In health insurance, there is an idea of "per member per month" pricing. A member is a single insured individual. A member might be an employee of a company who offers a plan from the insurer. Or the member might be the spouse or a child of that individual. Since anyone can get sick, we measure the risk of the population in terms of all the members. And so many healthcare offerings offered through employers or insurers are provided on a per-member pricing model. The theory is that this is a fair way to allocate costs to the client. If an employer has 5,000 members, their health cost risk will be about five times that of one with 1,000 members.
Except, of course, it's more complicated than that. A small fraction of people consume most healthcare. For example, most people do not have surgery in a given year, but surgery drives many costs. Pharmaceutical use causes a plurality of the expenses in most employee-centric health insurance plans. These are also unevenly distributed.
Most offerings into employers and health plans - together called "payer" organizations - only affect a small number of the members because that is where the costs are. A service to help manage diabetes will help with the health risk and target just the minority with that chronic disease.
The most common pricing is a recurring cost for the recurring benefit scaled to the size of the population. The pricing model creates simplicity since the gain is the overall risk reduction in the population. The most straightforward pricing model for the vendors is per member per month: "pmpm."
However, the delivery is just a tiny part of the population. Diabetes might affect 10% of your members. The service will focus on identifying and helping those people so that services will be targeted, not widespread.
Second, the value to the health plan is reducing costs from what they would otherwise be. Paying based on the size of my population does not seem to align with value. The diabetes vendor makes more money if I hire more employees. On the other hand, the vendor does not make more or less if they do a good job reducing my costs.
"PMPM" aligns neither the costs nor the benefits of the service. And this misalignment is an ongoing problem in healthcare. How do you price these services in a way that aligns incentives between the parties? Many have tried, and most have failed.
In my opinion, this alignment challenge is why these services are generally under-adopted. Healthcare is more expensive for all due to people getting sicker and dying instead of living better (if not excellent) health.
Connect this to pricing in software as a service. The theory is the same. We often offer the same units - per-firm or per-seat. But we have an intuitive understanding that value and pricing are not well aligned.
My theory is that this disconnect simultaneously is why we fall back to a "pmpm"-like pricing model and underprice for it. Figuring out which client business we help and targeting pricing to reflect that benefit will unlock value for the client and ourselves.
Pricing alignment helps the client because they will be more likely to use the services to help them when they are comfortable with more aspects of the business deal.
Pricing alignment helps the vendor because it generates more sales and usually increases the benefit returning to the vendor. Increases on both dimensions mean benefits accrue at a geometric rate.
Finding the alternative is difficult. In insurance, the innovative edge is the vendor getting into insurance itself. For example, a diabetes management vendor confident in bringing down costs wants to profit from that impact. They can offer a second layer of insurance to the employer or insurance company. The diabetes company takes on the risk of the identified diabetic population.
So if the individuals drive more cost, that would be paid by the at-risk vendor, but not the insurance company. Say a median person has 200/month in health care costs. A diabetes patient might cost 1000/month. And a diabetes patient in crisis might charge 10,000 in a month - or more! The vendor would offer to buy the risk from the insurance company at, say, 1,000 per month. That way, if the patient is average, the management company makes nothing. If the patient is below-average costs, the management company makes a profit. And if above, the management company takes a hit.
Since costs are uneven over a population - even a segmented population like this one - the question of profit or loss has to take a broader view than the individual. Do the management company's services reduce the number of people in crisis? Does it drive down their costs on average and in most months? Then the average health costs of a person look more like $800 instead of $1000, which means they benefit when their patients benefit.
What I love about this model is that it turns the vendor into a buyer. Instead of selling services, they are purchasing risk from the insurer. Now the insurer has less insurance risk on their books, and the diabetes company will make money only if they help the people on whom they "bought" the insurance. Incentives are aligned, and the salesforce becomes a buying force. It is much easier to buy things from a company than sell them, and the market can open up.
The trick is that you need to be good at your job and manage the risk of accidental exposure. For example, say you buy the insurance risk on a diabetes patient, and the patient gets in a car accident. That would be a side-effect risk. What a challenging position for a startup to take - what if you cannot deliver? Getting re-financing (or reinsurance in the case of my hypothetical diabetes manager) will be a challenge.
There are other, more straightforward means of aligning incentives, but start big! Asking more significant questions of the pricing may or may not flip you from a seller to a buyer, but it will start with the confidence you have in your solution and a deep understanding of the client's needs. When you leverage your pricing model to do well for both the client and your firm, everybody wins.
Photo by National Cancer Institute on Unsplash