Symptoms & causes: Why diabetes strips are $18 on a hospital bill and less than a buck on Amazon.

On Sunday, Business Insider ran a piece called The Most Infuriating Paragraph You Might Ever Read About The Healthcare System

It referenced rants on “Steven Brill’s epic cover story for Time on why healthcare costs so much.”

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The paragraph that set them off from the Brill article should – according to Business Insider — “legitimately get anyone’s blood boiling.”

By the time Steven D. died at his home in Northern California the following November, he had lived for an additional 11 months. And Alice had collected bills totaling $902,452. The family’s first bill — for $348,000 — which arrived when Steven got home from the Seton Medical Center in Daly City, Calif., was full of all the usual chargemaster profit grabs: $18 each for 88 diabetes-test strips that Amazon sells in boxes of 50 for $27.85; $24 each for 19 niacin pills that are sold in drugstores for about a nickel apiece.

There were also four boxes of sterile gauze pads for $77 each. None of that was considered part of what was provided in return for Seton’s facility charge for the intensive-care unit for two days at $13,225 a day, 12 days in the critical unit at $7,315 a day and one day in a standard room (all of which totaled $120,116 over 15 days). There was also $20,886 for CT scans and $24,251 for lab work.

As for why we can have a system where diabetes-test strips are sold for $18/each in one place, while Amazon sells a box of 50 for $27.85, see this, great piece by Sarah Kliff on the lack of price controls in the US.

My opinion: Apparently these guys have never heard of “absorption costing” or bothered to really ask “why is healthcare so costly?”

First, let’s do absorption costing … a method for allocating overhead to products and services, and then charging to recover the costs.

Simplifying, there are 2 basic kinds of costs: fixed costs and variable costs.

Technical note: there are some hybrid costs – called semi-variable – but they just complicate things.

Variable costs are, for example, what a hospital pays to its supplier for diabetes strips … probably less than a buck … otherwise they’d buy them from Amazon.

Then there are variable processing costs associated with the stocking and dispensing of the strips, e.g. stocking costs, nursing costs, record-keeping.

So, the variable cost of a hospital cost is legitimately higher than Amazon’s.

Probably not enough higher to reconcile to $18.

Where does the rest of the difference come from?

Well left-leaning Time (and Business Insider) are quick to attribute the rest to “chargemaster profit grabs”.

Hmmm.

Ignores the fact that (a) many hospitals are not-for-profit, (b) in general, hospitals don’t make much money, and (c) hospitals – the the droves – are closing.

The difference is overhead – all the expenses incurred operating a hospital – and how all of those overhead costs are recovered.

Keep in mind that much of a hospital’s cost structure is made up of

(a) plant and equipment – all the beds and machines that are required to dispense medical services,

(b) compliance people and processes – required to feed the government and insurance system bears,

(c) malpractice insurance, claims, and avoidance procedures, and (d) unreimbursed services – think, indigent care and artificially low Medicare & Medicaid reimbursements.

A hospital has two basic pricing choices.

They could price like cell phone and rental car companies.

That is, offer an apparently low base cost ($29.99 per day for a car) and then add on for every deviation from the most basic offering … and add a slew of costs “below the line” to cover franchise fees, fuel surcharges, airport fees, hazard charges, local taxes.

You get the picture.

The $29.99 per day car – a good deal – ends up costing $300 for 5 days.

The other pricing option is to fully assign all of these overhead and “indirect costs” to the products themselves.

That’s apparently what hospital’s do.

The answer turns out to be the same … they just differ in optics,

Would the inflammatory Time paragraph be any better if if the diabetes strip was only a buck and and 10s of thousands of dollars were added to the bill to cover all the overhead costs listed above?

I doubt it.

Maybe the folks at Time & BI should look at the root causes of the problem and not just rant like ignoramuses.

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8 Responses to “Symptoms & causes: Why diabetes strips are $18 on a hospital bill and less than a buck on Amazon.”

  1. Greg Gentschev (@gentschev) Says:

    You’re right that the article doesn’t address overhead. And yet, what are we to make of the 3100% overhead rate implied by the $18 diabetes strip? Does that seem like reasonable pricing? I don’t find questioning that, whether it’s the dollar price or the overhead allocation, inflammatory.

  2. Alexander S Says:

    I keep thinking of Porters 5 forces ….

    Forget Amazon..The prices charged to Medicare are just so different than those charged to individual consumers.

    1a. Do you think Medicare bullies hospitals into submission to obtain far more favorable rates for its beneficiaries than those charged to individual consumers? Or is it a fair negotiation process?

    1b. Do the hospitals even “need” business from Medicare, or are they forced to provide services to its beneficiaries by law, and so then they have to recoup their overhead by gouging individual consumers?

    3. What would be your perspective if you didn’t have a corporate insurance coverage and were under 65? What would you do?

    Looking forward to your response!

    Stay well,

    Alexander

  3. John Carpenter Says:

    I wonder if there is not a basic tenant of business missing here…competition. Everything about the medical profession is controlled either by the government or the American Medical Association. Even the number of doctors that are produced each year is managed. My bet it is managed to keep the number smaller than required. I wonder if the same does not apply to other aspects.

    Even the medical care we receive, historically regarded as excellent, seems to be declining. Average life span in the US is no-longer world-leading.

    Maybe the Time article may be the first step in a hard lesson for the medical profession and the government offices “regulating” them.

  4. Andrew L. Says:

    Actually, TIME is doing the right thing by at least driving the conversation. For being such a huge chunk of the economy, the American People have very little insight into how the system works.

    First, there is significant competition in healthcare delivery. Doctors compete over patients, hospitals compete over physicians and offerings, and insurance companies compete on price, acceptance, and scope of care. Just because they compete, however, does not make healthcare a market. So…

    …Second, stop thinking about healthcare as an effective or remotely efficient market – it is a broken market (and not just because of government). How much does your provider charge for a blood test or checkup? You don’t know? Exactly. In an emergency, do you price check on the ER on yelp before the ambo takes you there?

    Third, Medicare and Medicaid drive 60% of admissions but provide just 90% and 89% of the actual costs of care. Those are 2009 stats, mind you, and those numbers are guaranteed to be lower today.

    Fourth, the statistics on life expectancy are flawed. Here’s why: More than any other nation on the globe, Americans die from preventable causes. Said another way, we eat, sit, and smoke ourselves to death. Don’t blame that on your doctor.

    Finally, the question of what drives healthcare prices has been pretty conclusively answered in a March 11 econometric study of 3,400 hospitals (53% of population). Turns out that you can explain 83% of the variation in hospital pricing through the variation in hospital costs. Shocker.

    • Alexander S Says:

      Andrew, I’m thinking about what you said:”Third, Medicare and Medicaid drive 60% of admissions but provide just 90% and 89% of the actual costs of care. Are you suggesting that Medicare and Medicaid are loss-leaders? And if so, how?
      Doesn’t finance dogma teach us to only “invest in NPV-positive projects – so why would a hospital accept Medicare patients ? Under the current regime wouldnt it be better off treating privately insured or non-insured patients only?.

      • Andrew L. Says:

        Sorry, you lost me in the flurry of B-school jargon there.

        I do not suggest that Medicare and Medicaid are loss leaders. They are 43% of total healthcare payments and for patients 65+ (where the largest share of healthcare services occur) they are 70%-ish of payments. M/M is the market – especially for hospitals that have huge capital costs.

        Also, nearly all of the services offered to a Medicare patient are covered by Medicare – unless you can sell them on a breast augmentation or a room upgrade.

        Docs are a little different. With lower fixed costs,many docs are increasingly refusing M/M patients.

        You will start to see (as in Massachusetts) the acceptance of M/M as part of hospital contracts or part of physician licensing. Otherwise, docs simply won’t touch those guys.

        Hey, after this, can we talk about the inelasticity of healthcare costs and oligopsony?

  5. Alexander S Says:

    Andrew, perhaps I did not communicate clearly….

    You had said:”Third, Medicare and Medicaid drive 60% of admissions but provide just 90% and 89% of the actual costs of care.”

    Doesn’t this suggest that, with the M/M revenue received for care given, hospitals are not entirely covering their costs on the M/M services provided (i.e. not only are they not breaking-even on M/M services, but they actually made a loss of 10-11% on that care)?

  6. Alexander S Says:

    Here’s another gem to add to the cost of healthcare discussion:

    “A study suggests that bankruptcies due to medical bills increased by nearly 50 percent in a six-year period, from 46 percent in 2001 to 62 percent in 2007, and most of those who filed for bankruptcy were middle-class, well-educated homeowners, according to a report that will be published in the August issue of The American Journal of Medicine.”

    More detail here:
    http://www.businessweek.com/bwdaily/dnflash/content/jun2009/db2009064_666715.htm

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