The Hospital Market, Part 1

1. The Hospital Market, Part 1 Health Economics Vivian Ho Fall 2007

3. Outline • Hospital Industry Structure • Hospital Conduct • Industry Performance

4. 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)

6. Hospital Industry Structure • From 1980-2004 # of hospitals declined 17%. • # of beds declined 30%. • Community hospitals • medical and surgical services. • Short-term stays (<30 days). • Nonprofit 60% • For-profit 17% • State & Local 23%

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

9. 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?

10. 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.

11. 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.

12. 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.

13. A Formal Competitiveness Measure • Herfindahl-Hirschman Index i = 1,…N hospitals in a given market. Si = market share (%) of hospital i.

14. A Formal Competitiveness Measure • Example: 5 hospitals in a market with shares: 35, 30, 20, 10, 5. 352 + 302 + 202 + 102 + 52 = 2650

15. Properties 1) 0 < 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

16. 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

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

18. Barriers to Entry • Def’n: 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).

19. 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.

20. 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.

21. 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.

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

23. Wall Street Journal 2/2/98

24. Can acquisition of nonprofits still work? • Advantages for for-profits. 1) NPs have built-in community trust. 2) Affiliated w/ region’s 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.

25. 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.

26. 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.”

27. 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. • “I’m getting calls telling me ‘don’t you dare pick Columbia,’ while pro-choice advocates object to affiliation with Catholic,” says a hospital board member.

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

29. 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.

30. 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.

31. 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.

32. DIC - Diagnostic Imaging Center FOSC - Freestanding Outpatient Surgery Center

33. 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.

34. 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.

35. Wall Street Journal 5/2/97

36. 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 firm’s 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)