At the Margins

What the telecom wars can teach us about hospital pricing strategy

I was just talking to a colleague about the recent public furor about hospital pricing, and he told me a great out-of-industry story, one from earlier in his career, that I thought was worth sharing more broadly because it casts the pricing issue in a new—and in some ways even more threatening—light.

The tale of the terrible telecom

Many years ago, when my colleague was a young management consultant, he worked on an engagement for a large telecommunications company. The telecom company’s CEO had decided they needed a better pricing strategy, and my colleague's consulting firm was brought in to help.

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The consultants quickly discovered the CEO was right—his telecom company was frequently losing bidding contests to competitors, far more often than chance would suggest. And the contracts it was winning were often unprofitable.

The real problem: Poor cost accounting

More digging uncovered an uncomfortable fact: the client had a poor grasp of how much it cost to provide their services, but competitors seemed to have a much better handle on their cost structure.

This is how it played out in the market: competitor companies offered below-average pricing to customers when the actual costs of delivering the services were lower than average—say, when a competitor already owned a fiber-optic switching center located in a customer’s building.

But my colleague's client didn't take its costs into account in setting prices, and therefore would miss out on opportunities to be the low-price option, even when it held a cost advantage over competitors. By the same token, if for some reason a customer would be more expensive than average to serve, his client would still charge them the standard rate—and margins would suffer.

What happened in the end? With the help of the consultants, the telecom company realized they had a cost accounting problem just as much as they had a pricing problem. But they didn’t realize soon enough—before too long, they were acquired by a more successful competitor.

Could hospitals suffer a similar fate?

You might be wondering what this story has to do with health care.

Well, the brouhaha about hospital pricing has brought to light what the industry has known for a long time—most health care organizations do not have a solid grasp on what their costs are for providing any given service.

Until now, the sloppiness of health care pricing hasn't mattered for most providers and most consumers, since the multiple and byzantine ways that health care gets paid for in the U.S. means that "price" is usually irrelevant to actual payment.

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But as ever more health care costs are paid out-of-pocket, thanks to the prevalence of high-deductible health plans and other cost-sharing schemes, price may be finally become an important factor in whether your institution wins patients’ business.

If you don’t have a clear view of how much it costs you to provide services, and your competitors do, you could suffer the same fate as my colleague's client: overpricing where you actually hold a competitive advantage, underpricing where your cost structure is less favorable, and ultimately falling behind the rest of the market.

Michael KoppenhefferMichael Koppenheffer is an expert on health care product development, marketing, and technological innovation, with two decades of experience as a consultant and researcher.

See all of Michael's blog posts.