The use of cost information in pricing decisions and cost management strategies

This dissertation, using the data from the hospital industry, examines the use of cost information in decision making and cost management strategies. First, this dissertation investigates how firms' market power affects their cost management in response to a dual payment system. Using data from California hospitals over the years 1980-1991, I find that both dominant and non-dominant hospitals reallocate more overhead costs to cost-based services. However, hospitals' choice of cost-decreasing or cost-increasing strategies shows a strong correlation to their relative market power. Specifically, hospitals with weak market power reduce the direct costs of fixed-rate services in response to a dual payment system and do not increase the direct costs of cost-based services. However, hospitals with strong market power do not reduce direct costs of fixed-rate services. Furthermore, they increase the direct costs of cost-based services, since they are likely to exploit their market positions and charge a high price for cost-based services. This dissertation demonstrates that under a dual payment system, hospitals do not adopt inefficient cost-shifting unless they have enough market power. My findings also provide implications for policy-makers; it is crucial for regulatory institutions to secure the relative bargaining power of cost-based buyers.; Second, this dissertation examines how hospitals with long-term capacity commitment determine the weight on allocated costs in negotiating prices when they experience different levels of capacity utilization and demand stochasticity. Using cost and price data from California hospitals over the years 1993-1999 when hospitals competed on price, this dissertation provides archival evidence pertinent to the debates on full cost pricing versus variable cost pricing. I find that the level of capacity utilization positively affects the association between price and unit allocated cost. Hospitals with a high level of capacity utilization put a positive weight on allocated costs, which measure the opportunity cost of capacity usage. In contrast, hospitals with huge excess capacity put no weight on allocated costs since allocated costs are irrelevant to pricing. Furthermore, the results suggest that hospitals reduce the weight on allocated costs with increased demand stochasticity since demand stochasticity increases the measurement error of opportunity costs measured by allocated costs.