Contracts for Healthcare Referral Services: Coordination via Outcome-Based Penalty Contracts

Abstract

This work focuses on the business-to-business interaction between a service requester and a service provider in a healthcare environment. The requester is the primary caregiver responsible for managing the health of a population of patients. When a patient requires advanced care outside of the requester’s expertise, the requester refers the patient to a provider and pays for the referral services. Treatment may succeed or fail, and in the case of failure, the requester incurs further follow-up costs. The requester may exert preventive effort to reduce the volume of referrals. The provider may exert nonreimbursable effort to reduce the chance of treatment failure. We analyze payment contracts between the two firms. We find that fee-for-service (FFS) induces neither system nor social optimum effort outcomes. However, a penalty contract can generally coordinate the effort decisions with either the system optimum or the social optimum. Furthermore, we find that patients may benefit from having a coordinating contract replace FFS. However, the types of procedures that make a coordinating contract most advantageous for the requester and provider are not necessarily the same as those that make the patients better off than under FFS. Yet, in most cases, the coordinating contract improves social welfare, as compared to FFS, and brings it close to the social optimum. Hence, the requester–provider coordinating contract can be considered as an improvement over FFS for the entire system. The online appendix is available at https://doi.org/10.1287/mnsc.2017.3000 . This paper was accepted by Serguei Netessine, operations management.