Identifying A Pricing Strategy
To make decisions about the cost 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.
The “Cost-to-Charge Ratio Method” is one of the most used methods, and it is used to evaluate the proportion overhead cost of individual-based services. It uses two sets of assumptions: indirect cost and reimbursement rates. This method is considered a “golden standard”, and it is a good choice when diagnoses related to average costs are being examined. However, it is not very reliable for determining the relative costs of the hospital (Shwartz et al., 1995). The “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 the service and the time consumed while providing that service. It is mostly used when calculating overhead costs, and it is also used when estimates regarding RVU values have been gathered. The disadvantage of this method is that it is beneficial for physicians who work faster, and it penalizes those who do not. It may be encouraging for some to employ this method; however, it may cause physicians to over-utilize resources like tests. This may rack up the overheads, which 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 that it is a very accurate method to regulate product costs and provides information about the behaviour of those costs, which helps in making better decisions. However, the disadvantage of this method is that it can be expensive and complex and may not benefit small organizations. The “Time-Driven-Activity-Based Costing (TDABC) Method” is a relatively new method and emphasises the complete cycle of the patient’s care rather than focusing on the individual cost of services. This method has more accuracy than the Activity-Based Costing Method, which allows the activities that are high towards the resources to be highly traceable, but if they are 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 by 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 phase 4 requires services to be at $90,000, then the fixed cost would be 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 than 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 transplants will still be reasonably low. The final recommendation would be $108,890. This calculation is based on the 20% proportion of the marginal volume of an additional 31 patients.
The Cost Outlier method should be used for this case study, and $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 cross-subsidization should be utilized to ensure full cost coverage. 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.
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