Fix Medicare's Bizarre Auction Program

Here’s a piece co-authored with auction guru Peter Cramton, a professor of economics at the University of Maryland:

Fix Medicare’s Bizarre Auction Program
By Ian Ayres and Peter Cramton

Harry Truman once quipped, “Give me a one-handed economist! All my economists say, ‘On the one hand, on the other'” Often even a lone economist has difficulty making a recommendation. While true on certain matters, there are many issues where economists do agree about the right and wrong course of action. A case in point is competitive bidding for Medicare supplies.

Economists and other auction experts agree that using administrative prices from 25 years ago to set Medicare prices is a bad idea, and that a much better approach is to price Medicare supplies in competitive auctions. That is not surprising. What is surprising is the degree of consensus that Medicare’s shift to auctions is fatally flawed and must be fixed for the Medicare auctions to succeed in lowering costs while maintaining quality for medical equipment and supplies.

For the last ten years, the Centers for Medicare and Medicaid Services has been testing an auction approach that is incredible in the inefficiency of its flawed design. This policy brief lays out a number of weaknesses with the auction procedure but it is sufficient to focus on the interaction of just two:

Bids are not binding commitments
In the Medicare auction bidders are not bound by their bids. Any auction winner can decline to sign a supply contract following the auction. This undermines the credibility of bids and encourages low-ball bids in which the supplier acquires at no cost the option to sign a supply contract. This aspect of the current system has led to the predictable outcome where a number of bidders, realizing that prices were set below their costs, have refused to sign contracts.

Flawed median-bid pricing rule
As is standard in multi-unit procurement auctions, bids are sorted from lowest to highest, and winners are selected, lowest bid first, until the cumulative supply quantity equals the estimated demand. Non-standard is that the current system sets reimbursement prices using the median of the winning bids rather than using the clearing price. Since most providers are small, they lack the resources to invest in information and strategy in preparing bids. For them an effective and easy strategy is the low-ball bid, as any one firm’s impact on price is negligible. The low-ball bid is appealing to these firms because it is a winning bid with a negligible effect on the price. However, with many firms following this strategy the median-bid price is significantly biased downward and possibly below the cost of all suppliers. This possibility is not a problem for the low-ball bidders since, as described above, suppliers have the option of not signing the contract in such an event. Equally troubling is that fifty-percent of the winning bidders are offered a contract price less than their bids.(emphasis added)

There are good reasons why we have never seen a median pricing rule combined with withdrawable bidding. It is not likely to elicit serious signals of value. You can read more about the auction rules, the relevant portion of the Federal Register explaining the final rules, a journal article showing some of the problems, and the official bidding form, eligibility requirements, and quality standards).

One of us recently asked a group of auction experts (mostly prominent economists but also computer scientists and engineers) to be signatories of a letter to Chairman Stark, House Ways and Means Health Subcommittee, advocating the use of auctions to price Medicare supplies, but sharply criticizing the government’s proposed auction approach, which the administering agency (the Centers for Medicare and Medicaid Services) has been testing for the last ten years in several metropolitan areas. In less than 48 hours, 167 experts signed the letter-including multiple Nobel prize winners and members of the National Academy of Sciences.

Medicare should junk the flawed procurement auction rules and take advantage of the enormous advances that have been made in auctions and market design to fix the auction rules. “The appropriate bidding mechanism would arise from a collaboration of government officials, industry representatives, and auction experts,” wrote Peter and Brett Katzman in the policy brief mentioned above. “It would emphasize transparency, good price and assignment discovery, and strategic simplicity. The result would be sustainable long-term competition among suppliers that reduces costs while maintaining high quality.” This approach has been used with great success in other complex settings such as government auctions of radio spectrum and modern electricity markets. The engagement of auction experts should not be surprising. The economic problems being solved are far from trivial. The government would never consider building a bridge without the input of bridge experts on its design. Similarly, the government should enlist the help of expert auction designers when structuring complex auction markets. (In full disclosure, we have provided paid advice to government and non-governmental entities on how best to structure auctions.)

The mystery is why the government has failed over a period of more than ten years to engage auction experts in the design and testing of the Medicare auctions. The letter confirms that any expert would be able to quickly identify fatal flaws in the Medicare competitive bidding program. We suspect the problem is that CMS initially did not realize that auction expertise was required, and once they spent millions of dollars developing the failed approach, they stuck with it rather than admit that mistakes were made. This bureaucratic inertia is seen not just in government but in all organizational decision making.


I'm extremely amused that someone thought this auction system could potentially work. Sounds like a disaster born of bureaucracy to me - starting with standard clearing price/nonwithdrawable bids auction, then a republican complains that they're paying more than the bids - so, median price it is; then a democrat complains that the companies might end up not making a profit at that (lower) price, so withdrawable bids it is. Clears committee 13-11. Another victory for the democratic process.

Nitpick: Elicit, not illicit, although I suppose one could suggest that the lowball bids are somewhat illicit...


I think you mean "elicit" serious signals of value.

And I do hope this unusual consensus can fix Medicare Auctions.


Typo: illicit vs. elicit


Maybe I'm just cynical, but maybe the auction design is suboptimal... by design. Or I should say, it is sub-optimal for the goal of reducing medicare costs. It may, however, be optimal for something else, like, say, increasing medical supplier profits while giving the appearance of competitive bidding. If that is the true goal, ignoring all the experts starts looking a lot less "bizarre" and a lot more predictable.


i agree with Alex- no mystery here- the visible hand of capitalism greases the palms of legislators to draft policy in industry's own image- i had an experience on the front lines: a patient needed to flush drainage at home, and so a sales rep handed a script to the doc for a month's supply of plastic bins- these were basically curved plastic bowls- the doc asked how much they were, and the sales rep quoted $7 per bowl, and that medicare would cover it- the doc was so outraged that she refused to sign!- obviously, the patient could get bowls at the dollar store, or simply use a real bowl, using sanitizer- the default of the system right now is price gouging by the med equip industry which is subsidized by citizen tax $, which goes into private pockets

Philip Meyer

There may be some tweaks need to fix the program, but unfortunately, the gluttonous home medical equipment industry wants to scrap the whole thing and keep the current administered pricing system that overpays them at our expense.

Fix competitive bidding but don't let the selfish home medical equipment industry anywhere near the fix.

While this letter sounds legit, why did its authors wait so long before publishing it. I hope they didn't do it at the behest of the home medical equipment industry.


You commentors have no clue! I work for a small DME company & this competitive bidding program is a farce. Wait till you or your family are forced into a nursing home because there are no companies able to supply the equipment and supplies for them to stay in their home. Any person with a brain knows that when you reduce competitors you do not end up with better quality at cheaper prices!

John Reed

Great article. Objective sources. Hope it's not too late. A few comments too. Medicare's pricing is not, as is widely quoted, an antiquated overpriced model from 25 years ago. In 2009 alone, payments fell by more than 30% over 2008 for many product categories. Reimbursement has been systematically reduced year after year without competitive bidding, including the elimination of CFR mandated inflationary price adjustments for the past 13 years. The CMS Office of the Actuary has the evidence. Gluttonous? Capitalistic? Selfish? Regulations and compliance requirements for this industry are ridiculous. For every egregious example like frankenduf's, I can give 100 more where providers lose money on each patient transaction. When the best of the best companies earn about 10% net income, no one can sustain a 40% reduction in cash flow that rolls directly to the bottom line. And Medicare has 1100 industry financial statements to prove it. Alex, Philip and frankenduf, walk a day in my shoes. What other industry requires suppliers to provide care and service for months or even years without receiving payment for many patients. I offer complete transparency and an open invitation to share the facts with anyone.


JK Jensen

I have a unique perspective on this topic. I studied Econonomics at the University of Chicago & I am currently the CEO of a small medical equipment supplier. I understand how auction theory could be applied to this sector and I agree CMS' approach is deeply flawed (but it is not a laughing matter for those of us affected by it).

I applaud Dr. Ayres for his analysis and credibility that he and the academic community are bringing to this flawed system. I can only hope that it is not too late to reverse CMS' disregard the process' flaws. I must point out that the deep reimbursement cuts that have resulted from CMS' flawed system have already taken effect in many areas of the country. These cuts are resulting in many non-intended effects on patients and small businesses (e.g. reduced service levels for Medicare patients who depend on supplies like supplimental Oxygen to sustain their lives).

Lastly, I have to disagree with other's comments that the medical supplies market is bloated and gluttonous. I wish CMS and the detractors could walk in our shoes. Or better yet, sit in my cheap chair in my windowless office and listen try to come up with a viable business model that can withstand a 30% reimbursement cut from a buisness with already thin margins. You don't need to be a Chicago trained economist to see that won't work for long.



People-People-People>> CAREER politicians..WE TAX payers have had our pockets > taxes we pay < < if only 1/2 taxes - fees eliminated(STIMULUS)-DAH >>Look at EV1.ORG..another rip off.
COSTS on Medical never answered..and keeps going up.
Some thoughts..ONE tax..Sales-Fed/StateNO tax on food ..PERIOD.
Medicare ONLY(They pay 80%)-WE PAY INTO ANYWAY.>No Sup.Ins needed< ..if Doc/Hospitals/Meds want more..there problem submitting justification for more costs to Medicare. ALL others DUMP.>> DONE < < Soc. Security...TAKE IT want to invest..YOUR MONEY.>>DONE< < Nuc power.and other alternatives NOW.>>DONE< < Just for thought--BAIL OUT-- Only the BIG guys got it..and this is not--NOT--they way is suppose to work.. CEO's and the rest..getting money for failed companies...??? grab there estates..put them in towards unemployment Beneies...DONE.. what Mil's have done before..APPLY...or be sent back.>>DONE< < You want protection>>DO it--your right.>>DONE< < Common sense lawyer.. Ambulance chasers>and you know what I mean>thrown in jail-Lic. pulled.>>DONE< < - > you can not fix STUPID < NO MORE FREE get sit on your A%$ your fired.>>DONE< < Pensions, retirement--sure..mandated..Unions>> start doing your job as watch dog not SUCKUP and another political ARM.>>DONE< < Lobbyist >>> IN JAIL < << or get a REAL job.. Companies sending jobs oversea >>get a seperate tax just for them-only exception>>DONE< < Schools..Tenure workee no help kids--your GONE>>DONE< < ALL books/budgets are to be open and listed-Fed/State/County/City/Schools..for ALL to see and voted on...(2yr-budget)>>DONE< < CAREER politicians...>> 2terms >>4yr terms>ALL levels>>DONE< < >> see the politicians give tons of excuses why none of this would work ---they will LIE< < >>>> DONE <<<<


Robert Bynum

Your kidding right? You can't figure out why they auction system is so badly designed?

Maybe because certain powers withing the government do not want an efficent auction. If the bidding fails to produce a bidder willing to sign a contract at below the cost of production then the purchase agencies can go outside of the bidding process in awarding contracts to chosen suppliers. That is where the power is - awarding the contracts as no bid contracts.


I didn't need to read more than "Medicare" and "auction" to think "what a bad freaking idea." Stupid, stupid, stupid.

Josh Davis,


Fascinating comments. I, like Teresa, John and JK work in the durable medical equipment (DME) industry. Unfortunately, what the general public knows about our industry is acquired through media reports of "widespread fraud" and overpriced wheelchairs. What most do not know is that many, many people are able to remain at home to be cared for by their families at a reasonable cost. Very few realize that this is the ONLY health care segment that is forced to provide oxygen equipment for 2 years with no reimbursement - I'll say this again for emphasis - NO reimbursement for 2 years. We are required to continue our services - even if the patient leaves our area. Educational materials to the patient from Medicare basically tell the patient that reimbursement has far exceeded our cost - a fact that leaves out the service aspect (refer to the comment above - that we are required to continue to provide equipment and service during this period)
My firm belief is that the vast majority of suppliers are good, law-abiding, hard working companies who are currently struggling to make the necessary changes to our business models to ensure we can continue to provide high quality equipment and service.
It occurred to me recently that because of the continued push for competitive bidding and inevitable reimbursement cuts, DME companies will be no different than some supplier who sells over the Internet - no personal service - no basic instruction on safe use of the equipment. Place your call, get out your credit card and have your oxygen delivered in a brown box from the UPS man.



Instead of calling this program "Competitive Bidding" a better name would be "The Saving Money at ANY COST program". This program will fail but my fear is not before it puts many of the hardworking DME Providers out of a job and forcing many Americans to have cheap medical supplies. The Government should not sugar coat this program and just be honest by saying that for years DME has been corrupt and fraudulent so they have decided to abolish DME all together. There are companies out there that are taking advantage of Medicare but not all of them reside with DME.


I too am an owner of a DME company for nearly twenty years. I like the rest of my colleagues who have written above lament the drastics cuts we have been forced to endure coupled with onerous, expensive regulations and changes we continually have piled upon us. No one talks about the service we provide that at times the patient can not reimburse us for. Or the doctor who requests us to provide equipment free of charge because the patient has no coverage or statistically does not qualify for reimbursement. I have to provide my service 24/7, everyday of the year. It hardly seems possible, but looking down the road I seriously doubt there will be many providers left to take care of these people. One can't get a plumber to pull into your drive for less than seventy five dollars and here we are being asked to provide life sustaining equipment with the slightest blip in our delivery model will end up being a loss. It has been a total race to the bottom. Will the last one out please turn off the light?


Philip Meyer

Here we see the DME industry continuing to demand subsidies from government. Hey fellas, guess what, this country deeply in debt and Medicare is going brankrupt. Because you were grossly overpaid for so many years too many of you got into the business and now you shriek because some of you might be put out of business with reduced rates. Get real, we can't afford to keep all of you afloat, stop demanding welfare.


Oh! Mr Meyer, if only you had a clue about what you speak. Show me this gluttony, subsidy and overpayment? At less than 2% of Medicare expenditures per year and less than .1% of the total fraud and abuse in Medicare, getting rid ot the entire DMEPOS benefit will not come close to saving Medicare. You know what will cost Medicare billions? Paying for these patients to be in a hospital or nursing home instead of at their home.


I hate to even join the fray here with all of the useless comments submitted by the Philips of the internet world...but here goes.
People, look at the growth of healthcare over the past 10 years. THEN look at the growth of the DME over the past 10 years. You will find a line that looks flat! Inflated-NO, glutinous-NO, Welfare? Philip you are ...well if I wrote it, it would be a flame.
No DME provider could ever be paid a fraudulent claim if MEDICARE did their job! Medicare, CMS, pays contractors to process claims. Those contracts include weeding out fraud. Medicare must be held responsible. Wait...I forgot the government never causes any of our problems...The fraud therefor must rest with Employers that PAY employees, that pay taxes.
Competitive bidding is going to cost 100,000 jobs. That's right! Look it up. Just what our country needs. Blame the people doing good, the DME providers for the problems of our Medicare program.
The Competitive bidding program if flawed. Congress will be held responsible after this stern warning from 165 economists that have nothing to do with the DME industry!
Want to save money? Try asking people from inside the industry where the waste is. What? Yes, ask the industry how to save money.
Lets look at an example, a Nebulizer, a machine that most often helps people inhale medicine for a lung problem.
The Nebulizer costs about $30 dollars. Medicare only allows this to be a rental item. It rents for about $15 a month. Medicare requires that the first three rentals are at 10%. and the remaining 10 months are at 7.5% of Medicare allowed price. If one does the math, the DME dealer receives 105% of Medicares allowed amount for a purchase.
Now the dealer has sent out 13 billings to Medicare, 13 billings to a coinsurance and perhaps 13 billings to the patient. The dealer has to post payments 13 times for Medicare, 13 times for the coinsurance and perhaps 13 times for the patient. Medicare has had to process 13 payments to the DME, the coinsurance has had to process 13 payments to the DME and perhaps the patient has had to process 13 payments to the DME. Do the math folks!
That is up to 117 transactions to pay for a $30 Machine!
Put whatever cost you care to, for each transaction and NO ONE EVER MAKES ANY MONEY. Its stupid! Yes, ask someone inside the industry how to save money,... let's see, make a nebulizer a one time purchase at say $60 dollars? No that's too easy.
MEDICARE is the problem, not the DME provider!



In a free market society you get what you pay for. When you pay the DME companies, all of whom are already on razor thin margins from years worth of Medicare cuts, 26% less then you get 26% less of everything back.

You don't get the newest technology - the guy down the street with good private insurance has a shiny new portable oxygen concentrator on his waist, busily making an infinite supply of oxygen, while you're lugging around a ten pound oxygen tank on a wheeled cart that you have to change out for another ten pound tank every couple of hours.

You don't get the best service - that same guy down the street has someone show up at his house in the middle of the night when his BiPAP malfunctions, while you have to wait until your understaffed provider can get around to you a day or two later.

In a nutshell, while that guy down the street gets to deal with a well established, well staffed, well equipped company you get to switch to whoever promised to spend the least amount of money on you. Who do you think will be more satisfied with what they're getting?



What I fear most is the reduction in suppliers/competitors. It is not an easy task to clear all of the hurdles to just open one's doors (ie licensing @ least in California) then have to get credentialed etc to possibly service patients who have Medicare etc. If suppliers decide to close their doors or they do go out of business because of loss of revenue (perfect timing to given the nature of emplpyment), we will still be left with fewer suppliers. I have always thought the more suppliers the better to have more options/competitors. Maybe patients need to learn to also shop around for their needs. Most I imagine just go to one place and not realize providers have different makes, models, services, and prices. One the government side, maybe stop adding new and/or revising outdated regulations that are creating unnecessary administrative costs.

The system needs to save money but reducing suppliers I think will hurt access in the long term because barriers to entry are quite high not to just sell privately but also to be awarded contracts to bill insurance.

My other thought is why would more weight be given to the CVS' or hospitals of the world to be exempted from such programs than the small DME guy due to "access"? It seems unfair and noncompetitive to single out the dme company since the same would apply to them. If a company - no matter who it is (hospital, pharmacy big or small, dme big or small) - is going to sell a product that is now part of the bid program, they must follow the same rules like the rest of us to have a level playing field.