Grease, friction, and Amway markups in healthcare

With a few exceptions, U.S. consumers spend at least twice as much per capita on healthcare than they do in a dozen other countries with true universal coverage and equal, if not better, outcomes. Bad, right? Here is the sticky part: most of that extra cash that you and your employer fork out pays the salaries of hundreds of thousands of people, including perhaps your neighbor, or perhaps even you.

An analysis cited by Kaiser Health News estimates that a major overhaul of the U.S. healthcare system could eliminate as many as 2 million jobs. There are as many as 10 million people currently working in healthcare in the U.S. Whether your particular job is at risk may depend on which of my three categories your role in the industry might be tagged. Are you grease for the healthcare economy, are you friction, or are you an “Amway-style markup”?

Amway-style markups in healthcare

I grew up in the heart of Amway country in Western Michigan and was living there at its inception. Although Amway is not the societal fad that it once was (“Let me come to your house and tell how you can get rich!”) we still have Betsy DeVos,  the daughter-in-law of one of the company’s founders, around as Secretary of Education, because billionaires’ families know so much about schools.

In the early 1980s I was teaching university accounting classes when a record fine was levied by the government of Canada against Amway. It’s the kind of story that only a CPA could love. But I will tell it anyway. [1]

The issue was, “What is the true ‘transfer price’ of a box of Amway detergent from its manufacturing plant (also owned by Amway) exported into Canada for its multi-level marketing pyramid of distributor/entrepreneurs?” Amway soap is incredibly cheap to make but going through its maze of distributors and a complex accounting system of markups, disguised as “performance bonuses,” the end-consumer price is comparatively high. You are not paying for the soap.

The high prices were sustainable in that market due to a lot of “magical thinking” by distributors and their loyal customers about the quality of the soap. Also, the profit margin was aided by most distributors at the very bottom of the pyramid personally delivering a lot of soap directly to customers for minimal compensation. It was Uber for soap in that regard.

Canada collected customs duties on any Amway product coming into Canada, and the transfer price, theoretically an “internal wholesale cost,” determined the size of those duties. Amway claimed a very low transfer price to minimize those duties, but the Canadian courts found that the complex rebate system, plus proof of fake invoices between the manufacturing and sales divisions of Amway, constituted fraud in that pricing. In November of 1983 the Canadian government fined Amway CA$28 million, which by my estimation would be worth almost US$58 million today.

A truly free market should theoretically squeeze out Amway-style multiple markups in the name of market efficiency, and Amway has faced stiff competitive winds in recent years. But the U.S. healthcare market is anything but efficient. There is much evidence that healthcare products and services are often “marked up” several times along the way before the insurance company or the consumer sees a bill.

The classic story here recounts generic acetaminophen pills billed by hospitals for many times their street value. Also consider a simple X-ray prescribed by a physician, carried out by a different medical facility and perhaps performed by a contractor technician from yet another firm. The X-ray is then read by a radiologist, who is likely part of yet a different practice, and is finally reviewed by that originating physician. In every step of the way not only is labor added, but overhead and profit markups are tacked on as well. These markups can easily lead to a bill of several hundred dollars for a simple scan.

I have written in the past about why a simple blood test might result in a charge of as little as $22 to as much as $725, depending on where in the country and in what kind of facility the test is performed. Stories abound about wide differences in prices at pharmacies and clinics depending on whether you want your insurance company billed or you alternatively offer cash on the spot. Amway-style markup pricing is everywhere in U.S. healthcare. How tied is your job to that kind of pricing?

Ever-rising costs also get magnified into even higher price increases in these extra markup tiers as well. The data over the past 30 years demonstrates that a 1% to 3% typical raise for bottom-tier employees grows into a 5% to 6% raise for managers and an 8%-10% increase in profit demands from the capital providers. More layers equal ever higher prices.

Economic friction

It is not uncommon for large medical practices to have as many medical billers working full time as there are direct care providers. In other words, if your physician sees you for 15 minutes, it may well take a staff member longer than 15 minutes to sort out the complex service codes, bill the correct payment plan servicer or Medicare in the correct way, and to address the inevitable denials of payment from those same payment servicers. That is economic friction. You intend to pay for the doctor’s services, but you must also pay for the clerical wages and workspace along the way, plus the I.T. guy supporting the larger staff, and so on.

The best national universal healthcare coverage systems, such as Germany’s, standardize billing and streamline payments to private hospitals and “sickness funds.” This greatly reduces the number of people required to perform these tasks. Good news for premium payers but bad news for those medical billers and their supervisors.

“Defensive medicine” is another often-cited healthcare friction. The theory goes that doctors order more tests than are necessary in order to prevent expensive lawsuits. At the point of service, however, this becomes harder to nail down. The line between good medical practice and excessive testing will always be a good debate.

There is no doubt that medical litigation in the U.S. far exceeds that of other countries. Lawyers warn that centralized healthcare systems clamp down on lawsuits to the detriment of patients (and lawyers). Again in practice, however, this situation looks a bit different from the other side of the ocean.

While living in England in the early 2000s as an NHS-covered employee and corporate manager, I saw that different perspective. Americans jump quickly to the courts for compensation when things go south medically often more out of fear than due to physician incompetence. In the U.S. system, especially before the ACA, a poor outcome from a medical procedure, regardless of fault, could easily leave you uninsurable and liable for high medical bills for the rest of your life. In the U.K., however, the assumption is that you will have lifetime medical care paid for by the government in this unfortunate event. Therefore, the courts look favorably on medical lawsuits only when there is demonstrable negligence involved.

The more centralized standards-setting in these universal-coverage countries also protects the physician, and so excessive testing loses most remaining motivation. For good or bad, if you went into a spine surgery that only had a known 50% chance of success, you would not be able to sue if you weren’t cured. On the other hand, you would have free medical care for life. Good news for you but not necessarily for your attorney. The economic friction from excessive tests and litigation thus drops dramatically in these countries.

Economic grease

Some new jobs and work processes introduce economic grease into the system, delivering better and cheaper end products. Often this takes on the form of disintermediation, in which jobs or even entire industries get swept away in the tide of new technologies and smarter business models. When was the last time you used a travel agent, for instance, or bought a newspaper for its classified advertising section?

It is harder to find disintermediation going on in healthcare, but when it does hit it can have negative side-effects along with the positive ones. For instance, convenient and low-cost urgent care centers can significantly reduce non-emergency congestion in hospital emergency rooms. On the other hand, the financial model of emergency services, with its high fixed costs and required 24/7 access, can be seriously upset when the high-profit-margin influenza cases go to the neighborhood CVS clinic instead. A bad thing wrapped up in a good thing.

The increasing use of physician’s assistants and nurse practitioners to treat the large swath of “routine” healthcare is one of the most visible consumer-facing disintermediations. A bad thing or a good thing? The debate continues, although I think it is mostly a good thing.

For several years now the term “Walmartization of healthcare,” the entry of major economic players who radically the disrupt delivery and pricing of healthcare, has been seen as both threat and opportunity. While there is some of this going on, for instance in the consolidation and vertical integration of pharmacies and drug plans, we are primarily seeing just playing at the fringes to this point.

Recall that Walmart first flourished in rural America, where at the same time it delivered more and cheaper goods to small Midwestern towns, it also decimated the retail clothing and hardware businesses that once ringed the old town squares. I can take you on a very depressing tour of Iowa and Missouri rural county seats. Who would be the casualties of “extreme economic grease” in the healthcare industry?

It may well be that increased “economic grease” in the healthcare market could also destroy some of those “Amway markups” that keep pushing prices up, which would have positive long-term impacts. In the end, by the way, that Amway soap for which we paid too high a price caused an epic case of diaper rash on our then-infant son. There is an analogy to the U.S. healthcare system in there somewhere.


Notes:

  1. A detailed account of the Amway Canadian case is found here.

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