Sunday, September 30, 2012

Hearing Aid Costs - Consumer View

Premium hearing aids are sold to the Veterans Administration for less than $350/aid from leading hearing aid manufacturers around the world.  For private practices, Audiologists purchase premium hearing aids either directly from the manufacturers or from buying groups. They generally pay less than $1000 for each aid. Audiologists then mark up the aid and sell them to customers for $3000.  For a pair of aids audiologists receive $4000 above the cost of the aids for their services.  It takes an average of 4 hours to test, fit, and adjust aids. In that case, audiologists are charging $1000/hour.

What makes the high price worse, is that on the average, aids last 5 or less years and customers get to buy aids again, generally at a higher price than before.
The manufacturer's price of aids is hard to find. My first clue was in a PowerPoint presentation by Lucile Beck, Director of Audiology and Speech Pathology Service, Veterans Administration (Slide 16)

She gives the number of aids the VA purchased over the previous years and the average price the VA paid for the aids ($348).  I later read a report from "The Hill" newsletter that said the VA purchased aids from Phonak for an average of $333 each in an ongoing government contract lasting to 2014. 

What kind of aids does the VA use? "Aids" can be purchased for $20 on-line that are tiny amplifiers that may or not have a number of distortions and no features commonly found in "Premium Hearing Aids." According to audilogists I questioned, the VA uses "top of the line" hearing aids. 

The following paper lists features tested in VA hearing aids including:
Digital Signal Processing, Feedback Suppression Noise Reduction, Wireless Technology (non-FM), Automatic Functionality, Data Logging, Acoustic Telephone Program, Music Program, Programming Software, Adaptive Directionality, FM System, Volume Control, Integrated Real-Ear, Telecoil, and Remote Control.  Description and Test Results of VA Hearing Aids

The high cost of hearing aids are NOT due to production costs. The average production cost is $250.  The high cost of hearing aids is due to the combination of the $750 markup f rom the manufacturer/buyer's group and the $2000 markup from the private practice audiologist.

Below is a comparison of the cost breakdown of a hearing aid and iPad.  It was written based on (1) an article in the Economist discussing the cost breakdown of making and distributing an iPad, (2) a German government article discussing (in English fortunately) the cost breakdown and profits of Phonak and other manufacturers required as part of a merger request. This paper first appreared on a blog hosted by Patrick Frueuler.

15 May 2012

Why Does a Hearing Aid Cost Six Times More Than an iPad?
Ed Belcher 1    and    Patrick Freuler 2

This guest post was contributed by Ed Belcher, who put together this eye-opening, neat piece of analysis.

Did you ever wonder why a hearing aid can cost up to 6x more than an iPad? Peeling the onion on the cost structure of both devices reveals an eye-opening comparison into the dynamics of either industry. It can provide us with pointers on where the future price and cost tags could shift and should.

Hearing Aids vs. iPad

Let’s assume a high-end hearing aid costs $1000 to the audiologist when he/she buys it from the manufacturer and consequently gets sold for $3000 to the consumer. Now if you dissect the $3000 based on a study by the German Competition Regulator, the following total cost breakdown emerges:

                                         $           %Total                                                                                                
Production Costs             250             8%
R&D                                   75             3% 
Marketing                          250             8%
Overhead, Profits             425           14%
Retail                              2000            67%
Total                               3000          100%

Now, let’s take a closer look at the iPad: a recent study at the University of California, Irvine took a closer look at the cost structure of a regular iPad and came up with the following segmentation:

                                                                 $         %Total iPad
Production Costs                                   275           55%
R&D, Marketing, Overhead, Profits        150           30%
Retail                                                         75           15%
 Total                                                       500          100%

Bear with us, as we plot these numbers on a chart:

The_manufacturing and distribution costs of a hearing aid are upside-down in comparison to the manufacturing and distribution costs of an iPad.

The iPad is subject to hard, unfettered competition. Its manufacturer profit, marketing, R&D and dispensing costs combined take up 45% of the retail price.  The production cost takes the balance (55%) of the retail price.

Most hearing aids are made by the Big-6 consortium which shares patents and does business in a mutually beneficial way.  The dispensing businesses sell the aids at a price around 3x their wholesale cost.  In that case, the production cost of a hearing aid comprises only 8% of its bundled price.  The remaining 92% is made up mostly of dispensing fees, administration salaries, and profits.

Granted, the market structure is different for both products. For instance, the sheer sales volumes of iPads far surpass those of hearing aids: Apple sold 3Mn iPads in the first 72 hours of its recent launch. By contrast, 3Mn units are what the entire hearing aids industry sells in one year. This sales volume allows for different economies of scale, especially when it comes to retail.

Furthermore there is a more involved service component attached to hearing aid dispensing (however not as much as what is traditionally claimed). Hearing aid dispensing, based on personal experiences when shopping in varied businesses for hearing aids, took 1 hour for the exam and discussion of HA options; 1 hour for fitting and training; and up to 2 hours for up to four 30-minute adjustments/training, a total of 4 hours of contact time. Assuming $100 per hour, consultation should yield a total of $400 in dispensing service fees.

In any case, the comparison is still startling and should raise questions on whether the industry is really operating at its most favorable level for the consumer. Let’s look at the next piece of analysis.

What would a hearing aid cost if it had the iPad cost structure? 
The aforementioned hearing aid that a dispenser buys for $1000 costs about $250 to make, as we saw with the previous example. So we start with the $250 production cost.

If the iPad-structure were followed based on the $250 production cost (i.e. 55% of the total) then:

-          the final retail price for one hearing aid would be $250 / 0.55 = $455

-          If the specialist sells two aids for $455 each and adds $400 for four hours of service, a pair of high-end hearing aids would have a price of $1,310

Let’s pause here and put this figure into perspective: $1,310 is equivalent to 22% of the traditional $6000 for the same pair!

What does this calculation imply on the audiologist revenues per customer? The $455 retail price includes a 15% markup (same as the iPad) of $68.25/aid. The total proceeds to the dispenser is 2*$68.25 + $400 = $537 for each customer served.

The questions that remain are thus:
1.      Can industry prosper and sell aids for $387 (0.85*$455)?  After all, they have sold millions of aids to the VA with prices decreasing from $375 to $333/aid from 2004 to 2011 respectively, according to Lucille Beck, Director of Audiology, VA, and The Hill

2.      Can a specialist prosper with a 15% commission for aids sold and with a $100/hour rate for services (normally 4 hours) during and after the sale of the aids (i.e. $537 of proceeds per customer)?

Tell us what you think; we would love to hear your opinion!

1  Ph.D. EE, Career researcher (retired) in underwater acoustics at the University of Washington