Higher prices for the first few procedures, followed by a volume discount, may help balance risks and rewards
Some primary care organizations — physician practices and community hospital networks that may own such practices — have transformed into accountable care organizations (ACOs), acting much like a health insurer. ACOs receive set amounts from insurers or employers to care for a population of patients and then are responsible for the cost of all care those patients need. When a patient needs a specialist, the ACO must refer out for the services and pay for them.
This ACO-specialist relationship has created a new set of risks for each party. Unlike referring physician practices in traditional health care arrangements, ACO practices have keen financial interests in keeping referrals to specialists low. The ACO’s risk is that its patients will require more than the expected amount of specialist care, causing the ACO financial losses.
The specialist practice’s risk is that the ACO will be successful in limiting the amount of specialist care required, and that the specialist practice won’t have enough referrals to be profitable.
A two-price contract between these parties may help balance risks and rewards in the relationship, according to a working paper by UCLA Anderson’s Fernanda Bravo, Massachusetts Institute of Technology’s Retsef Levi and Georgia Perakis, and University of Toronto’s Gonzalo Romero. A negotiated volume discount, in which the ACO pays the specialist at a lower rate after a certain amount of business is referred, reduces key risks for both sides of the deal, the findings suggest.
A two-tier volume discount contract helps protect both sides against the exceptionally unpredictable demand for health care. If 200 of an ACO’s 400 members suddenly need hip replacements, it’s supposed to pay for all of those procedures. The lower price, after a certain number of new hips, keeps a lid on the ACO’s costs even when demand is high.
Specialists want protection against the lulls in business that the ACO is working so hard to create. Like other businesses, specialist practices require a certain level of work to maintain staff, equipment and other necessities of providing their services as needed. The higher fee at the front end helps cover these costs more quickly.
Traditional health insurers already ask specialists for volume discounts, but they often approach with a single price offer. Bravo and her colleagues began this study while working with a specialist care service under pressure to provide volume discounts to primary care practices that had recently joined an ACO.
Any particular industry aside, the paper seeks to deal with how risks, related to demand uncertainty, are best shared in the service chain. Volume-based discount contracts have been used in industries such as manufacturing and services, but the adoption of such practices in health care has been unusual. The main reason is that in the past it was an insurance company bearing all the risk of high costs and very large insurers could spread risk across enormous patient populations. In contrast, under the new environment, this risk is pushed down the service chain — to ACOs, say. The industry is slowly looking for best practices in other business settings and adapting these practices to the specifics of health care.
The two-price volume discount does a better job of reducing risk for both sides than single price contracts or other, more complicated, volume-based contracts, according to the findings.
Assistant Professor of Decisions, Operations and Technology Management
About the Research
Bravo, F., Levi, R., Perakis, G., & Romero, G. (in progress). A risk-sharing pricing contract in B2B service-based supply chains.