Briefly describe how outlier payments might be handled to ensure that the Center does not suffer large losses on outliers (patients with unusually high costs). (Hint: Cost outliers are identified by having costs that exceed a specified threshold.
here are the questions and cases.
Better Care Clinic
Fairbanks Memorial Hospital, an acute care hospital with 300 beds and 160 staff physicians, is one of 75 hospitals owned and operated by Health
Services of America, a for-profit, publicly owned company. Although there are two other acute care hospitals serving the same general population, Fairbanks historically has been highly profitable because of its well-appointed facilities, fine medical staff, and reputation for quality care. In addition to inpatient services, Fairbanks operates an emergency room within the
hospital complex and a stand-alone walk-in clinic, the Better Care Clinic, located about two miles from the hospital.
Todd Greene, Fairbanks’s chief executive officer (CEO), is concerned about Better Care Clinic’s financial performance. About ten years ago, all three area hospitals jumped onto the walk-in-clinic bandwagon, and within a short time, there were five such clinics scattered around the city. Now, only three are left, and none of them appears to be a big money maker. Todd wonders whether Fairbanks should continue to operate its clinic or close it down.
The clinic is currently handling a patient load of 45 visits per day, but it has the physical capacity to handle more visits—up to 60 per day. Todd has asked Jane Adams, Fairbanks’s chief financial officer, to look into the whole matter of the walk-in clinic. In their meeting, Todd stated that he
visualizes two potential outcomes for the clinic: (1) the clinic could be closed or (2) the clinic could continue to operate as is.
As a starting point for the analysis, Jane has collected the most recent historical financial and operating data for the clinic, which are summarized in Table 1. In assessing the historical data, Jane noted that one competing clinic had recently (December 2008) closed its doors. Furthermore, a review of several years of financial data revealed that the Fairbanks clinic does not have a pronounced seasonal utilization pattern.
Next, Jane met several times with the clinic’s director. The primary purpose of the meetings was to estimate the additional costs that would have to be borne if clinic volume rose above the current January/February average level of 45 visits per day. Any incremental volume would require additional expenditures for administrative and medical supplies, estimated to be $4.00 per patient visit for medical supplies, such as tongue blades, rubber gloves, bandages, and so on, and $1.00 per patient visit for administrative supplies, such as file folders and clinical record sheets.
Although the clinic has the physical capacity to handle 60 visits per day, it does not have staffing to support that volume. In fact, if the number of visits increased by 11 per day, another part-time nurse and physician would
have to be added to the clinic’s staff. The incremental costs associated with increased volume are summarized in Table 2.
Jane also learned that the building is leased on a long-term basis. Fairbanks could cancel the lease, but the lease contract calls for a cancellation penalty of three months rent, or $37,500, at the current lease rate. In addition, Jane was startled to read in the newspaper that Baptist Hospital, Fairbanks’s major competitor, had just bought the city’s largest primary care group practice, and Baptist’s CEO was quoted as saying that more group practice acquisitions are planned. Jane wondered whether Baptist’s actions should influence the decision regarding the clinic’s fate.
Finally, in earlier conversations, Todd also wondered whether the clinic could “inflate” its way to profitability; that is, if volume remained at its current level, could the clinic be expected to become profitable in, say, five years, solely because of inflationary increases in revenues? Overall, Jane must consider all relevant factors—both quantitative and qualitative—and come up with a reasonable recommendation regarding the future of the clinic.
Better Care Clinic
Historical Financial Data
CY 2008 Jan/Feb 2009
Number of visits 41 45
Net revenue $1,524 $1,845
Salaries and wages $ 428 $ 451
Physician fees 533 600
Malpractice insurance 87 107
Travel and education 15 0
General insurance 22 28
Utilities 41 36
Equipment leases 4 5
Building lease 400 417
Other operating expenses 288 300
Total operating expenses $1,818 $1,944
Net profit (loss) ($ 294) ($ 99)
Better Care Clinic
Incremental Cost Data
Medical supplies $4.00 per visit
Administrative supplies 1.00
Total variable costs $5.00 per visit
Salaries and wages $ 100
Physician fees 267
Total daily semifixed costs $ 367
Note: The semifixed costs are daily costs that apply when volume increases by 11–20 visits. However, the physical capacity of the clinic is only 60 visits per day.
1. Using the historical data as a guide, construct a pro forma (forecasted) profit and loss statement for the clinic’s average day for all of 2009 assuming the status quo. With no change in volume (utilization), is the clinic projected to make a profit?
2. How many additional daily visits must be generated to break even?
3. Thus far, the analysis has considered the clinic’s near-term profitability—that is, an average day in 2009. Redo the forecasted profit and loss statement developed in Question 1 for an average day in 2014, five years hence, assuming that volume stays constant (does not increase). (Hint: You must consider likely changes in revenues and costs due to inflation and other factors. The idea here is to see whether the clinic can “inflate” its way to profitability even if volume remains at its current level.)
4. Suppose you just found out that the $3,215 monthly malpractice insurance charge is based on an accounting allocation scheme that divides the hospital’s total annual malpractice insurance costs by the total annual number of inpatient days and outpatient visits to obtain a per-episode charge. Then, the per-episode value is multiplied by each department’s projected number of patient days or outpatient visits to obtain each department’s malpractice cost allocation. What impact does this allocation scheme have on the clinic’s true (cash) profitability? (No calculations are necessary.)
5. Does the clinic have any value to the hospital beyond that considered by the numerical analysis just conducted? Do the actions by Baptist Hospital have any bearing on the final decision regarding the clinic?
6. What is your final recommendation concerning the future of the walk-in clinic?
Panhandle Medical Practice
Panhandle Medical Practice is a group practice owned by the area’s leading hospital, Panhandle Regional Medical Center. The practice includes both primary care and specialty physicians, with an emphasis on internal medicine, obstetrics, pediatrics, and surgery. The practice has three different locations, each one staffed with a mix of primary care and specialist physicians.
Traditionally, ancillary services have been performed at the hospital. Still, some ancillary services are best performed at the practice locations for one or more of the following reasons: lower costs, increased physician
efficiency, and improved patient convenience. For example, one of the
practice locations now has a diagnostic imaging capability. When the scanner was moved from the hospital to the practice location, volume increased, costs decreased, and both physician and patient satisfaction improved.
The proposal now being considered is to provide ultrasound services at the practice locations. Preliminary analysis indicates that two approaches are most suitable. Alternative 1 involves the purchase of three ultrasound machines, one for each of the practice’s three locations. Patients would schedule appointments, generally at the location that they are using, during preset times on particular days of the week. Then, the full-time ultrasound technician would travel from one location to another to administer the tests as scheduled.
In Alternative 2, patient scheduling would be the same, but only one
ultrasound machine would be purchased. It would be mounted in a van that the technician would drive to each of the three practice locations. Most of the operating costs of the two alternatives are identical, but Alternative 2 has the added cost of operating the van and setting up the machine after each move.
The two alternatives differ substantially in initial costs because
Alternative 1 requires three ultrasound machines at a cost of $75,000 each, whereas Alternative 2 requires only one. However, Alternative 2 requires a van, which with necessary modifications would cost $40,000. Thus, the start-up costs for Alternative 1 total 3 × $75,000 = $225,000, while those for Alternative 2 amount to only $75,000 + $40,000 = $115,000.
Note, though, that because the two alternatives have different operating costs, a proper cost analysis of the two alternatives must include both initial (capital) and operating costs. The hospital’s financial staff considered several methods for estimating the operating costs of each alternative. After much discussion, they decided that the activity-based costing (ABC) method would be best. Furthermore, an ad hoc task force was assigned the task of performing the cost analysis.
To begin the ABC analysis, the task force had to develop the activities involved in the two alternatives. This was accomplished by conducting “walk-throughs” of the entire process from the standpoints of the patient, the ultrasound technician, and the billing and collections department. The results are contained in Table 1. A review of the activities confirms that all except one—machine setup—are applicable to both alternatives.
The next step in the ABC process is to detail the costs associated with each activity. This step uses financial, operational, and volume data, along with the appropriate cost driver for each activity, to estimate resource consumption. Note that traditional costing, which often focuses on department-level costs, typically first deals with direct costs and then allocates indirect (overhead) costs proportionally according to a predetermined allocation rate.
In ABC, the activities required to produce some service, including both direct and indirect, are estimated simultaneously. For example, Table 1 contains activities that entail direct costs (such as technician time) and activities that entail indirect costs (such as billing and collection). Although the ABC method is more complex and hence costlier than the traditional method, it is the only way to accurately (more or less) estimate the costs of individual services.
Activity cost detail on a per-procedure basis is shown in Table 2. In essence, each activity is assigned a cost driver that is most highly correlated with the actual utilization of resources. Then the number of driver units, along with the cost per unit, is estimated for each activity. The product of the number of units multiplied by the cost per unit gives the cost of each activity. Finally, the activity costs are summed to obtain the total cost per procedure.
Many of the activity costs cannot be estimated without a volume estimate. The best estimate is that 50 procedures would be done each week, regardless of which alternative is chosen. Assuming the technician works 48 weeks per year, the annual volume estimate is 2,400 procedures. Of course, a much greater total volume can be accommodated under Alternative 1, with three machines, than with Alternative 2, with only one machine. However, to keep the initial analysis manageable, the decision was made to assume the same annual volume regardless of the alternative chosen.
In addition to the costs mentioned thus far, some other costs are thought to be relevant to the decision. First, in addition to the obvious costs of operating the van (primarily gas expenses), it is estimated that annual maintenance costs will run about $1,000. Furthermore, annual maintenance costs on each of the three machines under Alternative 1 are estimated at $500, while the annual maintenance costs for the single machine under Alternative 2 are estimated at a higher $1,000 because of added wear and tear. Also, the manufacturer of the ultrasound machines has indicated that a 5 percent discount may be available if three machines, as opposed to only one, are purchased.
Finally, to have a rough estimate of total annual costs over the life of the equipment, it is necessary to make assumptions about the useful life of the ultrasound machines and the van. Although somewhat controversial, the decision was made to assume a five-year life for both the ultrasound machines and the van. Furthermore, the assumption was made that the value of these assets would be negligible at the end of five years.
Assume that you are the chairperson of the ad hoc task force. Your charge is to evaluate the two alternatives and to make a recommendation on which one to accept. Because the revenues are assumed to be identical for the two alternatives, the decision can be made solely on the basis of costs. As part of the analysis, it will be necessary to estimate the costs of the two alternatives on a per procedure and annual basis. In addition, any qualitative factors that are relevant to the decision must be considered before the recommendation is made.
To keep the analysis manageable, the task force was instructed to assume that operating costs remain constant over the useful life of the equipment. For comparative purposes, this assumption is not too egregious because the activities are roughly the same for both alternatives, and hence inflation would have a somewhat neutral impact on costs.
Panhandle Regional Medical Center
Activities Associated with Alternatives 1 and 2
1. Appointment scheduling
2. Patient check-in
3. Ultrasound testing
4. Patient checkout
5. Film processing
6. Film reading
7. Billing and collection
8. General administration
9. Transportation and setup (Alternative 2 only)
Panhandle Regional Medical Center
Activity Cost Detail
Activity Cost Driver Volume per Unit
Appointment scheduling Receptionist time 3 minutes $ .20
Patient check-in Receptionist time 5 minutes .20
Ultrasound testing Technician time 45 minutes .40
Physician time 1.5 minutes 3.00
Supplies per procedure 1 packet 9.00
Patient checkout Receptionist time 5 minutes .20
Film processing Technician time 10 minutes .40
Film reading Contract terms per procedure 40.00
Billing and collection Overhead costs per procedure 6.80
General administration Overhead costs per procedure 1.25
Transportation/setup* Technician time 6 minutes 1.00
*Alternative 2 only
1. Physician time for testing (15 minutes) is needed for one of every ten patients.
2. Supplies consist of linen, probe cover, gel, film, and print paper.
3. There are no radiologists in the practice. Films will be read by the hospital’s radiologists at a contract fee of $40 per procedure.
4. Billing and collection costs are based on an average cost per medical services bill.
5. General administration costs are based on an estimate of facilities and other administrative costs.
6. Transportation/setup is based on ten procedures per day at each location and includes vehicle operating costs, excluding maintenance.
1. Estimate the base case cost of each alternative regarding the provision of ultrasound services. (For now, ignore the discount if three units are purchased.)
2. Which alternative has the lower total cost?
3. What value for travel and setup costs would make the costs of the two alternatives the same?
4. Now consider the 5 percent discount. What impact does this discount have on the decision? What discount amount would make the two alternatives equal in costs?
5. What subjective factors would influence the decision as to which alternative to choose?
6. What is your final decision?
Twin Falls Community Hospital
(Capital Investment Analysis)
Twin Falls Community Hospital is a 250-bed, not-for-profit hospital located in the city of Twin Falls, the largest city in Idaho’s Magic Valley region and the seventh largest in the state. The hospital was founded in 1972 and today is acknowledged to be one of the leading healthcare providers in the area.
Twin Falls’ management is currently evaluating a proposed ambulatory (outpatient) surgery center. Over 80 percent of all outpatient surgery is performed by specialists in gastroenterology, gynecology, ophthalmology, otolaryngology, orthopedics, plastic surgery, and urology. Ambulatory surgery requires an average of about one and one-half hours; minor procedures take about one hour or less, and major procedures take about two or more hours. About 60 percent of the procedures are performed under general anesthesia, 30 percent under local anesthesia, and 10 percent under regional or spinal anesthesia. In general, operating rooms are built in pairs so that a patient can be prepped in one room while the surgeon is completing a procedure in the other room.
The outpatient surgery market has experienced significant growth since the first ambulatory surgery center opened in 1970. This growth has been fueled by three factors. First, rapid advancements in technology have enabled many procedures that were historically performed in inpatient surgical suites to be switched to outpatient settings. This shift was caused mainly by advances in laser, laparoscopic, endoscopic, and arthroscopic technologies. Second, Medicare has been aggressive in approving new minimally invasive surgery techniques, so the number of Medicare patients utilizing outpatient surgery services has grown substantially. Finally, patients prefer outpatient surgeries because they are more convenient, and third-party payers prefer them because they are less costly.
These factors have led to a situation in which the number of inpatient surgeries has grown little (if at all) in recent years while the number of outpatient procedures has been growing at over 10 percent annually. Rapid growth in the number of outpatient surgeries has been accompanied by a corresponding growth in the number of outpatient surgical facilities. The number currently stands at about 5,000 nationwide, so competition in many areas has become intense. Somewhat surprisingly, there is no outpatient surgery center in the Twin Falls area, although there have been rumors that local physicians are exploring the feasibility of a physician-owned facility.
The hospital currently owns a parcel of land that is a perfect location for the surgery center. The land was purchased five years ago for $350,000, and last year the hospital spent (and expensed for tax purposes) $25,000 to clear the land and put in sewer and utility lines. If sold in today’s market, the land would bring in $500,000, net of realtor commissions and fees. Land prices have been extremely volatile, so the hospital’s standard procedure is to assume a salvage value equal to the current value of the land.
The surgery center building, which will house four operating suites, would cost $5 million, and the equipment would cost an additional $5 million, for a total of $10 million. The project will probably have a long life, but the hospital typically assumes a five-year life in its capital budgeting analyses and then approximates the value of the cash flows beyond year five by including a terminal, or salvage, value in the analysis. To estimate the terminal value, the hospital typically uses the market value of the building and equipment after five years, which for this project is estimated to be $5 million, excluding the land value.
The expected volume at the surgery center is 20 procedures a day. The average charge per procedure is expected to be $1,500, but charity care, bad debts, managed care plan discounts, and other allowances lower the net revenue amount to $1,000. The center would be open five days a week, 50 weeks a year, for a total of 250 days a year. Labor costs to run the surgery center are estimated at $800,000 per year, including fringe benefits. Supplies costs, on average, would run $400 per procedure, including anesthetics. Utilities, including hazardous waste disposal, would add another $50,000 in annual costs. If the surgery center were built, the hospital’s cash overhead costs would increase by $36,000 annually, primarily for housekeeping and buildings and grounds maintenance.
One of the most difficult factors to deal with in project analysis is inflation. Both input costs and charges in the healthcare industry have been rising at about twice the rate of overall inflation. Furthermore, inflationary pressures have been highly variable. Because of the difficulties involved in forecasting inflation rates, the hospital begins each analysis by assuming that both revenues and costs, except for depreciation, will increase at a constant rate. Under current conditions, this rate is assumed to be 3 percent. The hospital’s corporate cost of capital is 10 percent.
When the project was mentioned briefly at the last meeting of the hospital’s board of directors, several questions were raised. In particular, one director wanted to make sure that a risk analysis was performed prior to presenting the proposal to the board. Recently, the board was forced to close a day care center that appeared to be profitable when analyzed but turned out to be a big money loser. They do not want a repeat of that occurrence.
Another director stated that she thought the hospital was putting too much faith in the numbers: “After all,” she pointed out, “that is what got us into trouble on the day care center. We need to start worrying more about how projects fit into our strategic vision and how they impact the services that we currently offer.” Another director, who also is the hospital’s chief of medicine, expressed concern over the impact of the ambulatory surgery center on the current volume of inpatient surgeries.
To develop the data needed for the risk (scenario) analysis, Jules Bergman, the hospital’s director of capital budgeting, met with department heads of surgery, marketing, and facilities. After several sessions, they concluded that only two input variables are highly uncertain: number of procedures per day and building/equipment salvage value. If another entity entered the local ambulatory surgery market, the number of procedures could be as low as 15 per day. Conversely, if acceptance is strong and no competing centers are built, the number of procedures could be as high as 25 per day, compared to the most likely value of 20 per day. If real estate and medical equipment values stay strong, the building/equipment salvage value could be as high as $7 million, but if the market weakens, the salvage value could be as low as $3 million, compared to an expected value of $5 million. Jules also discussed the probabilities of the various scenarios with the medical and marketing staffs, and after a great deal of discussion reached a consensus of 70 percent for the most likely case and 15 percent each for the best and worst cases.
Assume that the hospital has hired you as a financial consultant. Your task is to conduct a complete project analysis on the ambulatory surgery center and to present your findings and recommendations to the hospital’s board of directors. To get you started, Table 1 contains the cash flow analysis for the first three years.
Partial Cash Flow Analysis
0 1 2 3
Land opportunity cost Building/equipment cost ($500,000)
Net revenues $5,000,000 $5,150,000 $5,304,500
Less: Labor costs 800,000 824,000 848,720
Utilities costs 50,000 51,500 53,045
Supplies 2,000,000 2,060,000 2,121,800
Incremental overhead 36,000 37,080 38,192
Net income $2,114,000 $2,177,420 $2,242,743
Plus: Net land salvage value
Plus: Net building/equipment salvage value
Net cash flow ($10,500,000) $2,114,000 $2,177,420 $2,242,743
1. Complete Table 1 by adding the cash flows for years four and five.
2. What is the project’s payback, net present value (NPV), and internal rate of return? Interpret each of these measures.
3. Suppose that the project would be allocated $10,000 of existing overhead costs. Should these costs be included in the cash flow analysis? Explain.
4. It is likely that many of the procedures at the outpatient surgery center would have otherwise been performed at the hospital’s inpatient surgery unit. How should the analysis incorporate the cannibalization of inpatient surgeries? Would the handling of cannibalization change if you believed that the local physicians were going to open an outpatient surgery center of their own? (Discuss only the issues here—no numbers required.)
5. Conduct a scenario analysis. What is its expected NPV? What is the worst-and best-case NPVs? How does the worst-case value help in assessing the hospital’s ability to bear the risk of this investment?
6. Now assume that the project is judged to have high risk. Furthermore, the hospital’s standard procedure is to use a three percentage point risk adjustment. What is the project’s NPV after adjusting for the assessment of high risk?
7. What is your final recommendation regarding the proposed outpatient surgery center?
(Marginal Cost Pricing)
University Hospital is a regional leader in the very intense and medically sophisticated area of organ transplants. Mark Lewis, the director of the Transplant Center, has been with the Hospital for ten years. When Mark joined the hospital, he was put in charge of a kidney and heart transplant program that averaged 50 transplants per year. Today, the Transplant Center performs over 200 transplants annually, including transplants from the newly initiated liver, lung, and pancreas programs.
The liver transplant program is the most successful of all organ programs in terms of volume and revenues. Last year, volume totaled 100 transplants, and this year Mark is optimistic that the liver program can do even better. However, he knows that increased volume is largely dependent on the number of organ donors and his success in negotiating a new contract with the
Transplant Management Corporation (TMC), the largest transplant-benefits company in the nation.
Because transplants are relatively rare in comparison with other, more conventional medical treatments, only the largest health insurers have the expertise to manage transplant services. However, the costs to insurers for transplant services are typically very large—usually in the six-to-seven-figure range. To ensure the best and most cost-effective management of transplant services, most health insurers outsource transplant management to companies, such as TMC, that specialize in these services.
Contracting for transplant services is unique and complex because of the sophistication of the medical procedures involved. Transplant services consist of five phases: (1) patient evaluation, (2) patient care while awaiting surgery, (3) organ procurement, (4) surgery and the attendant inpatient stay, and (5) one year of follow-up visits. The costs involved in Phase 1 are relatively simple to estimate, but the remaining phases can be extremely variable in terms of resource utilization, and hence costs, because of differences in patient acuity and surgical outcomes.
Historically, reimbursement for transplant services has been handled in a number of different ways. Initially, many providers bundled all five phases together and offered insurers a single, global rate. Although this method simplified the contracting process, the rate set was often chosen more on the
basis of building market share than on covering costs. Indeed, many providers could not even estimate with any confidence the true costs of providing transplant services.
Somewhat ironically, success in gaining market share usually increases the financial risk of the transplant program because higher volumes increase the likelihood of higher acuity patients. Although the total costs associated with all phases of a liver transplant average about $400,000, the amount can more than quadruple if the patient requires a re-transplant or if other complications occur. Because of this extreme variability in costs, outlier protection is a critical aspect of contract negotiations if the reimbursement methodology is a fixed prospective rate.
Thus far, several elements of the proposed contract with TMC have been finalized. Specifically, Phases 1, 2, and 5 will be reimbursed at a set discount from charges. Furthermore, to reduce the amount of financial risk borne by University Hospital, Phase 3 (organ procurement) will be reimbursed on a cost basis. This makes sense because the cost of Phase 3 is almost completely uncontrollable by the Center. In general, Phase 4 costs are divided into two categories: hospital costs and physician costs. Physician costs have already been agreed on, so what needs to be hammered out (and the make-or-break part of the contract) is the hospital reimbursement amount for Phase 4.
The key to a sound negotiation with TMC is to identify relevant costs. Mark plans to be aggressive in pricing these services, because he wants the contract. He feels that the additional volume will lower per-transplant cost and hence increase the Center’s profitability. Still, he wants to set a price that does not degrade the current profitability of the Center, which is good but not spectacular.
To help with the decision, Mark compiled the Phase 4 hospital costs of 12 recent liver transplant patients. In reviewing these data, shown in Table 1, Mark noted that a total average cost of $119,805 for 19 days’ average length of stay (LOS) translates to a staggering per diem (per day) average cost of over $6,000.
Mark is convinced that a price close to $120,000, which would cover total costs, would not be acceptable to TMC. So, he examined the possibility of lowering costs by reducing the average LOS. However, the costs associated with Phase 4 are not a linear function of LOS. The first day of Phase 4 is usually the most costly, whereas the last day is usually the least costly. Indeed, over half of Phase 4 costs occur in the first 24 hours of hospitalization.
Because it would be difficult to lower Phase 4 hospital costs by reducing LOS, Mark decided to pursue a different strategy. His experience at the
Transplant Center has convinced him that there are economies of scale present in liver transplants, and hence the marginal cost of each transplant is lower than the average cost. Thus, Mark believes that he can base the contract price on marginal costs rather than total (full) costs. Such a rate would (hopefully) be attractive to TMC yet, at the same time, preserve the Center’s profitability.
Assume that you have been hired as a consultant to recommend a fixed price (the base rate) that should be proposed in the contract negotiations for Phase 4 hospital services. To help in the analysis, Mark has indicated that approximately 60 percent of nursing, ancillary, operating room, and laboratory costs are fixed. The remaining costs—radiology, drug, and other services—are predominantly variable.
Patient Age LOS Total Costs University Transplant Center
Phase 4 Hospital Costs
Nursing Ancillary OR Lab Radiology
Cost Cost Cost Cost Cost Drug Cost Other Costs
A 61 25 $141,092 $10,261 $65,416 $6,770 $13,712 $1,483 $20,992 $22,458
B 56 15 139,306 11,969 63,668 8,501 7,409 2,261 24,504 20,994
C 42 12 74,259 6,939 33,661 3,128 5,279 668 6,964 17,620
D 52 13 115,349 7,221 54,063 5,779 6,112 903 7,638 33,633
E 12 26 172,613 28,205 72,204 6,847 10,550 1,766 23,061 29,980
F 59 22 83,807 16,858 33,474 4,654 6,211 1,397 9,698 11,515
G 41 25 136,060 9,645 63,208 6,489 13,091 1,382 20,127 22,118
H 35 17 139,308 11,969 63,669 8,501 7,409 2,261 24,505 20,994
I 52 12 74,259 6,939 33,660 3,128 5,280 668 6,964 17,620
J 38 13 115,348 7,221 54,063 5,778 6,111 903 7,639 33,633
K 59 25 166,224 26,909 69,657 6,765 10,061 1,677 22,007 29,148
L 60 21 80,034 15,629 32,202 4,531 5,937 1,293 9,122 11,320
Average 47 19 $119,805 $13,314 $53,245 $5,906 $8,097 $1,389 $15,268 $22,586
1. What is the estimate of the marginal cost of the Phase 4 hospital services assuming, as given in the case that 60 percent of the designated costs are fixed and the remaining costs are variable?
2. Assume that the agreed-upon price is $90,000. What is the expected profit on the contract assuming that it brings in 20 new patients? (Assume for now that no new fixed costs would be required.)
3. Now assume that the additional patients will add $200,000 in total to the Center’s fixed costs. Now what is the expected profit on 20 new patients?
On 40 new patients? (No new fixed costs are required to support the second group of 20 patients.)
4. What role do the following factors play in the decision regarding whether to use marginal cost pricing on the new contract?
a. Reimbursement amounts paid by current transplant third-party payers
b. The amount of excess capacity in the transplant unit
c. The potential reaction by current payers to a new, lower-price contract
5. What is your final recommendation regarding the base rate for Phase 4 hospital services that should be built into the contract?
6. Should you worry only about the contract’s first year pricing, or should you develop a long-term pricing strategy for TMC? What are some possible features of a long-term pricing strategy?
7. Briefly describe how outlier payments might be handled to ensure that the Center does not suffer large losses on outliers (patients with unusually high costs). (Hint: Cost outliers are identified by having costs that exceed a specified threshold. Then, in addition to the standard payment, the provider is reimbursement for some percentage of the costs above the threshold. For this question, you must choose a cost threshold and outlier payment percentage.)
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