The Hospital Market, Part 1

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The Hospital Market, Part 1

• Health Economics
• Vivian Ho
• Fall 2007

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Outline

• Hospital Industry Structure
• Hospital Conduct
• Industry Performance

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Hospital Industry Structure

• Is the hospital market competitive?
• In general, competitiveness depends on
• number of hospitals
• barriers to entry
• demand/ number of buyers
• types of services/technology
• asymmetric information (patients hospitals)

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Hospital Industry Structure

• From 1980-2004 of hospitals declined 17.
• of beds declined 30.
• Community hospitals
• medical and surgical services.
• Short-term stays (lt30 days).
• Nonprofit 60
• For-profit 17
• State Local 23

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• Almost 50 in 50-199 bed size category.
• Public hospitals smallest.
• Often provide county hospital services in
  sparsely populated areas.

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The Relevant Market for Hospital Services

• Does existence of a large number of hospitals
  increase competitive market conditions for any
  given patient?
• What is the relevant product market?
• What is the relevant geographic market?

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The Relevant Product Market

• By Diagnosis
• All hospitals treating heart attack patients or
  providing hernia repair.
• Levels of care
• Primary care - prevention, early detection,
  treatment.
• Secondary care - more sophisticated treatment
• Tertiary care - arrests disease in progress.
• Quaternary care - med school affiliation.
• Research orientation.

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The Relevant Product Market

• Market for primary/secondary care local tertiary
  care may be regional/national in scope.
• Competitors are not just hospitals.
• Physician clinics, outpatient surgery centers can
  provide similar services.

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The Relevant Geographic Market

• Those hospitals offering similar cluster of
  inpatient services within same geographic area.
• Define such that small of people leave to
  purchase hospital services elsewhere, small
  of people enter from outside the area to buy
  services.
• Houston and El Paso, TX are separate geographic
  markets West University and River Oaks are not.

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A Formal Competitiveness Measure

• Herfindahl-Hirschman Index

i 1,N hospitals in a given market. Si market
share () of hospital i.
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A Formal Competitiveness Measure

• Example
• 5 hospitals in a market with shares
• 35, 30, 20, 10, 5.
• 352 302 202 102 52 2650

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• Properties
• 1) 0 lt HHI ? 10,000
• 2) Smaller of hospitals leads to
  increased HHI which results in a less competitive
  market.
• Example
• Suppose 2 smallest hospitals merge.
• 352 302 202 152 2750

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• 3) Equal market share for all hospitals leads to
  lower HHI which results in more competitive
  market.
• Example Suppose 4 hospitals had equal market
  share.
• 252 252 252 252 2500

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• Department of Justice challenges a merger when
• Postmerger HHI gt 1800, and premerger HHI would
  increase gt 50 points.
• OR
• Postmerger HHI gt 1000, and premerger HHI would
  increase gt 100 points.
• Postmerger HHI lt 1000 seldom challenged by
  Department of Justice.

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Barriers to Entry

• Defn a condition that imposes higher long-run
  costs of production on a new entrant than those
  born by firms in the market already.
• Institutional Barriers Certificate of Need (CON)
  laws.
• Required in certain states to open a hospital
  (designed to limit excess capacity).

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Barriers to Entry

• Economic Barriers
• a) Economies of scale - empirical evidence.
• Long run average costs of a community hospital
  probably reach a minimum at 200 beds.
• But estimates indicate cost curve very shallow
  i.e., few economies of scale.

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• b) Learning by doing hypothesis
• Over time, higher cumulative output, more
  experience leads to lower costs, higher quality.
• Stone et al. (1992) Relative risk of death for
  AIDS patients 2 times higher in low experience
  hospitals.
• AIDS discharges/10,000 disch. per year
• top 20 43-229 AIDS/10,000 disch. per year in
  1988.

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Barriers to Entry

• Low-experience hospitals also more likely to put
  patients in ICU, longer stays lead to higher
  costs.
• c) multi-hospital systems may achieve more
  economies of scale, but no empirical evidence.

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• Even so, will hospital chains dominate the future
  market?
• For-profit chains now focussing on acquiring
  nonprofits.
• Columbia/HCAs mistake
• acquired or joint ventured w/ weaker hospitals
  whose cash flow could be improved.
• Takeovers would tightly squeeze margins through
  layoffs, stringent cost controls.

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Wall Street Journal 2/2/98
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Can acquisition of nonprofits still work?

• Advantages for for-profits.
• 1) NPs have built-in community trust.
• 2) Affiliated w/ regions top specialists.
• 3) Many nonprofits are well-run.
• Returns of 15 on net revenue are common.
• Consolidation and improved economies of scale
  could be even more lucrative.

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Can acquisition of nonprofits still work?

• Advantages to community/hospital
• 1) Proceeds of sale go to charitable foundations
  for indigent care.
• 2) New FP pays state and federal taxes.
• 3) Hospital gets access to capital markets which
  it needs to expand, vertically integrate.

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Can acquisition of nonprofits still work?

• For-profit managers must be sensitive to
  community concerns.
• Columbia agreed to operate 24-hour emergency
  rooms for at least three years at the Boston-area
  hospitals, provide charity care and be
  accountable to the state for its community
  benefits.

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Can acquisition of nonprofits still work?

• Nonprofit managers must decide whether to solicit
  competitive bids.
• I think the bidding process helped get a better
  price, says a hospital chairman.
• Im getting calls telling me dont you dare
  pick Columbia, while pro-choice advocates object
  to affiliation with Catholic, says a hospital
  board member.

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Buyer Characteristics

• Major purchasers can exert buying power to obtain
  price discounts.

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• How managed care plans exercise buying power.

Source Elizabeth W. Hoy, Richard E. Curtis, and
Thomas Rice, Change and Growth in Managed Care,
Health Affairs 10 (Winter 1991), Exhibit 6.
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• Even if hospitals reimbursed according to
  charges, HMOs PPOs obtain discounts.
• More risk placed on hospitals through DRG payment
  and capitation.
• Keep in mind differences between HMOs PPOs,
  within types of HMOs narrowing overtime.

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Vertically Integrated Systems

• Vertical associations between firms operating in
  different, but related product markets.
• Insurers hospitals (Allina).
• Insurers physicians (Kaiser).
• Physicians hospitals (PHO).
• of physician practices owned or managed by
  hospital-based systems rose 60 b/w 1994-1995.
• 7,015 to 11,234.

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DIC - Diagnostic Imaging Center FOSC -
Freestanding Outpatient Surgery Center
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Advantages of Vertical Integration

• Solves the agency problem
• Aligns incentives of insurers w/ providers, or
  hospitals w/ physicians.
• Solves the monopoly pricing problem.
• An integrated hospital will sell its inputs to
  its insurer at marginal costs.
• Lowers transactions costs.
• Costs of negotiating, writing, monitoring, and
  enforcing contracts.

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Advantages of Vertical Integration

• Ensures supply of an input.
• Managed-care plans must ensure the supply of
  services from specialized physicians or hospital
  facilities.
• Improved coordination between firms.
• Information systems, review protocols.
• Improved monitoring.

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Wall Street Journal 5/2/97
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Anticompetitive Concerns

• Vertical integration could lead to market
  foreclosure and thus harm market competition.
• If there are multiple insurers in a market but
  only 1 hospital, an exclusive contract b/w 1
  insurer and the hospital is potentially
  anticompetitive.
• Vertical merger does not create or increase the
  firms power to restrict output. The ability to
  restrict output depends on the share of the
  market occupied by the firm. Horizontal mergers
  increase market share, but vertical mergers do
  not.
  (Robert Bork, 1978)

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