focus is on identifying and implementing strategic initiatives to help health systems grow profits. Prior to joining Ivy Ventures, Barrett was a financial analyst for the Financial Planning & Analysis Team at Wachovia Securities (now Wells Fargo Securities). He can be reached at: bclark@ivyventures.com.
J. Stephen Lindsey, FACHE, was CEO at HCA Henrico Doctors’ Hospital for 16 years. He has served as an affiliate professor in the MHA program at Virginia Commonwealth University. Mr. Lindsey is a principal of Ivy Ventures, LLC, a consulting firm that helps hospitals grow outpatient service lines. He is a fellow of the American College of Healthcare Executives. He can be reached at: slindsey@ivyventures.com.