Health Services Marketing 7-9 Discussions

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Welcome to Health Services Marketing. In this lesson, we will discuss pricing strategies and decisions in health care

 

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Upon completion of this lesson, you will be able to:

 

Describe the various tools of the marketing mix available to health care providers.

 

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Transparency is a term that is applied to a given situation in which prices are accessible to consumers prior to services being rendered. When there are price inconsistencies and absence of transparency, local, state, and federal government intervention may occur. Private insurance companies are involved in transparency as seen when Aetna made available online the prices it negotiated with Cincinnati area physicians regarding a significant amount of medical procedures and tests.

 

There is public concern regarding health care costs. In this lesson, we will discuss approaches that organizations can implement to set their prices. In our discussion, it is very important to keep in mind that pricing methods depend on a combination of who the pay is, what the product is, and the location where it is used. Our focus will be on the three types of payers:

Consumers

Government; and

Private entities.

 

as well as the pricing decisions that are essential to each of them.

 

 

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Consumers are one type of payer that for the most part have insurance that pays for most of their health care costs. However, we will discuss when insurance is not the consumer’s option to pay health care costs. The seller of health care products and services use traditional market analysis tools in this case. Traditionally consumers are price takers. Price takers are consumers that accept prices at face value or as given. In regards to health care products and services, consumers have traditionally been price takers.

 

Consumers use a frame of reference such as their knowledge on prior purchase, formal communication like advertisements, sales calls and brochures, informational communications like word of mouth from friends, colleagues, or family members, and point of purchase or online resources. It is important to have an understanding of how consumers obtain their price perceptions, reference prices, price quality inferences, and price cues.

 

Reference prices are prices that are the result of comparing a product’s indicated price to pricing information from memory or an external frame of reference. Price quality inferences are inferences that many consumers use price as an indicator of quality when there is no other information available. Price quality inferences are applied for products where consumers pay with their disposable income such in cases of cosmetic surgery. Consumers’ perception regarding health care product and services can also be affected by price cues. This is evident in products with prices that end in an odd number. Research indicates that consumers have a tendency to process prices in a left to right manner instead of by rounding. In this manner, price encoding is essential if there is a mental price break at the higher, rounded price.

 

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It is a normal practice for the seller to set a price upon development, introduction, or enters bids regarding a new product. Different industries have different pricing points or price tiers, and levels that can be found in a distribution channel. There is a seven step procedure used to assist an organization in considering the factors in setting its pricing policy:

 

Step One. Selecting the pricing objective. Five major objectives through its pricing can be pursued in order to decide where an organization wants to position its market offering: survival, maximum current profit, maximum market share, maximum market skimming, or product-quality leadership.

 

Survival is a short term objective that is appropriate when organizations are afflicted with overcapacity, intense competition, or changing consumer wants. As long as prices to cover variable costs and some fixed cost are covered, the organization remains in business. Since this is an short run objective, the organization must learn how to add value or face extinction in the long run. In order to obtain the maximum current profit, organizations estimate the demand and costs associated with alternative prices, choosing the one that provides maximum current profit, cash flow, or rate of return on investment. One trade off regarding current performance is that an organization may sacrifice long run performance by under spending on brand building or ignoring competitors’ long run responses. If the maximum market share objective is chosen by organizations, then they believe that a higher sales volume will lead to lower units costs and high long run profit. Market penetration is a tactic where the organization will set a very low price in order to obtain a high share. This tactic is appropriate when the market is highly price sensitive and a low price stimulates market growth. A collection of experience can cause production and distribution costs to fall and the lower price will discourage competition. This is not illegal predatory pricing. Illegal predatory pricing is when very large organizations price below their production cost to drive small, more poorly financed organizations out of business.

 

Organizations introducing new technology may set high prices to maximize market skimming to gain as much revenue as possible in the short run. Price skimming is when prices start high and are slowly lowered over time when competitive offerings and generic substitutes become available. This is seen in the pharmaceutical industry frequently. It is important to note that if prices are set too high, the product may fail to gain customers or may be excluded from formularies. Price skimming is ideal when:

 

One. There is a sufficient number of buyers have a high current demand;

Two. The unit costs of producing a small volume are not so high that they cancel the advantage of charging what the traffic will bear.

Three. The high initial price does not attract more competitors to the market, and

Four. The high price communicates the image of a superior product.

The aim is for organizations to become the product quality leaders in the market where they produce gold standard quality and charge premium prices.

 

Step Two. Determining demand. Price and demand are inversely related meaning that the higher the price, mthe lower the demand. In order to estimate demand, one must understand what affects price sensitivity. Consumers are most price sensitive when products are very costly or purchased frequently. The opposite is true also. Consumers are less price sensitive when price is only a small portion of the total charge to have, operate, and service the product over its lifetime. A seller is able to charge a higher price than its competition and still obtain the business if it can convince the customer that it offers the lowest total cost of ownership or TCO. In estimating demand, an organization can use one of three methods:

 

One. Analyze past data and their relationships to each other such as prices, units, sold, referrals, admissions, visits, and procedures;

Two. Conduct field experiments to observe the effect of varying prices on the same products in different, but similar, markets; or

Three. Use prospective surveys to explore how likely consumers indicate they are to purchase at various proposed prices.

 

Price elasticity of demand is the sensitivity of the volume change to alternation in price. The demand is inelastic if the demand change is minimal with a small change in price. Third party insurance coverage and other health care products and services fit into this category. If the demand changes with price, then it is elastic. The larger the volume growth as a result from a price reduction, the larger the positive price elasticity. Demand is likely to be less elastic under the following conditions:

 

One. There re few or no substitutes or competitors;

Two. Buyers do not notice the higher price;

Three. Buyers are slow to change their purchasing habits.

And four. Buyers believe the higher prices are justified.

 

The range of prices for which demand is inelastic is the price indifference band, and organizations apparently want to operate at the highest point in this range.

 

Step Three. Estimating costs. In estimating cost for a given product, the organization needs to charge a price that covers its cost of production, distribution, and selling the product as well as include a fair return for its effort and risk. There are types of cost and levels of productions. Fixed cost are cost that do not changed with production or sales revenue regardless of output and subject to capacity constraints. Variable costs differ directly with the level of production. Total costs consist of the sum of the fixed and variable costs for any given level of volume. Average cost is equal to total costs divided by volume.

 

Step Four. Analyzing competitors’ costs, prices and offers. An organization also looks at the competitors’ cost, prices, and possible price reactions into account through an analysis. During this process, the organization should consider the distinct features its product offers and whether they are valued by the customers who are willing to pay more. Shadow pricing is the practice of adjusting prices to keep them just under those of the competition.

 

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Step Five. Deciding whether to use price as a competitive strategy. Competitive strategy can be a marketing strategy since there are sales of many goods and services that are sensitive to price reductions.

 

Step Six. Selecting a pricing method. An organization can implement the three C’s to price products: customers’ demand schedule, the cost function, and competitors’ prices. The cost set a floor to the price. The competitors’ prices and the price of substitutes provide an orienting point, and customers’ value assessment of unique features established the price ceiling. There are three price setting methods: markup pricing, target return pricing, value pricing, and going rate pricing. Markup pricing is the most elementary pricing method. It is to add a standard markup to the product’s cost, either a fixed amount or a percentage. Markup pricing are popular for the following reasons: (1) the seller can estimate production costs easier than demand; (2) when all organizations in the industry implement this pricing method, prices tend to be similar if their cost are similar; therefore price competition is minimized; and (3) many people believe that cost plus pricing is fairer to both buyers and sellers. Sellers do not take advantage of the buyer when the latter’s demand increases and sellers earn a fair return on investment. Target return pricing is when the organization determines the price that would yield its target rate of return on investment (ROI). This method is used by public utilities. When using this method, the manufacturer must consider different prices and estimate their probable impacts on sales volume and profits. Value pricing is when the organization base their price on the customer’s perceived value of their product. In going rate pricing, the organization bases its price on the competitors’ prices.

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Step Seven. Selecting the final price. The organization must consider additional factors including the impact of other marketing activities, overall organizational pricing policies, gain and risk sharing pricing, public perceptions, and the impact of price on other parties. The final price must take into consideration the brand’s quality, positioning, and promotion associated to the competition (the influence of other marketing activities). In the pharmaceutical industry, direct to consumer (DTC) advertising can strongly impact patient demand for a particular medication. Organization pricing policies dictate the price ranges or methods of relative pricing for their portfolio of products and services. Pricing policy also allow salespeople a range in which they can negotiate with their customers. Buyers may not accept a seller’s proposal due to a high perceived level of risk. At times, the seller may offer to absorb part or all of the risk if the product does not deliver the full promised value/ This is called gain and risk sharing pricing. In setting the price, the organization must also look at the impact of price on other parties such as the reactions of other stakeholder to the proposed price. In addition, it is important for marketers to be cognizant of the laws regulating pricing. There are federal and state statues that protect consumers against deceptive pricing practices.

 

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Organizations usually develop a price structure that reflects variations regarding geographical demand and cost, market segment requirements, purchase timing, order levels, delivery frequency, guarantees, service contracts, and other factors. We will now discuss price adaptation strategies: geographical pricing, price discounts, and allowances, promotional pricing, and differentiated pricing.

 

Geographical pricing. The organization decides how much to charge customers in different locations. Over the counter medications prices may vary by neighborhoods.

 

Price discounts and allowance. Many organizations will adjust their list price and provide discounts and allowance for early payment, volume purchases, and off season buying. Discounting is a great tool if the organization can gain value in return such in the case when the customer agrees to:

 

Sign a three year contract;

Is willing to order electronically; or

Purchases in large quantities.

 

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Promotional pricing. Organizations can implement many pricing techniques to stimulate early purchase. These are:

 

One. Lost leader pricing. An example of lost leader pricing is obstetrical services. Hospitals are not able to charge enough to cover their expenses due to women being the primary decision makers for family’s health choices; therefore, investment in these services can assist in stimulating future hospital use when the need occurs.

Two. Special event pricing. Sellers will offer special prices to attract customers for special occasions such as opening a new store, launching a new product line, or celebrating some other special event.

Three. Seasonal discounts. Since health care revenue cycles can be cyclical, to smooth the demand, some organizations offer special pricing during predictable downturns. For example, cosmetic dermatology services are often promoted in the spring and summer months.

Four. Cash rebates. Health care organizations offer cash rebates to encourage purchase of a manufacturer’s products within a specific time period. An example of this would be coupons for diabetic patients toward the purchase of a glucose monitoring machine.

Five. Low interest financing. Organizations may offer low interest financing instead of cutting its price. This technique is attractive for health care information technology firms due to the price of annual service contracts being based on a percentage of the system’s sales price.

Six. Longer payment terms. This is a strategy used by medical device and pharmaceutical companies that stretches loans over longer periods and lowers the monthly payments.

Seven. Warranties and service contracts. Organizations can promote sales by adding a free, low cost or extended warranty or service contract.

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Eight. Psychological discounting. This is a strategy that involves setting an artificially high price and then offering the product significant savings.

 

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Differentiated pricing. Organizations often adjust their basic price to accommodate variances in customers, products and locations. Price discrimination happens when an organization sells a product at two or more prices that do not reflect a proportional difference in costs.

There are three degrees of price discrimination:

First degree discrimination is when the seller charges a separate price to each customer depending on the intensity of his demand.

Second degree discrimination is when the seller charges less to buyers who buy a larger volume.

And third degree discrimination is when the seller charges different amounts to different classes of buyers such as the following:

Customer segment pricing is when different customer groups are charged different prices for the same product. A classic example is that a health plan charges a low premium for students and a higher premium for senior citizens.

Product form pricing is when different versions of the product are priced differently, but not proportionately to their respective cost. A pharmaceutical company may charge 35 dollars for a thirty day supply of a drug in a 10 mg dosage, whereas the 15 milligram dose will cost 90 dollars.

Image pricing is when some organizations price the same product at two different levels based on different images held by different buyers.

Channel pricing is when pricing for the same item can be different depending on the distribution channel. An example of this is a ninety day supply of medication is usually cheaper if purchased from a mail order pharmacy than from the local drug store.

 

Location pricing is when the same product is priced differently at different locations even though the cost of offering at each location is the same. An example is a tertiary care hospital that offers cosmetic surgery services in its urban facilities in Washington, DC may charge a higher price for the same procedures offered by its satellite facility in Alexandria, Virginia.

 

Time pricing is when prices are varied by time of year or day of week. An example of this is if pharmacy traffic is slower midweek, it may offer discount prices on Wednesdays.

 

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Organization may have to change their prices due to various situations. We will now discuss price increases strategies.

 

Many organizations initiate price increases to maintain profits when they encounter cost inflation. However, organizations try to increase prices as few times as possible to avoid customer antagonism. When they anticipate rising cost, they often raise their prices by more than they expect in the short run. This is called anticipatory pricing. Over demand is another factor that causes price increases. In cases where the organization cannot supply all of its customers, it may use one of the following techniques:

 

Delayed quotation pricing. The organization does not set a final price until the product is finished or delivered. This implemented most in industries with long production lead times and in economies that are experiencing fast inflation.

 

Escalator clauses. The organization requires the customer to pay today’s price and all or part of any inflation increase that take place prior to delivery. This clause bases price increases on some specified price index. These contracts are evident in major project such as construction and standard in property rent agreements.

 

Unbundling. The organization maintains its price but removes or prices separately one or more components that were part of a former offer such as free delivery or installation.

 

Reduction of discounts. The organization instructs its sales force not to offer its normal cash and quantity discounts.

 

And reduction of size. The amount delivered to the customer is reduced while the price remains the same.

 

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Reactions to price changes. Market leaders can respond to frequent aggressive price cutting by newer or smaller organizations trying to establish market share by any of the following:

 

Maintain price and profit margin. The market leader can maintain its price and profit margin, it believes

 

One. It will lose too much profit if it reduced its price;

Two. It will not lose much market share to the competitor; and Three. It could regain market share when necessary.

 

Maintain price and add value. The organization may find it cheaper to maintain price and spend money to improve perceived quality instead of cut price and operate at a lower margin.

 

Reduce price. Prices can be lowered to match the competitor’s price. This strategy can be attractive if the organization needs to maintain a certain production volume to hold down its costs and if it foresees difficulty in regaining market share once it is lost.

 

Increase price and add brands. Prices can be raised and new brands introduced to bracket the attacking brand.

Launch a low price line. Lower priced items can be added to the line or a separate, lower priced brand can be created.

 

Any of these can be applied, but the organization must also factor the product’s state in the life cycle, its importance in the organization’s portfolio, the competitor’s intentions and resources, the market’s price and quality sensitivity, the behavior of costs with volume, and the company’s alternative opportunities.

 

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When the government is the payer of health care products and services, the seller must accept the amounts and payment methods the government sets. US Congress sets the method of payment and how rates will be increased or decreased over time and Centers for Medicare and Medcaid Services or CMS administer the pricing schemes for Medicare, Medicaid, and Veterans Administrative Programs. Prices are based on what was one, what was provided, and why or by procedure, product, and diagnosis. A series of standardized codes have been developed by different organizations to compare episodes of care, set prices, and expedite payment. The three common coding systems are as follows:

 

Current Procedural Terminology 4th Edition or CPT-4 is copyrighted by the American Medical Association. It is a system that list procedures, usually with a five digit code.

 

Healthcare Common Procedural Coding System or HCPCS is a government code that CMS issues and updates annually. This system include health care products such as injectable pharmaceutical, durable equipment and disposable medical supplies as well as procedures and professional services such as dentistry and temporary medical service codes. These codes are in the form of a letter followed by four digits.

 

International Classification of Disease or ICD is the World Health Organization’s disease listing system which countries may modify accordingly. The recent version is ICD-10 which was can into use after 1994. However, ICD-9CM is still in use. Most IDC-9CM codes are three digits, followed by up to two more digits after a decimal point.

 

Resource Based Relative Value Scale is a fee schedule that uses the CPT-4 coding system.

 

Diagnosis related group or DRG is a scheme that hospitals are paid that relies on ICD-9CM codes. The federal government sets many other fees according to a variety of prospective payment system. DRG is a flat fee regardless of the number or costs of services or products provided.

 

There are other considerations for pharmaceutical companies who price their products outside the US. Other countries consider drug prices when they decide whether to approve a drug for sale. The method these countries implement to determine the price often depends on a comparison to prices of the same product or therapeutic category in other selected nations or reference (index) pricing.

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Actuaries provides estimates of the frequency of utilization for a variety of health care services for the target population in a health care organizations. The estimate is equivalent in the product sector to the cost of goods sold. When the plan is on the market, the actual cost data for this utilization or medical expanse ratio can be obtained which accounts for 80 to 85 percent of the premiums that an organization charges. An additional 10 to 15 percent of premiums for sales, general and administrative or SG&A expenses are estimated. To provide an understanding on how much the consumer is responsible for paying for health care, the following must be defined:

 

Premium. This is the amount the consumer pays to purchase an insurance product. A certificate of insurance specifies what it covers and how much of the expense the plan will pay. The rest is the responsibility of the consumer.

 

Deductible. This is the amount the consumer pays prior to the insurance starts to cover charges.

 

Coinsurance. This is a percent of charges the patient pays.

The remainder is the responsibility of the insurance company.

 

Copayment. This is the amount the consumer patient pays for every encounter, whether it is for receiving a service or buying a product such as medication.

 

When health insurance is responsible for any benefits, all of these terms apply to determine the total consumer cost for a product or service. The actuarial cost previously discussed and the patient’s out of pocket cost such as deductibles, copayments, and coinsurance when pricing their products. Due to the majority of health care purchases being relatively low cost, even small increases in patients’ upfront payments can result in large premium reductions.

 

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We have now reached the end of this lesson. Let’s take a look at what we’ve covered.

 

First, we discussed the task of setting prices that differ depend on who the payer is:

Patient;

Government;

Private parties; or

A combination of any of the above.

 

Next, we looked at seven theories of setting appropriate prices for patients. These are

One. Selecting the pricing objective.

Two. Determining demand.

Three. Estimating costs.

Four. Analyzing competitors’ costs, prices, and offers.

Five. Deciding whether to use price as a competitive strategy.

Six. Selecting a pricing method such as markup, target return pricing, value pricing, and going rate pricing.

And seven. Selecting the final pricing.

 

In addition, we looked at modifying the theory by the any of the following other factors:

 

Health care organization’s brand strength;

Its pricing policies;

Government regulations; and

The impact of price on other stakeholders.

 

We also discussed prices going through more adjustment to take into account geographical factors, price discounts and allowances, promotional pricing, and differentiated pricing.

 

Next, we discuss when an organization needs to initiate a price increase or reduction and when to react to competitors’ price initiatives.

 

We then discussed how the government exercises its right to set prices for payment under the Medicare, Medicaid, and Veterans’ administration programs. It has also set up a system for price determination that depends on the nature of the product or service and where it is provided.

 

Finally, we discussed private insurers. They set the medical conditions that they will cover and indicate what they will pay. They often use governmental guidelines.

 

This concludes this lecture.