• Bilateral market power and the inappropriateness of HHIs: From the literature

    In their recent paper on hospital pries and hospital and insurer market structure, Moriya, Vogt and Gaynor hit two key points I’ve been pondering. First, they note correctly that hospital prices are set in relation to market power of not just hospitals and not just insurers, but of both.

    [W]e analyze the bilateral exercise of market power by both insurers and hospitals, whereas most of the previous literature analyzes the exercise of market power on only one side of the market. Only Staten et al. (1987, 1988), Sorensen (2003), and Melnick et al. (1992) analyze the bilateral exercise of market power. However, the first three studies focus on the concentration of insurers and the last one focuses on that of hospitals, and the measurement of the concentration of the other side is not very precise.

    More needs to be done in this area. On that very point and why it is important I’ll have more to say later in the month (publication pending).

    Next up, a thorny issue I’ve raised before. I wrote once,

    A more technically useful notion of market share is the Herfindahl index (hereafter denoted H), which is the sum of squared market shares.  H is proportional to the degree to which the prices firms charge exceed marginal costs in homogeneous goods markets, those for which products produced by one firm are perfect substitutes for those produced by another. The higher H the higher the price markup.

    However, few markets are perfectly homogeneous, but some are closer than others. Actually, hospital and health insurance markets are very far from homogeneous. One hospital can be quite different from another in many ways. It matters where you get your surgery! Insurance products differ in many dimensions. A high-deductible plan is not the same as a plan with first dollar coverage, for instance. Despite this, the FTC and DOJ still use H as a measure of market concentration in these industries. Thus, so do health economists, and so will I.

    And so do Morya, Vogt, and Gaynor, writing,

    A criticism of the […] use of the HHIs in a pricing equation [is that they] can only be directly derived from a theoretical model with Cournot competitors. That model clearly does not apply here. Hospital services are a differentiated product, and even more importantly, we are considering bilateral oligopoly. As stated previously, there is no theoretical consensus on bilateral oligopoly, hence no definitive empirical predictions. As a consequence, our analysis is best thought of as an empirical exploration of the idea that more concentrated markets has less price competition that is reflected in prices (higher for more concentrated sellers and lower for more concentrated buyers).

    Were I doing this work I’d have done about the same thing and, perhaps, justified it the same way. So the following is not a critique of the authors, but of the state of health economics. We need far more theory on bilateral oligopoly. Get cracking theorists!


    Melnick, G., J. Zwanziger, A. Bamezai and R. Pattison (1992), ‘The effect of market structure and bargaining position on hospital prices’, Journal of Health Economics, 11(3): 217–233.

    Sorensen, A. T. (2003), ‘Insurer-hospital bargaining: negotiated discounts in post-deregulation Connecticut’, Journal of Industrial Economics, 51(4): 469–490.

    Staten, M., W. Dunkelberg and J. Umbeck (1987), ‘Market share and the illusion of power: can Blue Cross force hospitals to discount?’, Journal of Health Economics, 6(1): 43–58.

    Staten, M., W. Dunkelberg and J. Umbeck (1988), ‘Market share/market power revisited, a new test for an old theory’, Journal of Health Economics, 7(1): 73–83.

    • While health insurance products currently vary a great deal, under Obamacare the product will be standardized into about four products of ascending coverage – bronze, silver, gold and platinum. (Medigap policies are already standardized in a similar way.) The standardization will make a big difference among shoppers.
      Of course, most people don’t distinguish among insurance policies, nor do they distinguish among hospitals, even though, as you state, differences exist. So the perception of the ability to substitute may be driving the market, despite the reality.
      Also interesting to consider the negotiations between bilateral oligopolies when one, the insurer, has regulated rates. (And the regulation will become stronger as Obamacare matures.) Not sure if that means the regulation puts one party at a disadvantage or it means the regulator exerts control over both markets.

      • @RZ – Good point. It is my understanding that the standardization you describe is under the exchanges, which will be a small part of the overall market. Maybe the idea (fear? concern? hope?) is that it will be the beginning of broader standardization.

        About your comment, “most people don’t distinguish among insurance policies, nor do they distinguish among hospitals,” do you have any evidence (papers?) to support that statement? It doesn’t describe me at all, but I’m not a typical consumer. However, it doesn’t require all consumers to make informed choices to affect a market. What’s the threshold? Beats me. (There’s probably research on this.)

    • No formal papers.
      For insurance, I think there’s no need to look farther than minimed policies (like McDonald’s has). These are barebones, low-limit policies that are marketed so that employers of the semiskilled can say their workers “have benefits.” (Insurers market them to employers that way, too, from my understanding.
      For hospitals, I think the unplanned nature of many hospital visits means there is minimal comparison shopping. One exception – maternity wards – reinforces the rule, I think.
      Of course, I’m thinking of shopping by the patient in both cases. I suspect doctors shop carefully for hospitals to practice at, and employers definitely shop group policies.
      Those point to a much different problem, the misalignment of incentives in the U.S. medical system. The people in charge of the purse are not the people under the knife. Doctors, hospitals and employers will tend make decisions in their best interests, at the expense of the patient.

    • Interesting papers. I had lunch with our VP of marketing today. He noted that their internal studies show that only 5%-10% of patients are sensitive to any kind of marketing effort. Patients are insensitive to price and quality. Best doctors, prettiest nurses, best food or nicest facilities matter little. What matters is being close. (The exception is usually for cancer patients.) Unfortunately, it seems like medical marketing journals are nearly all gated and I am too stingy to subscribe. Are the marketing folks an untapped area for research? I will confess I had never thought of them as a research source.


    • The key point to all discussions about hospitals is that FIRST we need to alter the Certificate of Need:


      If the data is drawn from states that artificially limit the creation of new hospitals, discussing the power to price is ridiculous.

      Steve, that will not be true when:

      1. Everyone has HD with maxed out HSAs
      2. There is true price exposure.

      A patient seeking vein ablation will drive 100 miles to save $1500 that they get to keep.