Growthand profitability are always the basis for setting up any business.These are the necessary objectives that a company needs to surviveand remain attractive both to the investors as well as their clients.A company’s profits refer to the revenue obtained after all theexpenses such as the production, manufacturing, and sales andmarketing expenses have been deducted. This money usually goes tothe owners of the company that contributed capital to the company.Growth, on the other hand, focuses on the market and sales are themeans of attaining the initial profit levels. After making theinitial profits, the firm’s next focus should be on attaining itsgrowth prospects (Admin,2013).
Thispaper is going to focus on the evaluation of the health industry inas far as growth and profitability of the sector are concerned. Theanalysis will be based factors such as cost, its pricing power andthe price elasticity of demand. The paper will be aided with the helpof collecting primary data through interviewing a top level officerin the ministry of health, in the United States of America. Thisevaluation is aimed at establishing how the health industry fits intothe broad economic setup and how the current and the future marketstructures shape the prospects of the industry.
Evaluationof the cost in the health industry
Costcan be defined as the monetary value of all the expenditures forservices, supplies, labor, equipment, products and all the otheritems bought for purposes of advancing the business interests. In thehealth sector, cost elements can be defined based on the acquisitionof the elements that are needed for purposes of providing themuch-needed health services. The total cost outlay of a firm is madeup of variable costs and the fixed costs. Fixedcostsare costs which do not vary with the level of production i.e. theyare fixed at all levels of production(admin, 2013).They are associated with fixed factors of production in the ShortRun. Examples are rent or premises, interest on loans and insurance.VariableCosts (VC)are costs, which vary with the level of production. The higher thelevel of production, the higher will be the variable costs. They areassociated with variable factors of production in the Short Run. Examples are costs of materials, the cost of fuels, labor costs andselling(admin, 2013).
Thesignificance of studying the cost elements of the health sectoraccording to the respondent is that it has a direct impact on theprofitability of the firms in the sector as well as its ability toachieve the growth prospects. The cost of the factors of productionalso has had a direct impact on the pricing mechanism of the company.The respondent indicated that since the objective of any health carefirm is to make profits, any increase in the cost of the factors ofproduction would always be passed on to the final service consumer inform of increased prices(admin,2013).This would, in turn, affect the demand for the product in referenceto the theory of demand which states that as prices of commoditiesincrease, their demand decreases. For an industry therefore toachieve its profitability and growth prospects, it has to make surethat the cost of operations is minimized as much as possible(Admin, 2013).
Pricingpower in the health industry
Inthe health sector, pricing power is very significant. The termpricing power refers to the ability of a company to the prices of itsprices without experiencing a drop in the demand levels. WarrenBuffet indicates that the most important decisions in doing anevaluation of any business are its pricing power. He asserts that ifyou have the power to increase prices without losing your customersto your competitors, then it means that you are running a very goodbusiness. And if you always have to have a prayer session beforeraising the prices of your goods and services evenly 10 percent, thenit means you are running a terrible business(“Addressingpricing power in health care markets: Principles and policy optionsto strengthen and shape markets,” 2015).According to the respondent, pricing power in the health sectorrarely leads to decrease in the level of demand. According to him,the pricing power in the health sector can successfully be executedcompared to other industries because of the nature of the industry.Studies indicate that the health sector is unique in the sense thatit deals with a specific client base whose price elasticity of demandis largely inelastic such that any price increase is unlikely to leadto a decrease in the levels of demand.
Marketcompetition is the best method of motivating the service providers toraise the efficiency and improve the quality of healthcare servicewhere the level of competition in the market is ineffective, the useof public policy can be used to regulate prices. At times when mostof the healthcare providers are finding it difficult to maintain, letalone increasing the levels of profits, the improvement of pricingcapabilities could have a long-term impact. The respondent indicatesthat the pricing performance and excellence improvement in a numberof firms in the health industry shows that such efforts translatesinto an increase in returns on investments of 2% to 7% depending onthe location of the company as well as the nature of the business(“Addressing pricing power in health care markets: Principles andpolicy options to strengthen and shape markets,” 2015).
Respondentsobtained from the interview has shown that there is an increasedlikelihood of success in the application of pricing power in the firmin question involve sits customers in the application of themechanism. This according to him involves getting the customer tounderstand the reasons for the increasing prices and explained tothem as to why the prices had to be increased. Reports indicate thatthe health sector being largely a service industry is labor intensivewith a customer base whose demand is inelastic(Morris et al, 2012).It is, therefore, easier to raise the prices without having theprofits affected due to a decrease in the level of demand. When theprices of raw materials rise, the sales representatives would notnormally know which prices to raise and by what proportion as well asthe timing of the price increase. Without that knowledge, theprospects of the firms earning profits are likely to evaporate. Thepricing power, therefore, needs some transparency so that thecustomers understand why they need value for their money(“Addressing pricing power in health care markets: Principles andpolicy options to strengthen and shape markets,” 2015).
Priceelasticity of demand in the health industry
Priceelasticity of demand refers to a measure of the responsiveness of thedemand for a product to the changes in the product’s own price.Price elasticity is significant in that it measures the relativemagnitude of the changes rather than the absolutes. Despite a widevariety of methods and available data, the demand for healthcare hasbeen found to be elastic. This corroborates the findings from theinterview which indicated that however much the prices of productsand services changed there is always a less than proportionatechange in the level of demand. This is partly due to the fact thatthe health sector is a sensitive industry and is a matter of life anddeath where alternatives are not always forthcoming(Pino, 2014).
Ifa proportionate change in price causes a less than proportionatechange in quantity demanded, demand is said to be price inelastic.The absolute value of price elasticity of demand, in this case, isless than one, that is, E01 for example in the case of necessities.Thevalue of price elasticity of demand is negative because of theinverse relationship between price and quantity demanded that is ifthe price falls, quantity demanded increases and if price increasesquantity demanded falls. However, in this case, the absolute value isconsidered since the interest is on the extent of change and not thedirection of change.Priceelasticity of demand can be measured in two ways, that is, pointelasticity of demand and arc elasticity of demand(Pino, 2014).
Pointelasticity of demandis a measure of price elasticity at a particular point on the demandcurve. It is valid for very small changes in price.
Fora straight-line demand curve, point elasticity can be found using thefollowing formula:
PointED= ΔQ/Q= ΔQ• P
WhereP/Q is the price divided by the quantity at the relevant point andΔQ/ΔPis the reciprocal of the slope of the demand curve.
Arcelasticity of demandrefers to a measure of price elasticity between two points on ademand curve (along a range of a demand curve)
Itcan be calculated both for linear and non-linear demand curves usingthe following formula:
ΔP(Q1+ Q2)/2ΔP Q1+ Q2
WhereP1and Q1representthe initial price and quantity respectively and P2and Q2represent the new price and quantity respectively
Althoughthe range of price elasticity changes is broad, it widely tends torevolve around -0.17, which means that a one percent increase in theprice of healthcare would result in a 0.17% reduction in the demandfor healthcare. The changes in demand, induced by price changes canlargely be attributed to the probability of one accessing thehealthcare services rather than an experience in the reduction ofvisits. The respondent also indicated that people with higherincomes are relatively elastic compared to the low-income earners.
Anycompany in the health sector seeks to attain maximum profitabilityand growth. They can, however, achieve this only and only if the firmis operating in an industry that supports the growth prospects of thefirm. This paper, therefore, concludes that the health industry hasa very great role to play in the economic set-up of any country ifthey are able to minimize their cost in order to increase profits aswell as making use of a price mechanism that would not drive away thecustomers leading to reduced demand. it is also important that thefirms operating in the industry are able to understand the demandelasticity of their customers before making any adjustments in theprices of their products in order to maintain their market share,increase profitability and consequently achieve its growth prospects,this way the health sector would be at the core of the economy in thecountry.
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