How is healthcare different from a commodity?

by Roger D. Jones, PhD

“How is healthcare different from a commodity?” may be as enigmatic as Caroll’s riddle from Alice in Wonderland, “Why is a raven like a writing desk?” Lewis Carroll did not posit an answer to the riddle, but many people have suggested answers. My favorite may be, “Because neither one can ride a bicycle.” Because healthcare in the U.S. costs more than 17% of GDP and health outcomes lag behind other industrial countries, the answer to the healthcare question may need to be less frivolous than the answer to the raven question.

In the U.S., healthcare purchasing and utilization decisions are made by three entities: the patients, the healthcare providers, and the payers. The person who uses the healthcare (patient) is not the person who orders the healthcare (provider) who is not the person who directly pays for the healthcare (payor). The healthcare transaction is much more complicated than the purchase of a sack of potatoes.

In economics, the simplest product is a commodity, a product in which the decision to buy is based solely on its price. The canonical commodity is a bushel of corn. For many purposes, such as feeding cattle, one bushel of corn is the same as another, except for how much it costs. There are buyers who would like to purchase a bushel (Demand) and sellers who would like to sell a bushel (Supply). The price of the transaction is negotiated or is the consequence of a bidding process.

Corn, however, has another property: it is planted in the spring and harvested in the fall. Its value has a temporal component. The corn seed in the spring has less value than the harvested corn in the autumn. Moreover, the buyers of the corn, e.g. the cattle producers, may have different needs for corn at different times of the year. Therefore, their willingness to pay a certain price for the corn varies throughout the year. In order to reduce the risk of both buyers and sellers, a new product, called a future was developed. A future is simply a guarantee that the corn will be sold at a certain price at a given time in the future. Buyers or sellers can purchase this future at a fixed price from the seller of the future, and the future seller absorbs the risk of price fluctuations. Since corn has been grown for many years, the future seller can calculate the risk he or she bears and can price the future accordingly. The transaction of buying and selling a bushel of corn has just increased in complexity from simply consideration of the price at a given time to consideration of the price now and the price at some future time.

We do not, however, make our purchasing decisions based solely on price and risk. We also base it on the quality of the particular product. For instance, a Mercedes Benz automobile is usually perceived to have higher value than a Chevy; thus we may be willing to pay more for the Mercedes than the Chevy. This is different than the time dependence of the value. This difference in value is due to workmanship, reliability, company reputation, social perceptions and other characteristics of the product. A purchasing or selling decision that takes price, time and value into account is more complex than a simple purchase of a bushel of corn at a particular time. The components of this tripolar transaction are of three types: 1) a component associated with cost or price, 2) a component associated with quality or value, and 3) a temporal component associated with risk. Risk can be mitigated by speed. For instance, if a bushel of corn could be grown in one day, there would be little need for a future’s contract associated with the product.

The tripolar transaction forms the basis of what is called the “triple constraint.” A company selling a customized product to a customer will often allow the customer to choose two options from the list of good, cheap or fast, which corresponds to the three product components, value, price and time/risk. If quality or value and speed of delivery are most valuable to the customer, then the price will be a little higher. If value and cost are important, then the project may need to be fit into down production times when production would otherwise be idle. This will delay delivery. If cost and time to delivery are important, then the quality of the product may suffer. A tripolar transaction significantly increases the flexibility of the buyers and sellers.

A similar tripartite concept in healthcare is called the “Iron Triangle.” The three components of the Iron Triangle are cost; quality; and access, which plays the role of the temporal component. The three players in the healthcare market: patients, providers, and payers, can be associated with the three components of the Iron Triangle. Providers are most closely associated with quality; payers are most closely associated with cost; and patients are the recipients of access.

Unlike the triple constraint, in which the buyer is allowed to choose two of three product characteristics, healthcare reform asks that all three characteristics are satisfied: near-universal access, lower costs, and improved outcomes. This interaction is addressed in current blogs and will be further addressed in future blogs. We, however, will leave a serious investigation of the riddle of the raven and writing desk to serious scholars.

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