Transfer Prices and Innovation in Public Healthcare: Costing and Clinical Choices in the NHS

The establishment of an internal market for clinical services in a publically funded National Health Service (NHS) requires a process for setting transfer prices. Given the values and logics of actors in a public healthcare system, attempts to determine an “optimal” price for specific treatments as prescribed by well-known transfer pricing texts, are likely to be inappropriate. Rejecting a reductionist model of Economic Man, the study adopted a richer perspective on actor reality through a pragmatic constructivist (PC) methodology. The PC methodology was used to interpret data drawn from a case study of a specialist healthcare centre of English NHS. The case study revealed different realities constructed by clinical and managerial actors. Clinical actors in the study were willing to spread a technological innovation but were not being supported by managers whose reality was influenced by centrally set tariff prices which favoured traditional high cost procedures rather than less costly technical innovations. Characterising the different realities as the “pragmatic truth” of managers and the “proactive truth” of clinicians, the challenge was to bring these together for a fully integrated and coherent solution. This challenge required avoiding a top-down “command and control” model of governance and greater flexibility for transfer pricing and incentives. More generally, the study supports alternative institutional mechanisms that can routinely promote the spread of new technological innovations which are not only clinically superior but, as this case illustrates, are sometimes cheaper than the current procedures

Discussion of decentralized capacity management and internal pricing

Dutta and Reichelstein (2010) study the role of transfer pricing and organizational choice in providing incentives for efficient decisions on the acquisition and subsequent reallocation of capacity within decentralized firms. Their analysis suggests that transfer prices based on the historical cost of capacity facilitate the efficient allocation of resources. They also find that symmetric responsibility center structures are generally better suited for providing efficient investment incentives than hybrid organizations. An important condition for the derivation of the two results is the linearity of the shadow prices of capacity. If shadow prices are nonlinear, transfer prices should be below (above) the historical cost of capacity in order to counteract the managers’ incentives to underinvest (overinvest). Because profit center organizations can use transfer prices for mitigating the inefficiency caused by nonlinear shadow prices, they offer a natural advantage over pure investment center organizations in implementing efficient capacity decisions. Overall, these observations suggest that the curvature of profit functions is an important factor in determining the suitable instruments for decentralized capacity management