Rebate debate continues – health industry rebates

Rebate debate continues – health industry rebates – column

Arnold Celnicker

Rebate debate continues

At the Health Industry Distributors Association (HIDA) convention, I spoke on the topic “Antitrust Aspects of Pricing to Group Purchasing Organizations.” In the Speaking Out column of the November issue of Health Industry Today, William J. Wooldridge (president of MedEcon Services) criticizes aspects of my presentation. Wooldridge claims that I examined the rebate system “only from a distributor’s point of view,” and that I “never discusse[d] the reasons the system exists from the manufacturer’s perspective.”

In fact, one of the themes of my presentation was that, from the manufacturer’s perspective, the rebate system is a pricing system that exists to maximize the manufacturer’s profits through economic price discrimination. (In essence, economic price discrimination means segmenting a market so that customers who are price sensitive pay a relatively low price, and those who are not price sensitive pay a relatively high price.) The heart of Wooldridge’s criticism is, presumably, not that I failed to discuss the manufacturer’s perspective, but that I failed to understand it.

Wooldridge argues that the manufacturer’s lower prices to hospitals or group purchasing organizations (GPOs) are justified by the large volume that these customers bring to the manufacturers. He concludes that “[t]he key according to Robinson-Patman, is that manufacturers should charge the same price for all ‘like’ volume.” Wooldridge’s legal conclusion is wrong.

The purpose of the robinson-Patman Act was to prevent a large volume customer from receiving lower prices simply because of its large volume. In other words, if Wooldridge were correct, it would be acceptable for a manufacturer to give large distributors a 20 percent greater discount than it gives all small distributors. Such volume pricing clearly raises a legal problem.

Moreover, Wooldridge’s economic premise, that increased volume lowers per unit manufacturing cost, generally is not borne out by economic studies. Within the range of production that is relevant, manufacturing costs are usually fairly constant, with increasing costs expected as capacity is approached. Costs that constantly decrease as output increases characterize a natural monopoly; a situation that rarely exists. Even in those rare instances of per unit manufacturing costs continually decreasing as volume increases, there is no reason to differentiate the contribution total volume of 1,000 units generated by a hospital from the contribution to total volume of 1,000 units generated by 100 doctors’ offices using 10 units each.

Although the automatic equating of aggregate volume with cost savings is economically erroneous and potentially illegal, the Robinson-Patman Act does allow for differing discounts based on “differences in the cost of manufacture, sale or delivery” to different customers. Wooldridge argues that greater discounts to a hospital or GPO than to a doctor’s office fall in this category because it costs less, per unit, to service a hospital.

Assuming that accounting data would support this generalization, the current rebate system still would not be justified. Manufacturers generally do not sell to doctors’ offices. Manufacturers usually sell to distributors and distributors resell to doctors’ offices. If we assume that the manufacturer does sell to the hospital (directly or through a distributor acting as an agent) then the question is whether it costs the manufacturer less to sell the hospital than it costs the manufacturer to sell to the distributor. Once the right question is asked, I believe that most industry members would agree that rebates, often in the 20 to 40 percent range, are not cost justified. (Note that any high per unit cost of servicing doctors’ offices is the distributor’s cost and is rightly reflected in the distributor’s mark-up to those accounts.)

As I emphasized at the HIDA meeting, the administration and the courts are hostile to the Robinson-Patman Act and rarely will find a violation. The defense of rebates presented by Wooldridge, however, is not sound. The most viable explanation of the rebate system is that manufacturers are engaged in profit-maximizing economic price discrimination.

The author is a former attorney for the Federal Trade Commission and is currently an assistant professor at Ohio State University.

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