Your local BC/BS plan has experienced high costs and unpredictable cost increases for total joint replacement cases in recent years. They have approached three competing hospital systems about taking a case rate for total knee replacements. The ‘case rate’ will cover all diagnostic work, the surgery itself and all rehabilitation needed to get the patient back to full functionality. Last year, BC/BS paid for 1000 total knee replacements in this region, and they project the same volume next year. The working assumption here is that the ‘winning’ bidder will get 100% of that volume next year.
The current breakdown of BC/BS business at these three facilities is as follows:
| Mercy | St. Sebastian | University | |
| Total Knee Procedures/ year | 500 | 350 | 150 |
| Current BC/BS hospital reimbursement/case | $22,000 | $21,000 | $24,500 |
| Allocated overhead cost/case | $7,500 | $8,500 | $9,000 |
| Implantable device cost/case | $5,000 | $5,000 | $4,500 |
| Other variable costs/case | $2,500 | $2,400 | $2,300 |
In addition to the hospital cost for these procedures, you can assume that BC/BS has also paid the following on average per case:
- Diagnostics (all) – $1,000
- Professional (all) – $2,000
- 30% of patients will require post-acute care at a rehab. facility at a cost of $15,000/case
- 70% of patients will go home with home care and other follow-up at a cost of $1,000/case
Case Questions:
- Assuming that the cost/case figures above remain constant, what would be the minimum that each system could bid to garner the BC/BS business such that its costs would be covered (i.e., this would not be a money losing venture). What happens to each hospital’s total profit if the winning bidder is awarded 100% of the volume?
- The economic term, “contribution” represents the portion of sales revenue that is not consumed by variable costs and so contributes to the coverage of fixed costs (and profit). As an example, a movie ticket costs $10, and we determine that $2 of that goes to variable cost coverage, $6 to fixed cost coverage and $2 to profit. $8, then, would be the ‘contribution’ towards coverage of non-variable costs. Using the notion of ‘contribution’, is there a case to be made for one or more of the hospitals to lower their offered price to a level at which they’d receive negative total margin? Thinking in terms of marginal volume gained, what is the lowest each hospital could bid in this scenario?
- Suppose that a new entrant comes late to the bidding process, and plans a super competitive bid of $13,900 per case. This is a new orthopedic institute that is made up of several orthopedic surgical groups. They have their own diagnostic facilities and can bring all of the rehabilitation assets that they’ll need. They also have a direct relationship with a device manufacturer and believe they can cut the cost of devices used down to $2,500 per case. They only thing they lack are the actual surgical facilities. They offer to lease OR time from each of the hospitals at $2,400 per case. Are the hospitals likely to accept that offer? What happens to the economic profit of each hospital if they do/ do not accept the offer?
