There has been a lot of press recently on performance-based contracting and pricing in healthcare. Today, the Wall Street Journal ran an article on performance-based pricing for pharmaceuticals. Performance-based pricing in business-to-business (B2B) and business-to-government (B2G) markets is not new. It has been around since at least the early 1960s. Healthcare, an industry many experts regard as being behind in procurement practices, is finally catching up.
I’ve done a number of presentations recently to healthcare supplier audiences about performance-based pricing and contracting. There does appear to be some confusion about the term “performance-based contracting and pricing.” Some suppliers think it is about setting prices to reward customers who purchase more volume from them. Others think it is about aligning price levels to a good-better-best product line strategy.
Better Align Buyer-Seller Interests
Performance-based contracting (PBC) or pricing is really about aligning the interests of buyers and sellers. The seller is paid for achieving an outcome or the actual value delivered by the product, service or solution. In a way, it’s insurance for both the buyer and seller. The arrangement could be a penalty if an outcome is not achieved or a guarantee of an outcome. It may also take the form of pricing per outcome achieved or some other pricing mechanism to share value and risk. The outcome is usually related to cost, time or quality metrics.
Rolls-Royce’s Power-by-the-Hour program for aircraft engine repair and maintenance is an example of paying per outcome achieved. Rather than price aircraft engine service and parts on a time and materials basis, the Power-by-The-Hour program prices based on cost-per-flying-hour basis. This aligns the interests of the manufacturer and operator, who only pays for engines that performed well. One academic study of the Rolls-Royce program showed that pricing based on the outcome rather than time and materials resulted in a reduction in unplanned downtime of 25%-40%.
In B2G markets, performance-based contracting has been used extensively for purchases and projects such as building roads and maintaining costly capital equipment. In B2B markets, PBC has been used for some time in advertising, commercial airlines, oil and gas, services, outsourcing, manufacturing, commercial shipping, and other markets. In many instances, PBC helps to push buyers and sellers beyond a transactional relationship.
MedTech Examples of Performance-Based Contracting
In healthcare, performance-based contracting has been used in the in vitro diagnostics segment for a while. Many in vitro diagnostic equipment manufacturers offer the customer an option to pay per-test-result (the outcome) rather than pay separately for the reagents and equipment used to generate a test result. PBC is also starting to be used more often for expensive drugs and medical devices. For example, St. Jude Medical announced that they would rebate 45 percent of the price paid for a Quadra heart rhythm device if revision surgery is needed in the first year after it is implanted.
5 Reasons Why MedTech Suppliers will Need to Put More Skin in the Game
Here are five reasons performance-based contracting and pricing is here to stay, and healthcare suppliers will need to have more skin in the game.
- Reimbursement Model: An increasing share of customer reimbursement is being tied to performance-based measures by payers. An example is the CMS value-based purchasing program in the USA.
- Buyer Sophistication: Buyers are becoming more sophisticated and have a deeper understanding of total cost of ownership/care and the capabilities to do PBC.
- Data and Analytics: Improvements in data will better enable measurement and tracking of outcomes to help make these arrangements less of an administrative burden.
- Cost-Pressures: Customers will continue to be under cost-pressure, and will no longer be willing to “trust” a supplier’s statement that a solution will deliver outcomes. Many hospital administrators, for example, can cite numerous instances of expensive devices and drugs that did not work as promised and cost hospitals millions.
- Move to Collaborative Models: Buyer-seller relationship models will continue to evolve from transactional to a more collaborative model which should will help enable risk-sharing arrangements.
A recent survey I conducted, along with Model N, of medical device executives showed that 43% of respondents believe 30% or more of their revenue will be tied to performance-based arrangements in ten years. This should be an opportunity for suppliers who are prepared, and can use these arrangements proactively and appropriately.
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