How splitting the bill impacts disruptive innovations in healthcare


Sep 8, 2016

In healthcare, it is very difficult for a patient to be overserved by the functionality of a diagnostic or therapeutic procedure (distinct from overtreatment and unnecessary care). If two tests are viable and covered by insurance, rarely would a patient prefer an important diagnostic test that is correct 85% of the time to one correct 95% of the time, regardless of the actual price. The price-insensitivity inherent in a third-party payment system makes it easier for patients to afford the current best option instead of an inferior one, because their out-of-pocket payment is similar either way. This is a case of moral hazard, where patients and physicians are less likely to guard against risk because they are protected from its consequences.

An analogous example of moral hazard from the restaurant industry is when a table of 10 pools the bill and splits the total evenly among each member of the group. If I prefer the $35 steak entrée instead of the potentially disruptive $25 chicken entrée (lower cost, high in protein, less fat, albeit less flavor), but I’m only willing to pay $28 for the steak, I am not likely to pay for it individually as it is $7 over my budget. However, when I pool the price as a part of the 10 person group, the $10 dollar difference in price is split evenly among the 10 members ($1 per member). As a result, the effective price of the steak entrée is a much more tempting $26 – an easy buy at $2 under my $28 budget. Thus, my choosing to purchase the cheaper and inferior option is less likely when pooling the bill.

A similar system of pooling risk is the norm in our healthcare system, as insurers pool premiums and use the premiums collected to purchase healthcare goods and services on behalf of their members. This seems good for patients, as it is easier to afford the best available treatment at the price of a marginal out-of-pocket payment as opposed to the actual cost. However, this creates a problem for potentially disruptive innovations. Disruptive technologies begin as cheaper and lower quality solutions that improve with sustaining innovations. Over time, they upend incumbent technologies when they meet the qualities demanded by mainstream consumers. The question then arises: How can disruptive innovations gain a foothold market in an industry such as healthcare where inferior goods and services are so readily disregarded in the first place?

One strategy becomes clear, and has positive implications for healthcare access, as one understands the difference between low-end and new-market disruptions.

Limits on low-end disruption in healthcare

A low-end disruptive good or service competes against an incumbent, seeking to gain a foothold market among customers who are overserved. Overserved customers are those willing to sacrifice some of the top-of-the-line performance demanded by high-end consumers, for a product that performs the same job with a less unsettling price tag. While many disruptive products lack the sophistication or quality of an incumbent, the disruptive product may better meet the needs valued by low-end consumers with features like portability, simplicity, or low maintenance costs.

An example of low-end disruption from the automobile manufacturing industry is Toyota and their sequence of vehicles’ market ascension in the United States (the Corona, Corolla, and Camry). Toyota’s innovative production processes allowed them to price their simplistic and dependable vehicles at a lower price point. Ultimately, they grew to compete for market share among the likes of Ford and GM as they moved up-market (eventually reaching higher-end customers with the Avalon model and Lexus line of vehicles).

The restaurant example above demonstrates just one of the ways in which the deck is stacked against low-end disruptive innovations attempting to gain a foothold market in healthcare, as pooling risk through a third party minimizes the cost advantage an inferior but potentially disruptive good or service may have over incumbents. Thus, low-end and potentially disruptive options that may actually cost less than incumbent options appear no more affordable to patients, despite advantages in actual cost. This decoupling of price and affordability combined with low-end market-entry regulation by the FDA makes low-end disruption an improbable feat in healthcare, and is a force pushing innovators to pursue costly sustaining innovations upon incumbent technologies as opposed to disruptions.

The potential of new-market innovation in healthcare

On the other hand, new-market disruptive products and services compete against nonconsumption, as opposed to incumbents. Nonconsumers are those who have not historically purchased the incumbent good or service. In healthcare, common nonconsumers for a typical procedure are those in health plans lacking coverage for the procedure and those who have a pre-existing condition or circumstance preventing them from utilizing the procedure. Thus, new-market innovations in healthcare should help patients make progress against the same health condition as the incumbent good or service, but reach patients in circumstances that prevent them from utilizing the incumbent technology.

In our restaurant analogy, this strategy would entail focusing efforts to sell the chicken dish at a different table with customers in different circumstances (a new market, so to speak). For example, a group who does not eat red meat for any number of potential reasons (moral, religious, or health) would gladly opt for the chicken entrée as an alternative source of protein and sustenance over the steak entrée. This foothold market, bound by different circumstances, outside of the mainstream, is where innovative chefs can gain feedback and work to improve their product by adding new spices or pairing the chicken with different sides in an effort to eventually catch the eye of mainstream steak entrée purchasers and convert them into chicken entrée purchasers.

New-market disruption is the path of less resistance for new and potentially disruptive technologies in healthcare today, as the decoupling of cost and affordability in third party payment models leave low-end disruption an unlikely feat. For an in-depth look into how a disruptive technology can use a new-market strategy to gain a foothold market in healthcare, stay tuned for my blog next week.

As a Research Associate, Ryan investigates potentially disruptive healthcare delivery models and the technologies that will enable their success. He is particularly interested in health information technology and is currently researching Disruptive Innovation in the space of electronic health records.