Innovation Incentives in a Pandemic

Abstract

The current pandemic has exposed the skewed nature of innovation incentives in American healthcare. Consider the case of a company that makes a medical device like a ventilator. The demands of its customers shape its incentives to innovate. The end consumers are patients who do not themselves pay for the device, whether they are insured or not (an uninsured patient is likely to receive free care or a large discount). The device maker will not increase sales to these customers by choosing a lower price. Purchase decision-makers are often physicians who are unaware of the price of the device (and regulations in the USA prevent the salesperson from telling the doctor the price, as that would be an inappropriate inducement). What will get the physician’s attention—and can be easily marketed—is additional quality or features of the device. These will also appeal to technicians or skilled nurses who work with the device; they are not responsible for budgets either. The fancy features might involve more convenience in terms of connecting inputs or positioning the patient, a better screen for observing measurements and settings, a greater choice of settings for pressure, oxygen, drug levels, and so forth. The hospital purchasing department may have some input into which device is chosen—and advocate for cost-effective choices—but at the end of the day, if a physician is convinced a device will provide better care, that device is likely to be chosen regardless of price. Therefore, the device manufacturer is incentivized to invent it.

These incremental quality improvements to the device may hold value for patients and caregivers, but the US medical purchasing process often has so many decision makers spending other people’s money that there is no reason to imagine that price is tightly connected to value. A consumer spending her own money on a product she consumes herself, for example, a loaf of bread, sees the nicer bag around the bread and can determine if that is worth a 10 percent price increase. A physician in a hospital is likely to ask if the new feature is an improvement or not, and then want to purchase the device if it has an improvement. Price may not part of that decision. The physician likely does not know how much the device costs, is not spending her own money, and understands that she is not spending her insured patients’ money either. Therefore, the manufacturer markets the improved features to physicians, as do its competitors, and competition takes place almost entirely on the basis of quality. This leads to expensive machines that have high levels of quality without regard for whether the value of those last units of quality is high for everyone, for a minority of patients, or for no patients.

In the absence of disruptive technology, a better device requires higher costs. In the world described above, the device maker only undertakes one kind of innovation: an improved machine at a higher cost. Over time, ventilators go from $7000 per machine to $10,000, to $25,000. Suppose a ‘standard’ ventilator has a price of $25,000. A manufacturer with an idea for how to make a $10,000 ventilator that is a very little bit worse than the $25,000 ventilator will have no customers. What physician would recommend purchasing the cheaper machine without all the settings and options of the best machine? Consider how different that is from a more functional market such as automobiles. Suppose a new auto maker found a way to make a BMW equivalent car but without the leather seats at half the price. There would likely be a huge demand for that vehicle.