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The Tension Between Healthcare Pricing and Consumerism

August 10, 2017

Last year, HGP discussed the concept of Exploiters and Solvers in the healthcare industry.  The U.S. healthcare economy is indisputably inefficient.  Inefficient markets create opportunities for exploitation or solution.  Exploiters seek to exploit inefficiencies to maximize returns for a select few.  Solvers seek to eliminate inefficiencies to maximize returns for many.  In the context of healthcare, one can quickly see the potential for moral hazard.  Martin Shkreli, for example, is an egregious exploiter.

However, exploiting versus solving in healthcare cannot be taken at face value because economic interests often do not align with patient interests.  Martin Shkreli is chastised for his actions, but many stakeholders in the healthcare industry pursue some degree of self-interest at the expense of  patients that ultimately utilize their product.  Two non-profit health systems in the same region may compete at the expense of the patients they serve.  Shkreli just crossed the subjective line of moral hazard. 

The basic economic pricing model underscores the disconnect.  Pricing is generally the equilibrium (or optimization point) between profit and quantity based on the consumer’s perceived value of the product.  In practical terms, this means that a product is priced as high as a customer can bear before choosing a substitute product.  The latter definition of pricing certainly sounds like a moral hazard in the context of healthcare, and it would be if the patient were the customer.  However, the patient is not the customer because he or she is not part of the economic equation to establish price equilibrium.

Payers sell to employers.  Providers sell to payers and employers.  Drug companies sell to pharmacies and distributors in a complex value chain.  High deductible health plans are shifting financial responsibility toward the patient, but not to the extent to disrupt economic pricing.  Value-based payment models may begin to address alignment of interests, but these models do not solve for making the patient the customer in economic terms.  The individual, whether the patient, member, employee, or consumer, is the derivative of another primary economic relationship. 

The supply and demand relationship matters because any company selling into these channels must be aware of basic economic relationships in order to design an effective go-to-market strategy.  Just as frequently as companies are guilty of being exploiters, they fall into the trap of idealism.  By idealism, we mean that companies design a patient-centric value proposition that is disconnected from the economic reality of the market.  We encourage companies and investors to take a pragmatic approach that mixes idealism with realism.

HGP sought to test a hypothesis: does the market assign different valuations to companies based on the value they deliver to patients?  HGP suspected, and the data shows, that there is an optimization zone: the highest valuations are achieved by companies that align economic interests with patient interests, but don’t necessarily compromise one for the other.  This zone will continue its progression to the right as value-based payment models and patient financial responsibility proliferate.  However, the data and our experience supports that a company is better off erring to the left than being too far to the right.  For example, anyone with experience in the Health IT industry can cite dozens of companies that have either failed or pivoted the business model after unsuccessfully launching into the patient (consumer) market.  Incentives are strong to manage the chronically and acutely ill, but there are very few economic incentives to manage health before health care even begins, even though the moral incentive is very strong.

Unfortunately, the economic model of healthcare is such that patients are a byproduct of traditional economic principle.  While this is not new information, it is often lost on those designing solution-oriented business models geared toward consumerism. Participants in the consumer market must balance the interests of the consumers they serve with the interests of other stakeholders that control the economics of the market. The reality is that consumerism, from an economic pricing perspective, is inching closer but has yet to reach the point of disrupting traditional healthcare economics.  Disrupting the fundamental economics of healthcare is the holy grail that would enable the health IT industry to unleash its full potential. Until then, business models that crack the nut of solving for conflicting stakeholder interests, shortening sales cycles, and improving the cost and quality of care will get there faster than those that ignore the economic reality of the market.