Evaluating the Alternative Strategies
Posted on July 26, 2009 - Filed Under Finance
What should Atlanta’s managers do? If Peachtree’s proposal is accepted, the clinic is expected to lose $580,962 rather than make a profit of $419,038 when no discount was demanded. The difference is a swing of $1 million in profit in the wrong direction, hardly an enticing prospect. What happened to
the “missing” $1 million? It is now in the hands of Peachtree HMO, which is paying $1 million less to one of its providers (25,000 visits × $40 savings = $1,000,000). This will be reflected as a cost savings on Peachtree’s income statement and, if the savings is not passed on to the ultimate payers (typically employers), will result in a profit increase.
If market forces in Atlanta Clinic’s service area suggest that making a counter offer to Peachtree is not feasible—perhaps because the clinic is being pitted against another provider—the comparison of a loss of $580,792 to a profit of $419,038 is irrelevant. The only relevant issue at hand for the short-term is the comparison of the $580,792 loss if the clinic accepts the proposal to the $1,376,462 loss if the proposal is rejected and Peachtree’s patients are lost to the clinic. Although neither outcome is very appealing, the
acceptance of the discount appears to be the lesser of two evils. In fact, the acceptance of the discount is better by $1,376,462 ? $580,792 = $795,670. Accepting the discount proposal is Atlanta’s best short-term strategy because Peachtree’s patients still produce a positive contribution margin of $60 ?
$28.18 = $31.82 per visit, which would be foregone if the clinic rebuffs Peachtree’s offer. That $31.82 per visit contribution margin, when multiplied by the expected 25,000 visits on the contract, puts $795,500 on the total contribution margin table that otherwise would be lost.
Taken From : HEALTHCARE FINANCE
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