In what follows I borrow heavily from studies by Cramton, Ellermeyer and Katzman (2015), Katzman and McGeary (2008), Yunan Ji (2021), and others.
CMS introduced a pilot bidding program for DMEPOS on a trial basis in selected counties from 1999 to 2002. The bidding program has since been expanded to cover larger areas.
DMEPOS is the acronym for durable medical equipment, prosthetics, orthotics and supplies. These are items that typically last at least three years and are provided to Medicare beneficiaries through prescriptions. The list covers a range of items from blood glucose monitors and strips to wheelchairs and patient lifts. The items are classified under type categories that group items that are similar or related into a single category.
The auction rule
Under the bidding system the qualified bidders are allowed to submit bids for the items with the restriction that a bidder must submit bids for all items in the category (and county) for which the bidder is bidding. The bidder is allowed to bid on multiple categories and counties.
For a given category, CMS calculates composite bid for each bidder using past quantities as weights. The bidders’ supply capabilities are considered. Then for that category, CMS allocates the right to supply the items in the category to bidders with the lowest bids that can meet the projected demand for the items in the category. These are the selected suppliers.
The price for each item is set equal to the median price from the selected suppliers for that item. A selected supplier may supply the items to the beneficiaries, but the price she will receive is that median price.
The problem with the auction design
There are two big problems with the auction design that together resulted in significant supply shortage resulting in beneficiaries unable to purchase/access the items.
The first is that CMS set the median price for each item as the price that suppliers received for the item. The suppliers are asked to bid based on their actual cost plus a normal profit. Under this pricing setting scheme, half the selected bidders’ bids would be below the price they receive. In other words, the price is lower than their “cost plus normal profit.” Why would such a supplier sell the item to a Medicare beneficiary for less than normal profit or even a loss when she can sell to the open market for a normal profit?
The second problem is what enables the supplier to not sell to the beneficiary. The CMS does not require suppliers to commit to a quantity of supply. Consequently, when a supplier sees that selling to open market rather than a Medicare beneficiary is more profitable, she can do that with impunity, and a supply shortage is created for the beneficiaries.