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You are the manager of a 20-physician cardiology practice

Economics

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You are the manager of a 20-physician cardiology practice. You are getting ready to advise your board about a proposal for capitated specialty care from a local HMO. Data from your fee-for-service practice show billings per member per month of $100 for visits, $80 for catheterizations, and $115 for lab. The practice owns the labs, and the profits are shared among the partners. Your estimate is that costs (aside from physician income) equal 25 percent of charges. The proposal from the HMO is for a rate of $275 per member per month. Your immediate reaction is to reject it. Your CFO makes two comments that give you pause. She argues, “Our overhead will drop significantly if we accept this proposal and convert 25 percent of our business to capitation. In addition, we should anticipate that our rates for visits, catheterizations, and tests will drop significantly once we convert.” The flip side of the pricing problem, contracting, is even tougher. Economic models of pricing tell us managers need to know what their incremental costs are, what markup over incremental costs they should expect, and what their rivals will bid. Each of these will be uncertain to some degree, and many healthcare firms have only sketchy cost data. This is especially true for incremental costs, which many firms are not prepared to track. Without good data on incremental costs, managers will be flying blind and may be tempted to base their bids on average costs. This usually costs some profitable business opportunities. In this case there are only two other cardiology groups in town. You are not sure whether they have been asked to bid or not. Your legal counsel has warned you that direct discussions with your rivals might leave you open to an anti-trust suit. Discussion questions:

• Why is your initial response to reject the offer?

• Why might overhead go down if you accept the contract?

• Why might utilization rates go down?

• What are the risks of accepting or refusing?

• What should you do next? Should you accept the proposal? Should you make a counteroffer?