Q and A: Economist slams bidding program

Thursday, September 30, 2010

YARMOUTH, Maine - Economist Peter Cramton has studied and created competitive bidding programs for 20 years and when it comes to Medicare's bidding program for DME, he doesn't mince words: "It will be a disaster." The University of Maryland economist played a lead role in writing a letter to the House Ways and Means Committee last month, pointing out the flaws in the program. His views were also published in The New York Times last week. Essentially, the DME bidding program should be scrapped and CMS should develop a new format from scratch, preferably with the help of a bidding expert, Cramton told HME last week during an interview.

HME News: First, how did you become aware of the DME bidding program?

Peter Cramton: The first time I heard about it was about a year ago when people were preparing to bid and one (provider) in the industry asked me if I would be able to help them. I sometimes advise participants in complex auctions. But before I got back to him, he committed to work with someone else.

News: You got 167 auction experts from around the world to sign onto your letter to the House Ways and Means Committee. How did you do that?

Cramton: I've been an academic and practitioner in this area for the last 20 years. There's a small group of experts around the world who do this sort of thing, and I just opened up my contact list and constructed an e-mail and wrote a little policy brief with (professor) Brett Katzman and sent it out to my colleagues, asking if they would be willing to be signatories. I gave them the source documents, the CMS auction rules, bidding forms, and other materials, and told them I needed a response within 48 hours.

HME: You addressed the letter to Pete Stark, chairman of the Subcommittee on Health. After reading your letter, do Stark and his staff think the program should be redesigned before it goes forward?

Cramton: I can't say what they think, but they are certainly motivated to see that it is done right, and, if nothing else, I think now they have some healthy skepticism with the current plan. I'm hopeful they are going to push for change.

HME: Since this is your area or expertise, I suspect you are in favor of auctions.

Cramton: I'm very much in favor of auctions. I think auctions can play a very important role in providing high-quality services at the lowest cost. But they have to be done right. This is a very complicated environment, and, unfortunately, CMS, in the initial design, did not consult experts and has not consulted experts, as far as I can tell, throughout the demonstrations, and they've encountered problems and put little Band-Aids on to try and fix the problems but the Band-Aids have been ineffective.

HME: Do you think a bidding program could work in the HME industry?

Cramton: Absolutely. It can work. I've seen auctions work in more complicated economic environments extremely well, but it has to be done right.

HME: With a program like this, if not constructed properly, it seems you open yourself to all types of problems. You touched on that in your letter. For example, you say bids must be binding commitments, but in Medicare's DME bidding program that is not the case.

Cramton: No they are not. This is a very basic principle of auction design. If you combine that with the median pricing rule, where you are setting the price equal to the median among the winning bids, those two factors are going to lead to seriously downward (pricing) bias.

HME: It allows people to bid very low, knowing the winning bid will be higher, right?

Cramton: Exactly. That's especially true for small bidders who don't have a lot of money to invest in bidding strategy and information. For them, they can say: "I'll just put in a low bid. I'll be a winner, and then I'll have the option to sign a contract later on. If I don't like the price later on, I can walk away." The problem is, if too many people do that, the price can be dramatically below anybody's cost. So the government gets a low price, but they can't get delivery of supplies that is needed. It becomes unsustainable. And especially here where the suppliers that win, when a lot of prices are below cost, they are going to have a strong incentive to selectively fill orders and steer customers away if the price is below their cost, simply saying, "We are out of that right now. We can get it to you in a couple of months, perhaps, but we can't get it to you now."

HME: You say that the DME bid prices are not related to cost. What does that mean?

Cramton: Using the median with a non-binding bid, one doesn't need to make it related to cost. You can make it much, much lower.

HME: You also criticize the program's lack of transparency. What do you mean exactly?

Cramton: Here it is 10 months from when the bids were submitted and we don't know who won. The quality standards are unclear. If they sign a contact, it's unclear exactly how performance will be evaluated and what the exact obligation is.

HME: I imagine in a good program we would not have all these questions.

Cramton: That is right. There would be very clear quality standards, very clear performance obligations. Everyone would know the implications of submitting a bid. It would never be the case that when you put in a bid for $100 that you'd be obligated to supply at a price lower than $100. It would have all the features of generally accepted auction practice.

HME: What if people were paid what they bid? Would that stop the low-balling?

Cramton: Pay-as-bid is a standard pricing rule. I would not recommend that here. I think a single clearing price is better--not this median price, which has the property that more that 50% of the winners are paid less than what they bid.

HME: What is the clearing price?

Cramton: The clearing price is the price at which supply and demand balance. That is the way all markets clear. You have your supply and demand graph and the two lines cross. Where do they cross? They cross at the market-clearing quantity and the market-clearing price. The nice thing about that price is it leads to an efficient supply.

HME: What happens when reimbursement drops below the clearing price?

Cramton: It creates a very serious strategic problem for the bidders. It forces them to distort their bids away from cost in quite complicated ways. The reaction to that, if you are small bidder, is just putting in a low ball bid and saying, "Okay, I don't' really get this. I'll put in a low-ball bid, and hopefully the median will be something I can do. And if it is not, I'll just walk away." That is not how to run an auction.

HME: No. You want people who are serious, who are going to bid based on their costs.

Cramton: Right. You want sustainable competition.

HME: I guess you think this does not create sustainable competition.

Cramton: Absolutely not. What it does is create a race to the bottom, which means the providers, over time, will become increasingly unreliable. The service quality will be poor. There will be lots of selective fulfillment. There will be many beneficiaries who will not receive the service that they need, and it will be a disaster.

HME: I'm not sure the HME industry would like any kind of competitive bidding program, but if it's going to be done, it should be done right.

Cramton: Absolutely. It can be done right, and when it is done right, what happens is the parties that end up supplying are the ones who can supply the high-quality services at the lowest possible cost. Over time, if some suppliers can lower their costs even further, they will get a larger piece of the market. That is competition. It is a win for everybody, except high-cost firms that can't compete. But that is life. They should be doing something else.