Simply put: Market power

Simply put” is an ongoing series. See the introduction for an explanation of the series and the full list of topics that have been or may be covered. Feel free to suggest other topics in that post.

Market power is the ability to negotiate (and obtain) a more favorable price. If you’re selling something and you have market power, you can sell it for more and make a higher profit doing so. Or, if you’re buying something and you have market power, you can buy it for less.

There are many sources of market power among participants in our health system. One source is that products in health care are not identical. One health care insurance policy offered by one firm is not exactly like one offered by another. Likewise, one health care service (a specific surgery by a specific surgeon, say) is not exactly like another. In fact, even the same surgery performed by the same surgeon on two different people can have different effects, making them somewhat different products.

When products are dissimilar, purchasers (consumers purchasing insurance or plans purchasing health services) do not shop based on price alone. Other features of the products matter. Based on those features, companies can charge more for their product than they could in a market in which the same exact (or very nearly so) product is sold by many companies (e.g., the market for gasoline or milk). Markets of similar but not identical products are called heterogeneous products markets.

Market power in a heterogeneous product market is amplified by market concentration. For example, many markets for health insurance or hospital services are “highly concentrated.” That means that the vast majority of individuals in those markets obtain their health insurance coverage or hospital care from only a few organizations. For example, a market with two insurance companies that split the population of policyholders equally is highly concentrated. On the other hand, a market in which ten firms split the population of policyholders equally is not very concentrated.

A high degree of market concentration is a source of market power because it implies there are very few options for consumers. Since products are heterogeneous, a consumer is far more likely to find a closer substitute in a ten-firm market than a two-firm market. Firms in a ten-firm market cannot raise their price as high without losing profit as can firms in a two-firm market.

Other sources of market power for hospitals include “star” or “must have” status and capacity constraints. “Must have” hospitals cannot be excluded from health plans’ contracting networks without the plans suffering a loss of customers. Such a hospital has the plans over a barrel and can charge higher rates. A hospital that is at capacity can also profitably raise its prices since it has more demand for its services than it can meet.

Purchasers (like health plans) can have market power too, the ability to negotiate lower prices. Health plans that severely restrict their network of contracted providers (and serve customers that tolerate such restrictions) have the power to bargain for lower prices in markets with a sufficient number of providers. For example, in a market with many hospitals a tightly networked plan may only include hospitals in their networks that are willing to accept relatively lower payments. That’s purchasing market power.

Further Reading

Santerre R and Neun S. Health Economics: Theories, Insights, and Industries Studies. Chapter 8.

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