By Matthew Majewski and Kira Gordon, CRA
Consolidation in the hospital and healthcare delivery sectors has better positioned larger hospital systems to negotiate lower prices for medical device products and technologies. This trend has introduced new levels of pricing pressure on manufacturers and is driving interest in alternative pricing models — including value-based agreements — across the sector.
Hospital Consolidation and Pricing Transparency
For medical device manufacturers, hospital consolidation means that the number of major accounts is declining at a rapid pace, with more than 60 percent of community hospitals now part of a larger health system.1 Reimbursement rates have not risen as rapidly as drug, device, and medical supply costs, putting cost pressures on hospitals.2 This, in turn, increases pricing pressure on device manufacturers as these consolidated health systems have more negotiating power.
A less obvious impact of consolidation is the potential for a significant increase in price transparency, which can have a profound impact on price negotiations. To highlight this point, consider a merger of two large healthcare providers. Each consolidated entity brings to the whole its own past experiences in procurement; what once were one-off deals not made available to others now are exposed to the broader audience.
In addition, pricing transparency is even escalating across large health systems due to published databases that serve as price benchmarking resources. Sites like MD Buyline and organizations like the Economic Cycle Research Institute (ECRI) collect pricing data that is readily available in a public database.
Although many device manufacturers are concerned that the combination of greater pricing transparency and growing customer negotiating power could lead to a “one low price” environment, it is unlikely that all devices will be equally impacted, at least in the near term. For example, products that are considered commodities — including many surgical supplies and basic instrumentation — will likely face higher levels of pricing pressure, while physician preference items (PPIs) could continue to be available based on clinician and hospital preferences, even at a higher price. However, many manufacturers report less physician support for PPIs than in the past.
To address the challenges increased transparency has created for device companies and to preserve pricing flexibility, manufacturers will need to develop value propositions that clearly demonstrate how a product will offer measurable value to patients, physicians, and/or hospitals. Manufacturers then will need to develop appropriate pricing strategies that accurately reflect assessments of value, while simultaneously accommodating customer risk.
Emergence of Value-Based Pricing
The current model for medical device pricing is often considered in the context of bundled reimbursement. For example, Medicare reimburses many surgical procedures as a bundle at a fixed rate. This is a form of gain-sharing, where hospitals benefit directly from cost-saving measures: hospital reimbursement remains fixed regardless of the individual costs of drugs, supplies, or devices used. As a result, it is important for a hospital and a clinician to carefully assess whether use of a device has sufficient value to justify increasing their costs and reducing their margins.
Given the current challenges associated with demonstrating value in a bundled reimbursement environment, device manufacturers are working to assess innovative value-based pricing models, including performance-based contracts, outcomes-based contracts, and other forms of risk-sharing. These options can be complex and require careful guidance to avoid uncertainty and present clear benchmarks.
Risk-Sharing versus Risk-Shifting
In response to an evolving pricing environment, manufacturers are considering alternative value-based arrangements where they share risk with hospital customers. One example is Stryker’s risk-sharing program for its SurgiCount solution.3
The SurgiCount Safety-Sponge System is designed to reduce the risk of leaving a surgical sponge inside a patient. It operates on a “scan-in/scan-out” process that accounts for every sponge used during surgery. Stryker agrees to provide up to $5 million to cover legal costs if a sponge is inadvertently left in a patient, according to the terms of its risk-sharing program. Additionally, Stryker agrees to refund incremental costs necessary for hospitals to implement the SurgiCount system over a prior sponge system for up to three years.
Many device manufacturers presume that, when a hospital raises the idea of a risk-sharing agreement, the hospital actually is looking for a guarantee like the one offered by Stryker. While this arrangement makes sense for Stryker, many device manufacturers, as they consider structuring their own agreements, should focus on risk mitigation and sharing, rather than on arrangements that shift risk largely or entirely back onto the manufacturer.
A performance- or outcomes-based pricing arrangement is the most familiar form of risk-sharing. This type of agreement can take many forms, but to be effective — regardless of the nature of the arrangement — a few operational guidelines should be taken into consideration.
For example, outcomes should be clear, measurable, and easily understood by both clinicians and the C-suite. Performance-based models also should demonstrate that they address material issues of concern. Additionally, agreements related to outcomes should apply directly and, where possible, exclusively to the device, and not involve extraneous factors.
With the Stryker SurgiCount risk-sharing program, acceptable terms for a performance-based agreement were achievable because it followed these guidelines. But, for many device manufacturers, developing such arrangements is challenging, particularly in the context of hospital reimbursement.
For example, Medicare reimburses hospital inpatient procedures as a 90-day bundle at a fixed rate. In general, hospitals do not receive additional reimbursement if a patient is readmitted within that time span; hospitals, in fact, may be penalized based on their 90-day readmission rate.4 As a result, manufacturers may claim their devices offer benefits such as reduced readmission rates, but many struggle with the challenge of designing a performance-based agreement around outcomes that can be linked back to use of their device. In many such cases, manufacturers and hospitals may also be unable to agree on mutually acceptable arrangements.
In addition, while many hospitals seem willing to consider risk-sharing pricing models and often raise the idea of value-based care, the range of factors involved can make it extremely difficult for hospitals to calculate their costs. This can make it challenging for manufacturers to make a reliable cost-offset argument. As a result of these challenges, many competitive bids remain more likely to be executed on a pure net price basis rather than with value-based arrangements.
With continued consolidation expected in the provider sector, greater transparency and pressure on pricing are likely to continue. In the years ahead, it will be crucial for medical device manufacturers to acknowledge the need to develop innovative pricing models to address these trends. Strategies will likely need to incorporate value-based pricing and manufacturers will need to consider new pricing models that can hold up to the influence of larger hospital systems in pricing negotiations.
Value-based pricing will remain a hot topic in healthcare, with more manufacturers considering options that maximize revenue while minimizing risk. While broad adoption is likely several years away, many manufacturers already are beginning to think critically about their pricing strategies. As the sector works to embrace value-based care, medical device manufacturers that struggle to demonstrate value for their products will be poised for failure. Those well-positioned to present rational pricing models are most likely to have the strongest advantage.
The views expressed herein are the authors’ and not those of Charles River Associates (CRA) or any of the organizations with which the authors are affiliated.
About The Authors
Matthew Majewski is a Vice President in CRA’s Life Sciences Practice. He has a track record of providing life science clients with analytically based solutions to their strategic issues. He has led a range of strategy engagements from product related topics to corporate challenges.
Kira Gordon is an Associate Principal in CRA’s Life Sciences Practice. She has experience across a number of therapeutic areas and healthcare markets, with a particular emphasis on medical-surgical devices.