20. Dr. Keith Smith on How Austrian Economics Helped Me Innovate

Dr. Keith Smith is an anesthesiologist and founder of both the Surgery Center of Oklahoma and the Free Market Medical Association. Surgery Center of Oklahoma has innovated in healthcare with a completely free market offering of transparent pricing with no hidden fees, with a radically patient-centric organization and different and better patient and doctor relationship protocols. Free Market Medical Association is a movement to encourage medical practitioners throughout the country to pursue a similar pathway of radical innovation. Dr. Smith took inspiration from Austrian Economics principles. Here are the seven principles he talks about on the Economics For Entrepreneurs podcast:

1. Subjective Value

This was the first Austrian principle that Dr. Smith learned from reading Menger and Mises. He applied subjective value thinking to the healthcare industry by asking, “Who is the customer?” and “Are health care industry participants focused on creating customer value?”

He realized that, since the patient is not paying the anesthesiologist or the surgeon, then there was no value exchange between the customer and the service provider. Therefore, there is no market relationship. The customer was not in a position to evaluate the quality and efficiency of the medical service that Surgery Center Of Oklahoma and its surgeons provided.

When a third party payer is paying the fees, the patient is not acting as the customer. The fee from the third party can never represent the right price — the one that properly reflects customer preferences — and much of what is dysfunctional in the health care system stems from this arrangement. The industry can not accommodate the fact that patients who wish to consume medical services value different aspects of the service in different ways. Some will pay any price to experience the value of immediate service: surgery today. Some will defer service to a later date to pay a lower price. Some want a surgeon that spends a lot of time with them before and after surgery. Some prefer speed and efficiency. All individuals create value in their own minds, and should be able to decide what price they will pay for that value. Subjective value theory guides Dr. Smith to run his surgery center to serve patients’ preferences.

2. Preference Rankings

The idea of preference rankings may sound theoretical, but Dr. Smith has found a practical way to make them a tool for building an organization.

When the patient and the surgeon are both customers of the surgery center, it can be hard to align the interests of both without conflict. Dr. Smith calls this desired outcome “accommodating all interests with boundaries”. Both the surgeons and the patients can make unreasonable demands that can’t both be accommodated in the service of good care. How to accommodate both? Just ask them what their preferences are and how they rank them. Many times, just having the conversation is a revelation — it reveals considerations to the patient or surgeon they had not appreciated before. For example, if a patient demands a local anesthetic and the doctor reveals a preference against it, the reasons for the surgeon’s ranking may bring new information to the patient and may change their preference.

Preference ranking provides an organizational tool to help Dr. Smith build his team of surgeons. A surgeon that frequently shows up late, or habitually takes an excessively long time for a procedure, may be revealing a preference for revenue over patient quality. By observing behavior, it becomes easy to identify a doctor (or a hospital) that is revenue focused compared to one that is truly focused on value, taking the long-term view and making every value exchange mutually beneficial. If a surgeon is observed acting in a way that is not in the patient’s best interest, Dr. Smith does not want him or her on the team. Asking preference ranking questions — what is important to you and how do you rank it? — is a good way to get to know someone you are considering for your team. It’s a troublesome thought process for some, and an enlightening one for others.

3. Self-Examination

Preference ranking can be applied in self-examination. Dr. Smith says, “I scour myself for inconsistencies”. He found one when he realized he was filing Medicare insurance claims that were paid with government funds which, he declares, is like “receiving stolen goods”. That, he realized, was inconsistent with his free market principles. And so he abandoned the practice and now treats Medicare patients at no cost. The acceptance of the market is the determinant of his business success — “to hug us or crush us”. Dr. Smith’s preference is to be consistent in his commitment to free market practices.

4. The Errors of Interventionism

The refusal to accept government money was just one step in expunging the corrupting and distorting effects of government intervention in the health care market. Dr. Smith examines every element of government intervention in the market and attempts to eliminate it from his business, to make sure his business does not benefit from it. He scrutinizes one situation after another and attempts to eliminate them all.

5. Dynamic Flexibility.

Austrian Capital Theory — and the Resource-Based View of the firm that derives from it — prescribes extreme flexibility of capital assets and resources to enable shuffling and recombining in response to changing consumer preferences. Dr. Smith describes the process of continuously looking for more knowledge, more learning and more flexibility as “radical entrepreneurship”. He looks for texts like Peter Klein’s The Capitalist And The Entrepreneur to provide new ideas and new initiatives. Continuous learning is part of Dr. Smith’s recipe, and he is always searching out readings that will change his mind.

6. Time Preference

Time preference is a core concept in Austrian economic theory. Entrepreneurship takes time. It requires patience, and the elevation of long-term goals over short term goals. It also requires foregoing present opportunities in order to pursue future benefit. What are you willing to forego in order to be an entrepreneur?

Dr. Smith found the most striking discussion — “jaw-dropping” in Dr. Smith’s words — of time preference in Hans-Hermann Hoppe’s Democracy: The God That Failed (i.e., the relevant passage starts at the very beginning of Chapter 1).

He found an immediate application in the business model for Surgery Center Of Oklahoma. As surgeons get older, their time preference changes. They want to monetize their ownership position in the partnership — to “cash out”. This often leaves junior surgeons “holding the bag”, because the partnership (or an intervening VC) may buy the departing surgeon’s position, but this is paid for out of the future earnings of the remaining partners. Through his understanding of time preference, Dr. Smith was able to anticipate this situation and organize his surgery center like a law firm — no partner pays anything to join and receives no exit payment when they leave. They also don’t own the real estate. So there is no opportunity to monetize on exit, which “saved SCO as a business” and brought stability by de-fanging an activity that doctors are known for.

7. The Austrian Way of Thinking

As important as any principle of economics is the Austrian Way of Thinking: rigorous reasoning based on logic and a priori axioms; being aware of assumptions and always examining them; respect for how others value things; understanding the difference between risk and uncertainty, and looking uncertainty in the eye; and generally exerting more logic and less emotion in conducting business.

Economics is the study of human behavior. Humans move from A to B because they prefer B to A. Understanding the logic of human action — and the motivation behind it — provides a lens through which to observe what is going on around you and to see it more clearly, obscuring distractions and perceiving conflicts of interest you might not see without the lens. The Austrian Way of Thinking brings confidence, decisiveness and calm. Physicians — and anyone — can benefit.