A study published in the May issue of The Quarterly Journal of Economics finds that the Centers for Medicare & Medicaid Services (CMS) Competitive Bidding Program for durable medical equipment (DME) “fails to generate competitive prices of goods and fails to satisfy demand.” The study was conducted and written by California Institute of Technology (Caltech), Pasadena, professor of political science and economics Charles R. Plott, PhD, and two of his students, Brian Merlob and Yuanjun Zhang.
Image courtesy of Caltech.
The bidding system-or auction- was designed by CMS to align Medicare reimbursement rates with market prices for DME and related services such as respiratory devices, wheelchairs, and hospital beds. In principle, auctions are an inexpensive and efficient way to procure goods. Unlike standard auctions, however, the CMS auction was designed with two unorthodox rules, the team said. First, the eventual selling price is set at the median of all of the winning bids. Second, bids are nonbinding, so companies can change their mind once the prices are set.
According to a Caltech press release, critics say that these rules cultivate a harmful bidding strategy. To ensure a winning bid, each company will make a very low offer; this carries no risk, because the companies can cancel their bid if the median price turns out to be too low. The result is that participants in the auction will tend to make low-ball bids, assuring that the median price will also be so low that few of the companies can actually afford it, leading them to cancel their offers. At the extreme, nothing is bought or sold and, Plott said, “the auction crashes. It’s just not an effective auction.” The press release further stated that critics warn that the government will then end up negotiating prices with individual companies, which negates the point of a competitive-bidding program in the first place.
The team conducted a year-long study of the bidding system to determine if such theoretical predictions translate into real-world behavior. They used computers at Caltech and the University of Maryland (UMD), College Park, to run a simplified version of the CMS auction and several other auction types. One, for example, followed more standard rules, with binding bids and prices set at the lowest bid that did not win, instead of the median of all winning offers. Each auction involved 12 or 16 bidders (student volunteers from Caltech and UMD), who first had to pass a quiz showing that they understood how the auctions worked. The volunteers were given just one item to sell-a generic “thing” (since the bidders’ behavior should be the same in a given auction type, regardless of the item being sold)-each at a different cost to them. The Caltech team also examined the effect of other auction features, such as whether the costs of each item for each bidder are public knowledge and the effect of charging bidders to participate.
The results, the researchers say, support critics of the CMS auction design. “It’s pretty disastrous what the bidders ended up doing,” Zhang said. In the simulated CMS-type auction, some people bid $0, and the “government” was not able to buy all the items it needed. The experiments also showed that a standard auction is much more efficient and successful: the government was able to buy all the items it needed, and the bidders who had the lowest costs were the winners.
Using this experimental approach, the researchers were able to pinpoint the fundamental problem of the CMS auction design: the two rules. “If you just get rid of one of those two rules, it doesn’t help-you still have problems,” Plott said. “So you have to get rid of both of them.”
CMS implemented the purchasing process in nine metropolitan areas across the country last year and plans to expand it to 91 in 2013.
