The Benefit of Price Discrimination
By James Foster
In his Monday Morning Update for 10/12/15, Mr. HIStalk first affirmed the effectiveness of the market in selecting among EHR vendors. Later, in response to a price survey, he expressed frustration with disparate costs of services, saying, "I still don’t understand why providers shouldn’t be required to offer their lowest prices to everybody." His complaint here is with what economists call "price discrimination.”
There are two general justifications for price discrimination: (1) differences in costs to the seller and (2) differences in value to the buyer. Cost differences may explain things like quantity discounts, since even if the widgets cost the same to produce, the marketing and sales costs are less if the seller has to deal with fewer buyers.
Even with the same quantity of what seems to be an identical product or service, there may be hidden costs that can justify a difference in price. For example, the price for a television purchased on credit in a poor neighborhood may be much higher than the price for the same model paid for in cash at a suburban Costco. Here the product is not just the electronics, but also the transaction costs involved in offering credit to poor-risk buyers.
Differences in value to the buyer are no less real and can be justified as a way to ensure that the goods are available at all. Most of us are familiar with the fact that adjacent passengers on the same flight can pay very different prices for the trip. On the one hand, this seems unfair ("I still don’t understand why providers shouldn’t be required to offer their lowest prices to everybody"). On the other hand, it is often the case that if everyone were charged the same price, the product or service could not be supplied at all.
That is, if the airline ticket prices were uniformly high, fewer people would make the purchase and the total revenue would not be sufficient to cover total cost. Likewise, if prices were uniformly low, the planes would be full (aren’t they already?) but the total revenue still would not be sufficient to cover total cost.
In order to provide air travel, airlines must segregate buyers into those that place lower value on the trip (vacationers who could drive or choose a different destination) and those that place a higher value on the trip (business travelers). This discrimination serves to benefit travelers who would not make the trip unless they still have some value over the price.
Healthcare providers face similar challenges as airlines: capital costs are high and marginal costs are low. Yet charging everyone the same (high or low) price would not yield enough revenue to pay for the equipment and staff. Therefore, quantity discounts are offered to large groups (represented by credit-worthy insurance plans) who can take their business across town, while unknown individuals who buy on credit typically face higher prices.
If this still seems unfair, before calling for more government regulation through price controls, we should investigate how government regulation might be contributing to problem. There are a few areas in healthcare where prices are standard, published, and declining over time, such as Lasik eye surgery. These typically are procedures where the consumer is responsible for the full price of the service and takes time to investigate before making a purchase.
Instead of imposing price controls (which have been disastrous in a variety of industries), we should look for policy changes that encouraged more consumer involvement and responsibility.
James Foster is director of operations for GemTalk Systems of Beaverton, OR.