Determining the optimal price for your offering

An increasing number of healthcare providers are offering their expertise outside of clinical care. How do you set a price for your services? Let’s walk through this important step.

An increasing number of healthcare providers are offering their expertise outside of clinical care. From side gigs to career transitions, healthcare providers are exiting a world in which they’re told how much their services/expertise will be compensated to one in which they must set a price.
How do you set a price for your services? What are the quantitative fundamentals that support a per unit price for your services? Let’s walk through this important step.

There are three pricing strategies that you can employ:

• profit-based pricing,

• revenue-based pricing, or

• sales-based pricing

Each has its role in a business, depending on:

• your immediate goals,

• the stage at which your company finds itself, and

• the funding event to which you are aiming.

We’ll discuss each of these in detail. First, we need to determine the *floor* of your price. Below this floor you will generate a negative profit and revenue. This floor is your marginal cost (red color).

Determining marginal cost

There are many ways to assess your marginal cost. The marginal cost (MC) is how much it costs to provide your service on a per-unit basis. In our case, the unit is one hour. How much does it cost to provide your service?

The direct method calculates this cost based on your hourly expenses. These would be your direct and indirect expenses, like the cost for a video call, electricity, rent per hour, and more.

The indirect method calculates this cost based on your lost opportunity. What revenue did you sacrifice in order to provide this new service? We’re going to use this method and start with an annual salary of $329,000 (the average salary for a nephrologist according to the 2022 Medscape Physician Compensation Survey).

The chunks of time that occupy a salaried nephrologist’s effort are on-call and outpatient.

On-call

According to a private practice nephrologist, most physicians are on-call one week per month → 12 weeks per year. During the on-call week, nephrologists work 7 days at 12 hours per day (all averages and mostly what I experienced). I calculate 1008 hours per year of on-call coverage.

Outpatient

For outpatient services, let’s say you work 5 days per week (no weekends). Deduct 4 weeks of vacation (20 business days) and 11 Federal holidays (let’s assume you receive all 11 holidays). Consider that one works 10 hours per day (8 hours at work and, unfortunately, 2 hours at home). All of these considerations/assumptions add up to 1450 hours per year of outpatient service.

Marginal cost = $133.85 per hour

Put it altogether and your MC is just under $134 per hour.

This is your opportunity cost - the revenue (per hour) that you lose because of the new service that you are providing.

Now that you know your marginal cost, you have your floor. You need to charge an hourly rate greater than $133.85. How much greater?

There are two ways to obtain pricing information from the marketplace: primary and secondary (ooh, fancy!).

Look at primary data sources as prospectively gathering new information. This effort usually takes the form of a conjoint analysis. We’re going to focus on this form of data gathering next.

Secondary data sources are retrospective analyses of existing pricing models. In our case, since you’re starting a new venture, there aren’t a lot of data sources (if any) to use. We won’t focus on this option in this exercise.

Conjoint analysis

A conjoint analysis can tell you three things about the marketplace:

1. how much customers are willing to pay for your service as a whole

2. how much customers are willing to pay for each level of your service (e.g., same-day service, follow-up consultations, offline research, networking efforts, etc.)

3. which attribute(s) of your service (within a level) are favored

We will focus on #1. Since we know our marginal cost, we need to deploy a conjoint analysis in which the lower end of the price range is more than our marginal cost. If it isn’t (i.e., we give the option of customers selecting $100 per hour as a price for our service), there’s a good chance we will receive bad data.

Bad data today results in poor profits tomorrow (attribute: yours truly).

Let’s decipher the demand curve for your service. The red line represents the marginal cost, which we calculated as the opportunity cost (a.k.a. lost revenue) per hour that you sacrifice in order to provide the new service to a customer. That cost is fixed at $133.85 per hour, no matter how much the marketplace demands your new service.

The black line represents the demand (a.k.a. willingness to pay) curve for your service based on your conjoint analysis. It is a downward sloping curve and is interpreted in the following way:

The lower your price per hour (y-axis), the more the market will demand of your service (x-axis).

The above statement is counterintuitive, so take a moment to understand it. We are using the variable on the y-axis to explain the variable on the x-axis. Normally, we don’t interpret a graph in this manner.

Traditionally, we use the x-axis variable (independent variable) to explain the y-axis variable (dependent variable). We’re doing the opposite here, which is the standard way by which a demand curve is interpreted.

Deriving the marginal revenue curve

We’re getting close. Very close. We need to derive 3 distinct price points, one each for a pricing strategy that revolves around:

• profit, or

• revenue, or

• sales

We need one more curve (3 curves for 3 strategies) to complete our graph and get some price points: the marginal revenue (MR) curve.

The MR curve is the first derivative of the demand curve (black). Since the demand curve is linear, the formula will take on the format: y = mx+b or Price = (negative slope)(quantity demanded) + some constant value. You can use Excel to give you the formula, which in this exposition is:

P = 359.6 - 2.71Q

The revenue (R) equation is:

R = 359.6Q - 2.71Q^2

The MR equation is:

MR = 359.6-5.42Q

We can graph the MR equation and superimpose it onto our existing graph and have the final result below:

Assuming you have a near-100% probability of getting a price of $251.20 per hour, you’ll make the most profit at that price point.

Option 3: sales-maximizing pricing strategy

When your business is in the Proof of Concept phase, you need to show to future angel investors, family, friends, fools (oops, I meant strangers who know nothing about you or your business and yet want to invest), and most importantly yourself, that you actually have an idea that can be transformed into a business. The proof comes in the form of sales.

Sales maximization can occur if you price your service to $0.00 or, even better (sarcasm), you pay people to use your service. Since neither is a legitimate pricing strategy, your sales-maximizing strategy occurs at a quantity demanded where the demand curve intersects the marginal cost. That intersection happens around a quantity demanded of 80-90 hours. The corresponding price point is somewhere at-or-slightly below $142.80 per hour.

There you have it. A quantitative way to identify three price points based on your pricing strategy:

• $142.80 per hour for sales maximization

• $169.90 per hour for revenue maximization

• $251.20 per hour for profit maximization

The only thing left is to add probabilities to these calculations. Doing so moves you from profit/revenue maximization to Expected (profit/revenue). Remember:

Profit ≠ E(profit)

Revenue ≠ E(revenue)