I bet you think I’m going to discuss the housing market. Nope. There’s another kind of foreclosure. It’s also a market phenomenon that occurs when the actions of one firm prevent another from remaining in or entering a market.
Foreclosure can be brought about by some of types of market predation I described yesterday. In particular, “vertical behavior” can lead to foreclosure. Vertical behavior is any action taken by a firm to more tightly control its supply or product chain. When a baker buys a wheat distributor, he has vertically integrated. He now owns a source of one of his inputs. An exclusive contract between a movie production company and a cable television network is a “vertical restraint.” It “restrains” that network from offering rivals’ content.
In their Handbook of Health Economics chapter on antitrust and competition in health care markets, Gaynor and Vogt describe the relationship between vertical behavior and foreclosure in health care:
The other major form of vertical behavior that has been of concern in health care antitrust have been vertical restraints that tend to reduce competition in the of the markets involved. These include vertical integration, exclusive dealing, and most-favored-nations contracts. A commonly used term for this effect is “foreclosure.” The reason for concern is obvious. Consider a situation with a health insurance duopoly and a hospital monopoly. If one of the insurers integrates with the hospital or engages it in an exclusive contract, it will have the ability to foreclose the other insurer from the market, thereby gaining monopoly power. … Since vertical restraints both involve potential anti-competitive effects and efficiencies, antitrust cases involving (non-price) vertical restraints are judged on a rule of reason basis. This makes economic analysis of effects on competition and efficiencies essential in such cases. …
The courts for the most part have found … insufficient evidence of anti-competitive effects. As indicated previously, the vast bulk of exclusive dealing cases or vertical integration cases have been rejected by the courts impacts
Not surprisingly, the authors note that the economics literature has found that vertical integration and restraints have been found to be efficiency enhancing, lowering firm costs. Hence, one might expect insurers to enter into exclusive or long-term contracts with providers.
Gal-Or (1996) considers the … [exclusive contracting] problem … with differentiated insurers. With differentiated insurers foreclosure can occur in equilibrium. In this case, a provider who agrees to an exclusive deal with an insurer will likely accept a lower payment rate in return for a larger volume of patients. If both insurers sign exclusive deals with different providers, this benefits insurers by reducing the outside options of the providers and thus reducing their payment rates. Encinosa (1996) considers exclusive deals between HMOs and physician groups. There is an incumbent HMO which has a cost advantage over a rival, but must invest in order to serve the entire market. When the incumbent HMO is risk averse, it may engage in an exclusive deal with the single provider. This will result in foreclosure and is socially inefficient. At present, however, exclusive contracts per se appear to be relatively rare between insurers and health care providers. Long term services contracts are common, and may confer a degree of exclusivity on an insurer who is a large buyer.
It is worth noting that the Gaynor and Vogt chapter from which I quote about a decade old. I do not know if exclusive contracting between hospitals and insurers has become more common.
(See also: Anticompetitive exclusion: Raising rivals’ costs to achieve power over price, by Krattenmaker and Salop. There the authors describe exclusionary rights as the “bottleneck” or “essential facilities” problem when it locks up the entire supply the the “supply squeeze” or “quantitative foreclosure” when it locks up a portion of it. Also described is the “price squeeze” or “cartel ringmaster” when a dominant firm facilitates a discriminatory cartel among suppliers. Finally, there’s the “Frankenstein monster” (!!!) which comes about from an exclusive contract with one supplier that results in a residual market structure that facilitates collusion among the remaining ones faced by rivals.)
References
Gal-Or, Esther (1996), “Exclusionary equilibria in health care markets,” Journal of Economics and Management Strategy, 6(1): 5-43.
Encinosa, W.E. (1996), “Exclusive contracting in health care markets,” unpublished manuscript, University of Michigan.
