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Market Definition in Healthcare R.S. Halbersma Introduction Methods for market definition Patient flow methods Patient choice methods Overview market definition methods Conclusion Market Definition in Healthcare R.S. Halbersma Dutch Healthcare Authority, TILEC extramural fellow February 2, 2011 R.S. Halbersma Market Definition in Healthcare

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Page 1: Market Definition in Healthcare - Tilburg University · PDF fileMarket Definition in Healthcare R.S. Halbersma Introduction Methods for market definition Patient flow methods

MarketDefinition inHealthcare

R.S.Halbersma

Introduction

Methods formarketdefinitionPatient flow

methods

Patient choice

methods

Overview

market

definition

methods

Conclusion

Market Definition in Healthcare

R.S. Halbersma

Dutch Healthcare Authority, TILEC extramural fellow

February 2, 2011

R.S. Halbersma Market Definition in Healthcare

Page 2: Market Definition in Healthcare - Tilburg University · PDF fileMarket Definition in Healthcare R.S. Halbersma Introduction Methods for market definition Patient flow methods

MarketDefinition inHealthcare

R.S.Halbersma

Introduction

Methods formarketdefinitionPatient flow

methods

Patient choice

methods

Overview

market

definition

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Conclusion

Preamble

Some of the research presented here wascommissioned by the NZa during 2006-2008:Dranove, Sfekas (Kellogg), Varkevisser, Schut(Erasmus), Gaynor, Vogt, Kleiner (CMU).A Dutch overview article of this subject waspublished jointly with Mikkers and Kersholt inMarkt & Mededinging (April, 2009).Together with Misja Mikkers and Peter Bogetoft, amonograph is in preparation on market structureand efficiency in health care.

R.S. Halbersma Market Definition in Healthcare

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MarketDefinition inHealthcare

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Introduction

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Introduction

Traditionally, competition and antitrustenforcement has been important in the U.S. healthcare system only.In recent years, however, more countries havestarted to turn away from strict supply rationingand price controls.Antitrust enforcement is becoming more importantas a result of recent market-oriented reforms in theNetherlands and Germany.The U.K. government also plans the establishmentof a sector specific competition authority (whichmainly will deal with mergers).

R.S. Halbersma Market Definition in Healthcare

Page 4: Market Definition in Healthcare - Tilburg University · PDF fileMarket Definition in Healthcare R.S. Halbersma Introduction Methods for market definition Patient flow methods

MarketDefinition inHealthcare

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Motivation

Merger waves in the countries with hospitalcompetition (U.S., Germany and the Netherlands).Mergers and restructuring also an issue incountries with state provision (UK and Denmark).Empirical literature generally agrees that hospitalmergers lead to higher prices and longer travel.Ostensibly, hospital mergers are done to raisequality, BUT

not clear if this cannot be done without a mergeractual quality improvements have a long time laga merger lowers incentives to provide quality (seee.g. "Death by Market Power", Gaynor, Propper,Morena-Serra, 2010)

R.S. Halbersma Market Definition in Healthcare

Page 5: Market Definition in Healthcare - Tilburg University · PDF fileMarket Definition in Healthcare R.S. Halbersma Introduction Methods for market definition Patient flow methods

MarketDefinition inHealthcare

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The number of hospitals in the Netherlands

R.S. Halbersma Market Definition in Healthcare

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Bed size matters

R.S. Halbersma Market Definition in Healthcare

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MarketDefinition inHealthcare

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Old-fashioned merger analysis

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.

Critically depends on the 1st step - market definition.

R.S. Halbersma Market Definition in Healthcare

Page 8: Market Definition in Healthcare - Tilburg University · PDF fileMarket Definition in Healthcare R.S. Halbersma Introduction Methods for market definition Patient flow methods

MarketDefinition inHealthcare

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The importance of market definition

"...it should be stressed first that market definition isnot of interest by itself, but only as preliminary steptowards the objective of assessing market power."

Massimo Motta (2004), Competition Policy: Theoryand Practice, Cambridge University Press, p.101

R.S. Halbersma Market Definition in Healthcare

Page 9: Market Definition in Healthcare - Tilburg University · PDF fileMarket Definition in Healthcare R.S. Halbersma Introduction Methods for market definition Patient flow methods

MarketDefinition inHealthcare

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SSNIP-test for market definition

A relevant market is a set of firms such that thosefirms, acting as a "hypothetical monopolist", couldprofitably impose a "small but significant andnon-transitory increase in price" (SSNIP).

A market consists therefore of a group of productswith no close substitutes outside the group andgood substitutes inside the group.Demand-side substitution key in market definitionSupply-side substitution (e.g. entry) usuallyaccounted for during competitive effects analysis

R.S. Halbersma Market Definition in Healthcare

Page 10: Market Definition in Healthcare - Tilburg University · PDF fileMarket Definition in Healthcare R.S. Halbersma Introduction Methods for market definition Patient flow methods

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Distinctive features of hospital markets

Most important distinctive features include:Demand-side: third-party payers, asymmetricinformation, costly searchSupply-side: differentiated products, regulatoryentry and exit barriers

Present in other markets as well, but their uniquecombination and extent substantially complicatehospital market definition.

Hospital markets are usually divided along twodimensions: a product market and a geographic market.

R.S. Halbersma Market Definition in Healthcare

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Product market (I)

A product market is a group of products with fewoutside demand or supply substitutes

For a patient: his diagnosisFor a doctor: his medical specialtyAbout 20-30 (e.g. cardiology, neurology, somesub-specialties)Similar to the ICD encoding of "Major DiagnosticCategory"

R.S. Halbersma Market Definition in Healthcare

Page 12: Market Definition in Healthcare - Tilburg University · PDF fileMarket Definition in Healthcare R.S. Halbersma Introduction Methods for market definition Patient flow methods

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Product market (II)

More aggregated hospital product marketsegmentations:

6 clusters of specialties with the samecomplexity/volume workload (Varkevisser et al.2006)3 clusters of services with similar medical resourcerequirements (e.g. primary/secondary/tertiary)2 clusters of services with similar duration(inpatient versus outpatient)

R.S. Halbersma Market Definition in Healthcare

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Geographic market (I)

A geographic market is an area with few outsidedemand or supply substitutes

Smallest sensible area consistent with privacy laws:ZIP code (pre-defined administrative areas)Needs threshold criterion for "few" outsidesubstitutesUsually implemented by straightforward patientflow analysis

Elzinga-Hogarty (1974, 1978)Critical Loss (Harris and Simons, 1989)

R.S. Halbersma Market Definition in Healthcare

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Elzinga-Hogarty method

LOFI = 1 − patient inflowspatients treated in area

LIFO = 1 − patient outflowspatients treated in area

Start with a narrowly defined market (e.g. ahospital’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 startingpoint, method of addition and threshold.

R.S. Halbersma Market Definition in Healthcare

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The EH-method is not informative (I)

Werden (1992): Hotelling line with hospitals A and Bon the end points

Absence of cross-area flows �= monopoly.Take identical services and a symmetricequilibrium with prices pA = pB at both ends.EH-market definition: both A and B are isolatedmonopolists.Yet an increase in pA will motivate a number ofpatients to switch from A to B.

R.S. Halbersma Market Definition in Healthcare

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The EH-method is not informative (II)

Presence of cross-area flows �= competitionAssume differentiated services and prices pA �= pBand qualities qA > qBEH-market definition: A and B are duopoly onsingle market.Yet an increase in pA will not necessarily lead topatients switching to B.The reason is that patients not already travellingto B could have medical reasons for going to A,not just because A is closer.Capps et al. (2002) dubbed this theSilent-Majority Fallacy.

R.S. Halbersma Market Definition in Healthcare

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The EH-method is not applicable to health care

Elzinga’s testimony during the Evanstonpost-merger litigation (2005)

EH-test designed for commodity markets (beer,coal).Should not be applied to differentiated productslike health care!Final nail in the coffin?

R.S. Halbersma Market Definition in Healthcare

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Critical Loss Analysis (I)

Look for a group of hospitals that can profitably imposea SSNIP (5-10%)

Define the Contribution Margin as CM = p−cp

Critical Loss = How much switching would haveto to occur to make the SSNIP unprofitable?

CL =

[SSNIP

CM + SSNIP

]

Actual Loss = How much switching actuallyoccurs after the SSNIP?Algorithm: start with merging firms, keep addingcompetitors until Actual Loss � Critical Loss

R.S. Halbersma Market Definition in Healthcare

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Critical Loss Analysis (II)

To do this analysis using only patient flow countingSplit 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 aSSNIP:

no switching in non-contestable ZIP codes,significant switching in contestable ZIP codes(30% in the literature)compute Actual Loss by summing switchingpercentage over all ZIP codes

R.S. Halbersma Market Definition in Healthcare

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Problems with Critical Loss Analysis

Framework is fine, in principle, as it implements theSSNIP-test.

In high margin industries, only a small amount ofswitching (small Critical Loss) is necessary toprevent a SSNIP.However, high margins also imply that demand isso inelastic that little switching will actually occur(small Actual Loss).Many defendants in U.S. case law have gottenaway with claiming both high margins and elasticdemand (and hence, very broad markets).

R.S. Halbersma Market Definition in Healthcare

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Patient choice methods

Compared to straightforward patient flow counting,econometric demand estimation allows for much moredetailed simulation of the SSNIP-test.

Three main methods have recently been developed inthe 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)

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Logit demand framework

In random choice theory, the utility of patient of type tgoing to hospital j has a structural and a stochastic part

Vtj = Utj + εtj

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, thehospital market shares within a network G are given by

stj =exp(Utj)∑

g∈G exp(Utg )

R.S. Halbersma Market Definition in Healthcare

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Critical Loss Analysis based on demand elasticity

Estimate the logit demand system on a patientdischarge database.Apply the SSNIP and calculate the switchingimplied by the demand system.Sum over ZIP codes to obtain the Actual Loss andcompare with the Critical Loss as before.Much more accurate than the contestable zipcodes variant.

R.S. Halbersma Market Definition in Healthcare

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Supply side modelling

One caveat of the SSNIP-test: does not computeprofit-maximizing post-merger price, only ifsignificant price increase is profitable.With kinked demand: a small price increase wouldnot be profitable while a large price increase would!The LOCI and Option Demand methods directlycompute the post-merger prices.

With LOCI, insurers are price-takers fromhospitals engaged in differentiated Bertrandcompetition.With Option Demand, insurers are engaged inNash-bargaining with a network of hospitals.

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The LOCI method

Consider a single-product hospital j . The profit functionis given by

Πj = pjDj(pj) − C (D(pj))

Assuming profit maximization, the first-order conditionsare given by

pj = C ′(D(pj)) − Dj(pj)∂Dj∂pj

Substituting the logit demand system, this becomes

pj = C ′(D(pj)) +1α

1Λj

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Interpreting LOCI (I)

LOCI is given in terms of observed market shares

Λj =∑

t

wtj(1 − stj)

weighted by the relative importance of eachpatient type for hospital j

wtj =Ntstj∑t

Ntstj

Λj measures the competitiveness in the marketLOCI takes on values between 0 and 1Λ = 0: hospital j is a monopolistΛ = 1: hospital j faces perfect competition

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Interpreting LOCI (II)

Monopolies (Λ = 0) have infinite prices. This is aresult of the logit assumption of no outside goods(i.e. perfectly inelastic market demand).Perfectly competitive markets (Λ = 1) have pricesabove marginal costs. Again, this is a result of thelogit demand system (Anderson et al. 1992).Gaynor et al. (2006) argues that, in practice, thisis not of great concern because antitrust is notconcerned with perfect competition andmonopolies are more likely to be price regulated.

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LOCI merger simulation (I)

Cannot directly estimate the costs and LOCIcoefficient α from the price equation.Need to first instrument for the endogenous LOCIby estimating a logit demand system on a patientdischarge database.Then do non-linear optimization of the originalprice equation to find the post-merger prices.Works, but is very time-consuming owing tocombinatorial explosion of logit (our patientdischarge database has 10 million records per year,with 100 hospitals).

Fortunately, there is a shortcut.

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LOCI merger simulation (II)

Without any estimation, one can directly computethe combined fixed effects γtj + βdtj from theobserved market shares (see Gaynor et al. 2006).Then to do a non-linear optimization of theoriginal price equation to find the post-mergerprice-cost markups.With the pre-merger Contribution MarginCM = p−c

p , the percentage price increase owing tothe merger is proportional to the percentageincrease in the inverse LOCI

Δpj

pprej

=Δ(Λj)

−1

(Λprej )−1 CM

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Option Demand method

Health insurance is an "option" on access tohospitals when neededThe "willingness to pay" (WTP) for an insurancedepends on the network of hospitalsWTP of consumers gives hospitals bargainingpower over insurers

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Willingness to pay for option demand

In a logit demand system, the expected utility ofpatient t having access to a network G is given by

Vt,G = ln∑g∈G

exp(Utg )

The marginal contribution of hospital j to network G is

ΔVj ,G =∑

t

Nt(Vt,G − Vt,G\j)

Substituting the logit demand system, this becomes

ΔVj ,G =∑

t

wtj

ln(

11−stj

)stj

This marginal added value is the willingness to pay foroption demand (Capps et al. 2003).

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Option Demand bargaining model

Assume the hospital-insurer market to be a bilateralmonopoly. The outside options of having no contractare zero profits for both firms. When the hospital iscontracted by insurer i for a price per service of pij , thehospital’s and insurer’s profits are given by

Πi = (ΔVj ,G − pij)Di (pij)

Πj = pijDj(pij) − C (Dj(pij))

The Nash-bargaining solution maximizes the product ofthe joint profits, and evenly splits the added value ofthe network’s added value over marginal costs

pij = C ′j +

ΔVj ,G − C ′j

2

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Option Demand merger simulation

With the pre-merger Contribution Margin CM = p−cp ,

the percentage price increase owing to the merger isproportional to the percentage increase in the hospital’sadded value

Δpj

pprej

=Δ(ΔVj)

(ΔV prej )

CM

Note the similarity with the predicted price increases forthe LOCI method.

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Overview market definition methods

Method Elzinga-Hogarty Critical Loss LOCI Option DemandDemand Observed patient flows Observed patient flows

estimated patientchoice

Estimated patient choice

stj =exp(Utj)∑

g∈G exp(Ugj)

Estimated patient choice

stj =exp(Utj)∑

g∈G exp(Ugj)

Supply Cournot Bertrand Differentiated Bertrand Nash bargaining

Marketpower

Market share

CMj =pj − cj

pj=

sjε

Market share

CMj =pj − cj

pj=

sjε

LOCI

Λj =∑

t

wtj(1 − stj)

WTP

ΔVj ,G =∑

t

wtj

ln(

11−stj

)stj

Merger sim-ulation

Change in concentra-tion

L =∑

i

s2j

ε=

HHIε

SSNIP-test of X%

ActualLoss <X

CM + X

Percentage price increase

Δpj

pprej

=Δ(Λj)

−1

(Λprej )−1 CM

Percentage price increase

Δpj

pprej

=Δ(ΔVj)

(ΔV prej )

CM

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Conclusions

The estimation of market power in health care iscrucial and difficultOld-fashioned methods (Elzing-Hogarty, CriticalLoss) based on patient flow counting have beenvery vulnerable in U.S. courts.Recent literature has developed 3 promisingmethods based on economic theory andeconometric estimation of patient choice.At NZa, we have successfully implemented and runthese 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