Market Definition in Healthcare R.S. Halbersma February 2, 2011
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Market Definition in Healthcare R.S. Halbersma Introduction Market Definition in Healthcare Methods for market definition Patient flow methods Patient choice methods Overview market definition methods Conclusion R.S. Halbersma Dutch Healthcare Authority, TILEC extramural fellow February 2, 2011 R.S. Halbersma Market Definition in Healthcare Preamble Market Definition in Healthcare R.S. Halbersma Introduction Methods for market definition Patient flow methods Patient choice methods Overview market definition methods Conclusion Some of the research presented here was commissioned by the NZa during 2006-2008: Dranove, Sfekas (Kellogg), Varkevisser, Schut (Erasmus), Gaynor, Vogt, Kleiner (CMU). A Dutch overview article of this subject was published jointly with Mikkers and Kersholt in Markt & Mededinging (April, 2009). Together with Misja Mikkers and Peter Bogetoft, a monograph is in preparation on market structure and efficiency in health care. R.S. Halbersma Market Definition in Healthcare Introduction Market Definition in Healthcare R.S. Halbersma Introduction Methods for market definition Patient flow methods Patient choice methods Overview market definition methods Conclusion Traditionally, competition and antitrust enforcement has been important in the U.S. health care system only. In recent years, however, more countries have started to turn away from strict supply rationing and price controls. Antitrust enforcement is becoming more important as a result of recent market-oriented reforms in the Netherlands and Germany. The U.K. government also plans the establishment of a sector specific competition authority (which mainly will deal with mergers). R.S. Halbersma Market Definition in Healthcare Motivation Market Definition in Healthcare R.S. Halbersma Introduction Methods for market definition Patient flow methods Patient choice methods Overview market definition methods Conclusion Merger waves in the countries with hospital competition (U.S., Germany and the Netherlands). Mergers and restructuring also an issue in countries with state provision (UK and Denmark). Empirical literature generally agrees that hospital mergers lead to higher prices and longer travel. Ostensibly, hospital mergers are done to raise quality, BUT not clear if this cannot be done without a merger actual quality improvements have a long time lag a merger lowers incentives to provide quality (see e.g. "Death by Market Power", Gaynor, Propper, Morena-Serra, 2010) R.S. Halbersma Market Definition in Healthcare The number of hospitals in the Netherlands Market Definition in Healthcare R.S. Halbersma Introduction Methods for market definition Patient flow methods Patient choice methods Overview market definition methods Conclusion R.S. Halbersma Market Definition in Healthcare Bed size matters Market Definition in Healthcare R.S. Halbersma Introduction Methods for market definition Patient flow methods Patient choice methods Overview market definition methods Conclusion R.S. Halbersma Market Definition in Healthcare Old-fashioned merger analysis Market Definition in Healthcare R.S. Halbersma Introduction 1 Define relevant market and identify competitors. 2 Calculate difference between pre- and post-merger market shares and competition indices (C4, HHI) and apply safe haven rules. 3 Competitive effects analysis: entry, efficiencies, failing firm, . . . 4 Write decision. Methods for market definition Patient flow methods Patient choice methods Overview market definition methods Conclusion Critically depends on the 1st step - market definition. R.S. Halbersma Market Definition in Healthcare The importance of market definition Market Definition in Healthcare R.S. Halbersma Introduction Methods for market definition Patient flow methods Patient choice methods Overview market definition methods "...it should be stressed first that market definition is not of interest by itself, but only as preliminary step towards the objective of assessing market power." Massimo Motta (2004), Competition Policy: Theory and Practice, Cambridge University Press, p.101 Conclusion R.S. Halbersma Market Definition in Healthcare SSNIP-test for market definition Market Definition in Healthcare R.S. Halbersma Introduction Methods for market definition Patient flow methods Patient choice methods Overview market definition methods Conclusion A relevant market is a set of firms such that those firms, acting as a "hypothetical monopolist", could profitably impose a "small but significant and non-transitory increase in price" (SSNIP). A market consists therefore of a group of products with no close substitutes outside the group and good substitutes inside the group. Demand-side substitution key in market definition Supply-side substitution (e.g. entry) usually accounted for during competitive effects analysis R.S. Halbersma Market Definition in Healthcare Distinctive features of hospital markets Market Definition in Healthcare R.S. Halbersma Introduction Methods for market definition Patient flow methods Patient choice methods Overview market definition methods Most important distinctive features include: Demand-side: third-party payers, asymmetric information, costly search Supply-side: differentiated products, regulatory entry and exit barriers Present in other markets as well, but their unique combination and extent substantially complicate hospital market definition. Conclusion Hospital markets are usually divided along two dimensions: a product market and a geographic market. R.S. Halbersma Market Definition in Healthcare Product market (I) Market Definition in Healthcare R.S. Halbersma Introduction Methods for market definition Patient flow methods Patient choice methods Overview market definition methods Conclusion A product market is a group of products with few outside demand or supply substitutes For a patient: his diagnosis For a doctor: his medical specialty About 20-30 (e.g. cardiology, neurology, some sub-specialties) Similar to the ICD encoding of "Major Diagnostic Category" R.S. Halbersma Market Definition in Healthcare Product market (II) Market Definition in Healthcare R.S. Halbersma Introduction Methods for market definition Patient flow methods Patient choice methods Overview market definition methods Conclusion More aggregated hospital product market segmentations: 6 clusters of specialties with the same complexity/volume workload (Varkevisser et al. 2006) 3 clusters of services with similar medical resource requirements (e.g. primary/secondary/tertiary) 2 clusters of services with similar duration (inpatient versus outpatient) R.S. Halbersma Market Definition in Healthcare Geographic market (I) Market Definition in Healthcare R.S. Halbersma Introduction Methods for market definition Patient flow methods Patient choice methods Overview market definition methods Conclusion A geographic market is an area with few outside demand or supply substitutes Smallest sensible area consistent with privacy laws: ZIP code (pre-defined administrative areas) Needs threshold criterion for "few" outside substitutes Usually implemented by straightforward patient flow analysis Elzinga-Hogarty (1974, 1978) Critical Loss (Harris and Simons, 1989) R.S. Halbersma Market Definition in Healthcare Elzinga-Hogarty method Market Definition in Healthcare R.S. Halbersma Introduction Methods for market definition Patient flow methods Patient choice methods Overview market definition methods Conclusion patient inflows LOFI = 1 − patients treated in area patient outflows LIFO = 1 − patients treated in area Start with a narrowly defined market (e.g. a hospital’s zip code location). Add zip codes until LIFO/LOFI thresholds are met. In practice: LOFI and LIFO 75% or 90% (arbitrarily defined). Market is not robust: depends on the starting point, method of addition and threshold. R.S. Halbersma Market Definition in Healthcare The EH-method is not informative (I) Market Definition in Healthcare R.S. Halbersma Introduction Methods for market definition Patient flow methods Patient choice methods Overview market definition methods Conclusion Werden (1992): Hotelling line with hospitals A and B on the end points Absence of cross-area flows = monopoly. Take identical services and a symmetric equilibrium with prices pA = pB at both ends. EH-market definition: both A and B are isolated monopolists. Yet an increase in pA will motivate a number of patients to switch from A to B. R.S. Halbersma Market Definition in Healthcare The EH-method is not informative (II) Market Definition in Healthcare R.S. Halbersma Introduction Methods for market definition Patient flow methods Patient choice methods Overview market definition methods Conclusion Presence of cross-area flows = competition Assume differentiated services and prices pA = pB and qualities qA > qB EH-market definition: A and B are duopoly on single market. Yet an increase in pA will not necessarily lead to patients switching to B. The reason is that patients not already travelling to B could have medical reasons for going to A, not just because A is closer. Capps et al. (2002) dubbed this the Silent-Majority Fallacy. R.S. Halbersma Market Definition in Healthcare The EH-method is not applicable to health care Market Definition in Healthcare R.S. Halbersma Introduction Methods for market definition Patient flow methods Patient choice methods Overview market definition methods Elzinga’s testimony during the Evanston post-merger litigation (2005) EH-test designed for commodity markets (beer, coal). Should not be applied to differentiated products like health care! Final nail in the coffin? Conclusion R.S. Halbersma Market Definition in Healthcare Critical Loss Analysis (I) Market Definition in Healthcare R.S. Halbersma Introduction Methods for market definition Patient flow methods Patient choice methods Overview market definition methods Conclusion Look for a group of hospitals that can profitably impose a SSNIP (5-10%) Define the Contribution Margin as CM = p−c p Critical Loss = How much switching would have to to occur to make the SSNIP unprofitable? SSNIP CL = CM + SSNIP Actual Loss = How much switching actually occurs after the SSNIP? Algorithm: start with merging firms, keep adding competitors until Actual Loss Critical Loss R.S. Halbersma Market Definition in Healthcare Critical Loss Analysis (II) Market Definition in Healthcare R.S. Halbersma Introduction Methods for market definition Patient flow methods Patient choice methods Overview market definition methods Conclusion To do this analysis using only patient flow counting Split ZIP codes in "contestable" and "non-contestable" A ZIP code is contestable if a minority (10%-25%) currently goes to outside hospitals (EH-threshold) Assumptions about patient switching after a SSNIP: no switching in non-contestable ZIP codes, significant switching in contestable ZIP codes (30% in the literature) compute Actual Loss by summing switching percentage over all ZIP codes R.S. Halbersma Market Definition in Healthcare Problems with Critical Loss Analysis Market Definition in Healthcare R.S. Halbersma Introduction Methods for market definition Patient flow methods Patient choice methods Overview market definition methods Conclusion Framework is fine, in principle, as it implements the SSNIP-test. In high margin industries, only a small amount of switching (small Critical Loss) is necessary to prevent a SSNIP. However, high margins also imply that demand is so inelastic that little switching will actually occur (small Actual Loss). Many defendants in U.S. case law have gotten away with claiming both high margins and elastic demand (and hence, very broad markets). R.S. Halbersma Market Definition in Healthcare Patient choice methods Market Definition in Healthcare R.S. Halbersma Compared to straightforward patient flow counting, econometric demand estimation allows for much more detailed simulation of the SSNIP-test. Introduction Methods for market definition Patient flow methods Patient choice methods Overview market definition methods Conclusion Three main methods have recently been developed in the literature (all using a logit demand specification) Critical Loss Analysis based on demand elasticity (Capps et al. 2002) Logit Competition Index (LOCI) method (Gaynor et al. 2006) Option Demand method (Capps et al. 2003) R.S. Halbersma Market Definition in Healthcare Logit demand framework Market Definition in Healthcare R.S. Halbersma In random choice theory, the utility of patient of type t going to hospital j has a structural and a stochastic part Vtj = Utj + εtj Introduction Methods for market definition Patient flow methods Patient choice methods Overview market definition methods Conclusion The structural part often includes a constant part, travel distance and a price part Utj = γtj + βdtj − αpj When the stochastic parts are i.i.d. extreme value, the hospital market shares within a network G are given by exp(Utj ) stj = g ∈G exp(Utg ) R.S. Halbersma Market Definition in Healthcare Critical Loss Analysis based on demand elasticity Market Definition in Healthcare R.S. Halbersma Introduction Methods for market definition Patient flow methods Patient choice methods Overview market definition methods Conclusion Estimate the logit demand system on a patient discharge database. Apply the SSNIP and calculate the switching implied by the demand system. Sum over ZIP codes to obtain the Actual Loss and compare with the Critical Loss as before. Much more accurate than the contestable zip codes variant. R.S. Halbersma Market Definition in Healthcare Supply side modelling Market Definition in Healthcare R.S. Halbersma Introduction Methods for market definition Patient flow methods Patient choice methods Overview market definition methods Conclusion One caveat of the SSNIP-test: does not compute profit-maximizing post-merger price, only if significant price increase is profitable. With kinked demand: a small price increase would not be profitable while a large price increase would! The LOCI and Option Demand methods directly compute the post-merger prices. With LOCI, insurers are price-takers from hospitals engaged in differentiated Bertrand competition. With Option Demand, insurers are engaged in Nash-bargaining with a network of hospitals. R.S. Halbersma Market Definition in Healthcare The LOCI method Market Definition in Healthcare R.S. Halbersma Consider a single-product hospital j. The profit function is given by Πj = pj Dj (pj ) − C (D(pj )) Introduction Methods for market definition Patient flow methods Patient choice methods Overview market definition methods Assuming profit maximization, the first-order conditions are given by pj = C (D(pj )) − Dj (pj ) ∂Dj ∂pj Conclusion Substituting the logit demand system, this becomes 1 1 pj = C (D(pj )) + α Λj R.S. Halbersma Market Definition in Healthcare Interpreting LOCI (I) Market Definition in Healthcare R.S. Halbersma LOCI is given in terms of observed market shares Λj = wtj (1 − stj ) t Introduction Methods for market definition Patient flow methods Patient choice methods Overview market definition methods weighted by the relative importance of each patient type for hospital j Nt stj wtj = Nt stj t Conclusion Λj measures the competitiveness in the market LOCI takes on values between 0 and 1 Λ = 0: hospital j is a monopolist Λ = 1: hospital j faces perfect competition R.S. Halbersma Market Definition in Healthcare Interpreting LOCI (II) Market Definition in Healthcare R.S. Halbersma Introduction Methods for market definition Patient flow methods Patient choice methods Overview market definition methods Conclusion Monopolies (Λ = 0) have infinite prices. This is a result of the logit assumption of no outside goods (i.e. perfectly inelastic market demand). Perfectly competitive markets (Λ = 1) have prices above marginal costs. Again, this is a result of the logit demand system (Anderson et al. 1992). Gaynor et al. (2006) argues that, in practice, this is not of great concern because antitrust is not concerned with perfect competition and monopolies are more likely to be price regulated. R.S. Halbersma Market Definition in Healthcare LOCI merger simulation (I) Market Definition in Healthcare R.S. Halbersma Introduction Methods for market definition Patient flow methods Patient choice methods Overview market definition methods Conclusion Cannot directly estimate the costs and LOCI coefficient α from the price equation. Need to first instrument for the endogenous LOCI by estimating a logit demand system on a patient discharge database. Then do non-linear optimization of the original price equation to find the post-merger prices. Works, but is very time-consuming owing to combinatorial explosion of logit (our patient discharge database has 10 million records per year, with 100 hospitals). Fortunately, there is a shortcut. R.S. Halbersma Market Definition in Healthcare LOCI merger simulation (II) Market Definition in Healthcare R.S. Halbersma Introduction Methods for market definition Patient flow methods Patient choice methods Overview market definition methods Conclusion Without any estimation, one can directly compute the combined fixed effects γtj + βdtj from the observed market shares (see Gaynor et al. 2006). Then to do a non-linear optimization of the original price equation to find the post-merger price-cost markups. With the pre-merger Contribution Margin CM = p−c p , the percentage price increase owing to the merger is proportional to the percentage increase in the inverse LOCI Δpj Δ(Λj )−1 pre = pre −1 CM pj (Λj ) R.S. Halbersma Market Definition in Healthcare Option Demand method Market Definition in Healthcare R.S. Halbersma Introduction Methods for market definition Patient flow methods Patient choice methods Overview market definition methods Health insurance is an "option" on access to hospitals when needed The "willingness to pay" (WTP) for an insurance depends on the network of hospitals WTP of consumers gives hospitals bargaining power over insurers Conclusion R.S. Halbersma Market Definition in Healthcare Willingness to pay for option demand Market Definition in Healthcare R.S. Halbersma In a logit demand system, the expected utility of patient t having access to a network G is given by exp(Utg ) Vt,G = ln g ∈G Introduction Methods for market definition Patient flow methods Patient choice methods Overview market definition methods Conclusion The marginal contribution of hospital j to network G is Nt (Vt,G − Vt,G \j ) ΔVj,G = t Substituting the logit demand system, this becomes 1 ln 1−s tj ΔVj,G = wtj stj t This marginal added value is the willingness to pay for option demand (Capps et al. 2003). R.S. Halbersma Market Definition in Healthcare Option Demand bargaining model Market Definition in Healthcare R.S. Halbersma Introduction Methods for market definition Patient flow methods Patient choice methods Overview market definition methods Conclusion Assume the hospital-insurer market to be a bilateral monopoly. The outside options of having no contract are zero profits for both firms. When the hospital is contracted by insurer i for a price per service of pij , the hospital’s and insurer’s profits are given by Πi = (ΔVj,G − pij )Di (pij ) Πj = pij Dj (pij ) − C (Dj (pij )) The Nash-bargaining solution maximizes the product of the joint profits, and evenly splits the added value of the network’s added value over marginal costs pij = Cj + R.S. Halbersma ΔVj,G − Cj 2 Market Definition in Healthcare Option Demand merger simulation Market Definition in Healthcare R.S. Halbersma Introduction Methods for market definition Patient flow methods Patient choice methods Overview market definition methods Conclusion With the pre-merger Contribution Margin CM = p−c p , the percentage price increase owing to the merger is proportional to the percentage increase in the hospital’s added value Δ(ΔVj ) Δpj pre = pre CM pj (ΔVj ) Note the similarity with the predicted price increases for the LOCI method. R.S. Halbersma Market Definition in Healthcare Overview market definition methods Market Definition in Healthcare R.S. Halbersma Method Demand Elzinga-Hogarty Observed patient flows estimated choice Introduction Methods for market definition Patient flow methods Patient choice methods Overview market definition methods Conclusion Critical Loss Observed patient flows patient LOCI Estimated patient choice exp(Utj ) g ∈G exp(Ugj ) stj = Option Demand Estimated patient choice exp(Utj ) g ∈G exp(Ugj ) stj = Supply Cournot Bertrand Differentiated Bertrand Nash bargaining Market power Market share Market share LOCI WTP pj − cj sj = CMj = pj ε pj − cj sj = CMj = pj ε Λj = wtj (1 − stj ) t ΔVj,G = t Merger simulation Change in concentration L= sj2 i ε = HHI ε SSNIP-test of X % ActualLoss < R.S. Halbersma X CM + X ln wtj 1 1−stj stj Percentage price increase Percentage price increase Δpj Δ(Λj )−1 CM pre = −1 pj (Λpre j ) Δpj Δ(ΔVj ) CM = pjpre (ΔVjpre ) Market Definition in Healthcare Conclusions Market Definition in Healthcare R.S. Halbersma Introduction Methods for market definition Patient flow methods Patient choice methods Overview market definition methods Conclusion The estimation of market power in health care is crucial and difficult Old-fashioned methods (Elzing-Hogarty, Critical Loss) based on patient flow counting have been very vulnerable in U.S. courts. Recent literature has developed 3 promising methods based on economic theory and econometric estimation of patient choice. At NZa, we have successfully implemented and run these methods on ongoing Dutch merger cases. New methods not tested in Dutch or U.S. courts. Computing merger efficiencies is another topic (future work-in-progress seminar by Misja Mikkers). R.S. Halbersma Market Definition in Healthcare
