Spiraling cost increases, coupled with lagging quality outcomes and a chronic lack of transparency, have garnered the attention of payers, patients and policymakers. Health care organizations face growing pressure to address these issues: One promising way to cut costs is through bundled pricing, an innovation that market leaders are employing.

In its most basic form, bundled pricing offers a fixed price for a defined set of services. Though it sounds simple, this radically different approach to pricing and risk brings its own challenges. Administrators in delivery organizations who are considering bundled pricing should evaluate carefully whether their organizations are prepared for implementation. If they don't, they're inviting organizational and financial setbacks.

Readiness for Bundled Pricing

To implement bundled pricing, health care administrators need to examine their own capabilities—technical, managerial and organizational. There are also some critical conditions that will have an impact on success. These include:

  • administrative-clinical alignment and history of constructive problem solving;
  • development of evidence-based care paths;
  • analytic and reporting capability;
  • variance management capability;
  • development of the economic- and clinical-value case.

Administrative-Clinical Alignment

Bundled pricing entails a level of collaboration between managers and clinicians that is a departure for the industry. Specifically, it requires managers to be involved in clinical decision-making—an area that traditionally has been sacrosanct. An assessment of your organization's readiness for bundled pricing must start with a clear-eyed evaluation of the relationship between managers and physicians.

Administrators have been reluctant to intrude on clinical decision-making because of concerns that doing so would drive community physicians to competitors. Even with the growth in physician employment, this remains a sensitive area. Two contributing factors are that (1) compliance with treatment guidelines has been optional and unmeasured except in adverse events, and (2) overutilization has had positive economic consequences for the delivery organization and the physician. Under bundled pricing, exactly the opposite is true—any unnecessary variance from treatment guidelines likely means cost to the organization, if not a negative impact on quality. And if treatment outcomes are not among the metrics used for evaluating success, bundled pricing repeats the problems created by HMOs by focusing purely on cost.

The need for physicians to reach consensus on treatment, to document it in care paths, and to be accountable for consistency in practice decisions is a critical aspect of the collaboration required for bundled pricing. Another has to do with the mechanics of billing.

Billing

Hospitals need to assess their relationships with third-party providers who will provide services under a bundled price. Laboratory technicians, pathologists and outside specialists who typically bill patients separately will need to bill the hospital so a single bill can be provided at the promised price to patients and payers. After all, a bundled price must be comprehensive, or it's not really a bundled price.

The need to restructure these billing arrangements raises other questions. How is the risk of variance in utilization allocated among outside providers? How will expected costs for outside providers be factored into a fixed price when those costs are not part of the charge database of the hospital and, therefore, not visible? Clearly, the relationship between the parties extends beyond the need to agree on care paths.

Sometimes the level of collaboration will be especially good in a particular service line or with a specific physician group. If so, these collaborations would be a good way to approach bundled pricing. Competent managers who are engaged in a good working relationship with involved clinicians are necessary for successful implementation of bundled pricing. Attempting to implement this approach without some reasonable level of trust and collaboration likely will be futile.

Development of Evidence-Based Care Paths

A first step is to establish consensus among clinicians regarding the way they treat patients with a specified condition. Establishing a care path also can help the organization incorporate and disseminate evidence-based improvements, quality enhancements and even proprietary practices or technologies that enhance quality or reduce cost.

Developing care paths is difficult and controversial. Many organizations have developed care paths that end up being nothing more than a stack of paper collecting dust on a shelf. Sometimes, the reason is that the discipline to monitor consistency of clinical decision-making is missing. More often, it's that managers lack the skills to influence changes in clinical practice, or that the care paths are detailed enough.

Analytic and Reporting Capability

If the initiative is to be structured, monitored and managed in a responsible way, finance and quality staff must be able to provide:

  • analysis of historic resource costs and charges;
  • modeling of expected costs and revenue;
  • cost and quality reporting to enable variance management.

Analysis of historic resource costs and charges. Chargemaster (or "list") prices for services provided in hospitals reflect many factors, but usually not direct costs. Such factors include the judgment of the Centers for Medicare & Medicaid Services as to what the underlying resource costs should be (as reflected in what it will pay); CMS may be influenced by the amount other institutions in the market area are charging, what various private payers will allow and, more generally, what the market will bear. In most organizations, cost-based accounting, which associates the labor and capital costs of each input to a service, is an idea whose time has not yet arrived.

What is typically available in the health care delivery setting is a historical database of charges and collections at the patient level. This data can be aggregated to provide information on the average charges and collections characteristic of a particular diagnosis or procedure. Obviously, this is an important starting point for setting a bundled price, because it's desirable from the provider's perspective to charge an amount that will be competitive, will provide sufficient operating margin, and will not expose the organization to revenue shortfalls.

Modeling of expected costs and revenue. Pricing raises a series of questions regarding the product parameters—more specifically, what is and is not included in the bundled price:

Will the bundled price cover just the acute care episode or will it include such post-acute care as rehabilitation or home health? Might it even cover pre-acute care components like weight-loss programs or physical conditioning? If it does cover more than acute care (and eventually it will), do you have access to the data to enable you to price these services, and how will you handle variances if services vary from the fixed price? What about the costs of treatment for comorbidities? Will these be included in the bundled price, or billed separately? If they are to be billed separately, how will they be identified and handled in the billing process?

Cost and quality reporting to enable variance management. Bundled pricing requires the hospital to manage utilization and outcomes that result from clinical and administrative decision-making, by diagnosis and by physician. The finance department must be able to generate a variety of cost analysis reports that are intelligible and credible. Clinical outcomes likewise must be reported regularly in ways that clinicians can understand, so they can discuss variances from financial and clinical targets.

Variance-Management Capability

Credible and intelligible reports are necessary to manage cost and quality effectively, but they are not sufficient. Midlevel managers—department heads and clinical chairs—also must initiate difficult conversations with clinicians about the impact of their clinical choices on cost and quality. Roles need to be redefined, and new accountabilities and capabilities need to be developed.

Development of the Economic- and Clinical-Value Case

For patients, bundled pricing provides more certainty in the cost of treatment and more transparency in the services provided. For payers, bundled pricing is a reduction in the risk of cost outliers and, more important, the assumption by providers of "skin in the game" for managing utilization. Providers have an incentive to adopt this approach soon, because it entails a significant development curve, and first movers can gain competitive advantage and a premium for their efforts.

Over the long term, however, bundled pricing brings a significant strategic threat—commoditization. Competitive pricing for specific bundled-price procedures will steer toward equivalence. When that happens, what reason will there be to choose one provider over another? That's where the economic- and clinical-value case becomes critical, and why providers need to turn their attention to developing theirs now.

The economic- and clinical-value case is the narrative, backed up by data, that explains how a provider institution provides superior clinical value (according to various measures of clinical success), and economic value (as measured by factors like recovery time and return to work). Many providers settle for mortality and morbidity statistics. Given the public's dissatisfaction with quality and growing consumer sentiment, undertaking bundled pricing without a plan for creating an economic- and clinical-value case is a setup for future problems.

Michael Abrams, M.A., is the managing partner at Numerof & Associates Inc., a strategic management-consulting firm in St. Louis.