Any Willing Provider
I am writing this letter in response to your request for information regarding the economic impact of H.R. 3559, Medicare Durable Medical Equipment Access Act of 2005.
In particular, I would like to comment on the impact of the provision that would allow
. . . suppliers that are classified as small businesses under the Small Business Act to continue to participate as suppliers at the selected award price so long as they submit bids at less than the fee schedule amount otherwise applicable to the items. . . .
Let me begin by making a few observations about this provision before discussing the impact it might have on the potential savings from competitive bidding for DME.
• According to the analysis of the proposed rule for competitive bidding by CMS, which may be found in the Federal Register, Volume 71, No. 83, May 1, 2006, approximately “90 percent of registered DMEPOS suppliers are considered small according to the SBA definition” (p. 25691). While true, this statement ignores the fact that these small businesses account for only about 30–40 percent of the overall market share in the industry. Thus, while the provision being offered in H.R. 3559 would allow a significant number of firms to participate in the market without
winning in the bidding process, the bidding process itself will be affected far less, if at all, since the remaining 10% of firms that must submit a winning bid to participate in the market represent such a large share of the overall market for DME.
• According to the analysis of the proposed rule for competitive bidding by CMS, “approximately 30,000 suppliers offer at least one product eligible for competitive bidding and are located in one of the largest 100 MSAs and could therefore be impacted by the program” (p. 25691).
Assuming that 90% of the impacted firms are small businesses, 3,000 firms, or an average of 30 firms per the 100 largest MSAs, will be required to submit a winning bid to participate in the market for DME. Generally speaking, 30 bidders is a significant number of bidders.
• While the proposed rule will require firms that participate in the market maintain some minimum quality standards, allowing small businesses to also participate in the market will provide a built-in incentive for firms to exceed the minimum standards to maintain market share. If a large number of firms are eliminated from the market, and it is likely that a competitive bidding process will eliminate most of the small firms, consumers will have a limited choice of suppliers, and knowing this, suppliers will have little incentive to exceed the minimum quality standards. If consumers have more choice and all firms charge similar prices, consumers will choose based on quality, convenience, and product support.
To maintain or gain market share, firms will need to raise their standards, and this is only possible if the market consists of a significant number of suppliers as this provision will allow. In addition to the items above, it is important to consider the impact that this provision will have on the cost of the competitive bidding program. I would like to respond to this in two ways.
First, are 30 bidders, or even 10 bidders, “enough” to obtain prices similar to the prices achieved during the demonstration projects, which are the basis for the savings estimates from the competitive bidding process? To answer this question it is important to note a couple of features about the competitive bidding process. Bidders that do not submit winning bids will be eliminated from participating in the market, and winning bidders will be chosen by accumulating bids until “winning” firms meet the demand in the area.
The 30 (or fewer) bidders in each MSA will include all of the large national and regional firms. These large firms can take advantage of economies of scale to expand and meet a large portion of the demand in a market, suggesting that a small number of firms, certainly less than 30, could meet the demand in any given market. With firms knowing that they will be eliminated from the market, they will have no choice but to submit bids that assure they can “win” and this can only happen if they submit their lowest bids.
This process is not unlike the Bertrand Oligopoly market taught in economics. In this market, firms compete based on price and losing firms are eliminated from the market. It can be easily shown in this market setting that with as few as two firms, assuming that one firm has the capacity to meet market demand, firms charge prices equal to their marginal cost, which represents the lowest price they could possibly accept. In the context of the competitive bidding program for DME, this suggests that if a relatively small number of bidders has the capacity to meet market demand, firms will be required to submit their lowest possible to bid to prevent being shut out of the market. This implies, therefore, that there are “enough” bidders to achieve the demonstration prices in the DME market and that this provision will not impose any negative impacts on the savings estimate for competitive bidding.
Second, I would like to refer you to a 1992 report by the General Accounting Office (GAO) on the impact of a restricted bidding process by the Corps of Engineers titled The Corps of Engineers’ Dredging Program for Small Businesses. This report investigated the impact of a restricted bidding process on the final bids. While this bidding program was not identical to the proposed competitive bidding program for DME, it had the feature that the number of firms bidding was reduced by the program, which the provision in H.R. 3559 would allow. The report was compiled because there were concerns that the reduced number of bidders would result in higher prices being bid by the remaining bidders. Two conclusions of the report are worth noting. First, contrary to the belief that more bidders would result in lower prices being bid, the report concluded that, in fact, the prices bid by firms were lower when fewer firms participated in the bidding process. Second, while the large firms in the market argued that “unrestricted” bidding would be more competitive, the report concludes that the number of bidders was actually higher when the bids were restricted. In addition, the report also argues that the number of bidders “may not be a clear measure of competition.”
Together, these suggest that the provision being proposed in H.R. 3559, which would allow qualified small businesses to participate in the market without submitting winning bids, will have little or no impact on the recent cost savings estimate for competitive bidding for DME. Overall, I believe this provision will be beneficial to the overall DME market, particularly in terms of product and service quality, without adversely impacting the savings from the competitive bidding program.
Kenneth H. Brown, Ph.D.
Calculating the classic Bertrand model
- MC = Marginal cost
- p1 = firm 1’s price level
- p2 = firm 2’s price level
- pM = monopoly price level
- Firm 1’s optimum price depends on where it believes firm 2 will set its prices. Pricing just below the other firm will obtain full market demand (D), though this is not optimal if the other firm is pricing below marginal cost as that would entail negative profits. In general terms, firm 1’s best response function is p1’’(p2), this gives firm 1 optimal price for each price set by firm 2.
- Diagram 1 shows firm 1’s reaction function p1’’(p2), with each firms strategy on each axis. It shows that when P2 is less than marginal cost (firm 2 pricing below MC) firm 1 prices at marginal cost, p1=MC. When firm 2 prices above MC but below monopoly prices, then firm 1 prices just below firm 2. When firm 2 prices above monopoly prices (PM) firm 1 prices at monopoly level, p1=pM.
- Because firm 2 has the same marginal cost as firm 1, its reaction function is symmetrical with respect to the 45 degree line. Diagram 2 shows both reaction functions.