Identifying a Pricing Strategy
To make decisions about the costing in a healthcare system, it is extremely important to understand different pricing strategies so that affordable yet profitable prices can be achieved. This paper will explain the four types of pricing strategies along with their advantages and disadvantages.
“Cost-to-Charge Ratio Method” is one of the most used method and it is used to evaluate the proportion overhead cost of individual based services. It uses two sets of assumptions which are indirect cost and reimbursement rates. This method is considered a “golden standard” and it is a good choice when diagnoses related average costs are being examined. However, it is not very reliable for determining the relative costs of the hospital (Shwartz et al., 1995). “Relative Value Unit Method” is the method that uses the intensity of the service provided to estimate the overhead cost of individual services. In simpler words, it takes into account the complexity of service and time consumed while providing that service. It is mostly used when calculating the overhead costs and it is also used when the estimates have been gathered regarding the RVU values. The disadvantage of this method is that it is beneficial for those physicians that work faster and penalizes the ones that do not. It may be encouraging for some to employ this method, however; it may cause the physicians to over-utilize resources like tests, etc. This may rack up the overheads that may not be ideal if efforts are being made to cut costs (Katz & Melmed, 2016).
“Activity-Based Costing Method” is a method that recognizes the activities required to provide a service, then estimates the cost that those activities may incur, and finally aggregates those costs through a bottom-up approach to costing. The main benefit of this technique is a very accurate method to regulate the product costs and provides information about the behavior of those costs which helps in making better decisions. However; the disadvantage of this method is that this method can be expensive, complex, and may not benefit small organizations. “Time-Driven-Activity-Based Costing (TDABC) Method” is a relatively new method and emphases on the complete cycle of the patient’s care relatively than focusing on the individual cost of services. This method has more accuracy than the Activity-Based Costing Method which allows the activities are high towards the resources to be highly traceable but if it is traced to the products then the traceability is low. The disadvantage of this method is that it is not very feasible.
Part 2: Case Study
$71,468 is the estimated marginal cost for the hospital services of Phase 4.
Total cost = Marginal (new) fixed costs + Variable costs
= Marginal (new) fixed costs + (Variable cost rate x Marginal volume)
$2,144,034 = $0 + $71,468 x 30
The average marginal cost per transplant= $71,468
If the marginal volume exceeds more than thirty patients then the Fixed Marginal Cost would increase up to 15-25% in proportion to the current fixed cost of $5,800,440, so additional fixed costs would be required if the volume exceeds thirty patients. If the phase 4 requires services to be at $90,000 then the fixed cost would 37%, as calculated below:
Total cost = Fixed costs + Variable costs
$119,805 = (Y x $80,562) + $90,000
Y = ($119,805 – $90,000) / $80,562
= 37%
If the proportion of the fixed costs is at 50% the price would increase to $79,524 but if the fixed cost proportion is at 70% then the price would decrease to $63,412.
| Marginal Contract Volume | 15% | 20% | 25% |
| 31 | $99,534 | $108,890 | $118,264 |
| 60 | $85,969 | $90,803 | $95,636 |
The marginal costs are calculated at less as compared to the average cost of the transplant procedure. The new marginal cost would be adjusted at 20% if the marginal volume exceeds 30 patients. In this way, the cost of transplant will still be reasonably low. The final recommendation would be $108,890 this calculation is based on the 20% proportion on the marginal volume of additional 31 patients.
The Cost Outlier method should be used for this case study and the amount of $118,246 should be added while keeping the contract threshold at 80%.
The first key learning point is that it is not sustainable to use the Marginal costs for the long-term but if it is being used for the long-term then to ensure the full cost coverage; cross-subsidization should be utilized as well. The second takeaway is that a deep understanding of cost structure is required to make relevant decisions about the underlying costs. Lastly, when facing extreme cost variability it is extremely important to have the ability to negotiate outlier protection (Reiter et al., 2021).
References
Katz, S., & Melmed, G. (2016). How Relative Value Units Undervalue the Cognitive Physician Visit: A Focus on Inflammatory Bowel Disease. Gastroenterology & Hepatology, 12(4), 240–244.
Reiter, K. L., Song, P. H., Gapenski, L. C., & Association of University Programs in Health Administration. (2021). Gapenski’s healthcare finance: An introduction to accounting and financial management. http://search.ebscohost.com/login.aspx?direct=true&scope=site&db=nlebk&db=nlabk&AN=2558485
Shwartz, M., Young, D., & Siegrist, R. (1995). The Ratio of Costs to Charges: How Good a Basis for Estimating Costs. Inquiry : A Journal of Medical Care Organization, Provision and Financing, 32, 476–481.
