How Markets Work – The Economics of Care Homes Spells Trouble For Councils

An understanding of how markets work should be a core element of every procurement professional’s knowledge base, and it is always fascinating to observe how an external change or stimulus (whether driven by the buyer or not) may eventually lead to a change in market behaviour.

Take residential social care in the UK. (Don’t switch off now, this is really interesting – and you will probably be old yourself one day, you know).  If you need to move into a care home, your income and wealth is now assessed. If it is above a certain level, around £23,000, you will have to pay for that care yourself, with rules covering issues such as whether you will be expected to sell your house to cover the costs.

If, on the other hand, you are broke, having either never had any wealth or because you have spent it all on drugs, gambling and Caribbean holidays, then the state will pay – though your local authority (council). But as a squeeze on local authority finances has bitten in recent years, they have got more aggressive in terms of their negotiations with care homes. Councils have used their leverage as major buyers to drive down real prices.

In response, care homes have increased their prices charged to individuals – “self-funders” as they tend to be called, to compensate for lower fees from councils.  So a council might be able to buy places in bulk for, say, £500 a week. But the real economic price that the home should be charging is perhaps £600 a week. So if their residents are split 50:50 between council paid and self-funders, then the home needs to charge the self-funders £700 a week to get their total income up to economic levels.

This seems blatantly unfair on self-funders, as well as being an interesting example of a monopsony buyer exerting their power. But, this is unsustainable from a longer-term market perspective, when you look at this carefully. Why? (Have a think for a moment).

Well, this fee structure means that a new market entrant can ignore the council-funded market, come along and offer self-funders a rate of £600 a week (or even a little more), and will clearly take business away from those existing homes charging £700 to subsidise council business. Not only will that be a significant saving, but the new provider can also offer a home that does not take council-funded people, which if you are a snob (or maybe just a realist) may be attractive to customers  – no need to mix with the “poor people” in the dining room!

So the new home does fine, but of course the place that previously had the 50:50 split gradually sees its self-funded residents pass away – and they will not be replaced by new self-funders. Now the home is uneconomic, as the £500 per head from the council is simply not enough. Either the home goes out of business, or it cuts its costs and provides unacceptable service, or it has to get the full economic rate from the council.

This effect does take time, because most existing residents don’t want to swap homes once they are settled in somewhere, even if it would save some money. But eventually, this understandable market reaction is going to lead to capacity issues and serious problems for local authorities, for those people without self-funding – and of course for the taxpayer.

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