Competition in the Health Care Marketplace

8/9/2019 Competition in the Health Care Marketplace

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RUNNING HEAD: COMPETITION

Competition in the Health Care Marketplace

Nia Llenas

University of Maryland University College


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I. Introduction

II. Literature Review

III.Hospital-Physician Competition

a. Free-riding

b. Models of affiliation

c. The salaried Physician

d. Physician-owned specialty hospitals

IV.Integration

V. Market Effects

VI.Conclusion

VII. References


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Introduction

During the 1990s, as managed care regulations tightened and risk contracting

expectations grew, hospitals quickly aligned with physician practices to ensure greater

bargaining power and the implementation of effective cost controls. These affiliations

were in the form of shared ownership operations such as, Independent Practice

Associations (IPAs) and Physician Hospital Organizations (PHOs) and Integrated Service

Models (ISMs) (Casalino & Robinson, 2003, p. 331). In fact, by 1996, over 40% of all

hospitals were affiliated with physician practices in one of the aforementioned models

(Cilberto & Dranove, 2006, p. 29).

Unfortunately for many, risk contracting failed to be widely accepted, managed care

loosened its restrictive beginnings and by 2000, most of the aforementioned affiliations

dissolved due to either economic stress or managerial differences (Cilberto % Dranove,

2006). On the contrary, todays competitive market has aroused new methods of

competing in the healthcare sector, which include vertical and horizontal integration,

mergers and acquisitions, physician management organizations and the new role of the

salaried physician, as well as ever present competition from physician owned specialty

hospitals.

The purpose of this paper is to examine the changing interaction between hospitals and

their competition, including hospitals and physicians, as well as, its role in the dynamics

of the market.

Literature Review

The affiliation between a hospital and its competitor (physicians included) has evolved

from one of mutual respect and independent growth to that of a singular entity with


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shared governance and financial incentive. Casalino and Robinson (2003) detail this

changed in the eras of pre-managed care, tight managed care, and loose managed care

(p. 332). Using the resource dependence theory and organizational economics to study

the advantages and disadvantages of each affiliation model, Casalino and Robinson,

apply these models to case studies of four different hospitals under various affiliation

agreements. The knowledge of not only the outcomes, but also the reasoning behind each

systems choice of affiliation is integral to understanding how hospital systems respond

to competition and the economic effects resulting.

Similarly, Mulholland (2007) examined the choices health systems are faced with

when competing with physicians in a particular market. Since the medical staff model in

the pre-managed care era, hospitals have increasingly progressed toward and prefer to

employ physicians to eliminate competition, ensure admissions and circumvent anti-

kickback and Stark law. In eliminating competition, Argue (2007), suggests that the only

truly efficient method is to eliminate transaction costs and free-riding, a basic externality

in the relationship between physicians and hospitals, by requiring each party to reimburse

each other for the value of economic benefit generated. Considering the illegality of such

payment, the most comparable step is employment or physician ownership.

The employment model, though popular, may not be as profitable as the physician

ownership model. Kennedy, Clay and Collier (2009) considered the financial

implications for hospitals moving into an employment model by comparing the risks,

benefits and costs of such a transaction. The resulting conclusion that the employment

model may be little more than a hedged investment against future competition as well as

a loss in opportunity costs is inconsistent at best and subject to the particular market.


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Although in comparison to physician ownership (typically 1-5% plus group share), this

previously mentioned view of employment is consistent with popular opinion (Argue,

2007, p. 349)

Another viable option for coping with competition is integration or consolidation.

Whether horizontal or vertical, the integration of hospitals and physician practices has

increased over the past twenty years. Huckman (2006) investigates shifts in market

power, quality, cost and price of cardiac services at hospitals in New York State. Also, in

light of the shifts in market power, Huckman posits that integration effectively leads to

business stealing which invariably affects quality and cost depending on the

competitiveness and size of the market.

In a study published simultaneously with Huckman (2006), Cuellar and Gertler (2006)

hypothesize that the rise of managed care which essentially causes integrations had

become a driving factor in the recent rise in health care costs. Unlike Huckman, Cuellar

and Gertler (2006) find that integrated organizations have higher prices especially when

in exclusive agreements or in less competitive markets.

A California based study by Cilberto and Dranove (2006) put forward the known

factors of integration in an analysis of the effect of change of prices within the hospital

but not between hospitals, and include attempts to differentiate between price effects

attributed to form-specific and hospital specific trends. Although no evidence of higher

prices were found, the authors admit that integration may be prefaced on intent to raise

prices that simply failed.

The benefits of vertical integration are undeniable. Increased bargaining power,

improved efficiency and a reduction of competing firms in the marketplace all serve to


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call coverage and serve on committees (Mulholland, 2007). However, no payment

actually changes hands, which creates a positive externality called free-riding. (Argue,

2007)

Free-Riding

Free riding is generally viewed as a market failure because it results in an "economically

inefficient outcome or a non-optimal allocation of resources (Argue, 2007, p. 354).If

transaction costs were eliminated, hence, the elimination of free riding, the referral

system would include payment by each party to the other for the value of the patient to

each entity.

Since both parties free ride, payment would force them to cope with and

internalize the cost of their own free riding.This stance would lead to net zero free riding,

the most economically efficient method, but payments between physicians and hospitals

have been deemed unethical and illegal.

In the instance that net free riding is not equal to zero and favor is skewed in favor of

the hospital, physicians can be expected to exit the relationship and move to ownership,

much like dentistry and ophthalmology. Conversely, when the relationship is skewed in

favor of the physician, hospitals seek to employ to capture the economic benefit of the

physician. (Argue, 2007)

Although free riding can be viewed as the basis for hospital affiliation or competition,

other studies view the intrusion of managed care as the trigger for the changes in the

relationship between the two entities. Casalino and Robinson (2003), offer four reasons

for affiliation. Care coordination, increased leverage with health plans, increased

admissions and increase cost savings under full or shared risk contracting permeate

literature today as the reasons given by administrators to justify vertical integration.


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Models ofAffiliation

There are three models of hospital-physician affiliation that are familiar today. The

medical staff model, the most common, did not require the levels of coordination seen

under managed care simply because payments were made on the volume of service

instead of the quality of service. Additional, the economic cost of inciting physician

loyalty was relatively high in the pre-managed care era and the medical staff model

required no capital investment or cost/revenue allocation, which in the managed care

environment, results in a disadvantage in terms of the transaction cost economies theory

and is counteractive to controlling the cost of care.

Staff physicians simply do not have

incentives to control cost. (Casalino & Robinson, 2003, p. 337)

The second model, the hospital-owned physician practice, depends on the employment

of physicians to ensure compliance with quality initiatives and cost-reduction strategies

as well as secure admission volumes. The most beneficial factor is the increased leverage

in negotiation health plan rates, because failure to reach consensus can result in the health

plan losing both hospital and provider form a network (Casalino & Robinson, 2003, p.

338)

The third and final model is the IPA or PHO, which maintains the united-front of a

hospital-owned physician practice but without the start-up costs. The allocation of

costs/revenues are decided jointly without the presence of a central authority leading

productivity and costs savings strategies to be fragmented (Casalino & Robinson, 2003,

p. 339)

Of the three models presented, staff physicians and IPA's/PHO's are still the largest

threat to a hospitals profitability. In the context of free-riding, these physicians


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essentially decide whether profitable patients are steered to a certain hospital and

furthermore, the inclusion of physician loyalty to a specific facility can compromise the

physician's position as the patient's agent (Mulholland, 2007).

The Salaried Physician

In the last then years, hospitals have been trending towards physician employment to

avoid the competitive aspects of the market and ensure access to services through

particular physicians. This is done now only by employing a single physician, but

through the purchase of physician owned practices. Interestingly, the opposite is also

taking place, physicians are purchasing health care facilities such as outpatient surgery

centers, laboratories and hospitals, which effectively create secondary revenue streams,

further confusing the concept of agency (Mulholland, 2007, p. 394). Salaried physicians

and physician-owned hospitals are a strong trend and while in many markets are a

panacea; do not work in others.

While the salaried physician can be a boon to profitability through increased alignment

with financial goals and incentives, the benefits of such employment must be classified as

direct/indirect and tangible/intangible in relation to physician-related costs and payments,

access, competitive positioning and alignment. (Kennedy, Clay & Collier, 2009, p. 75).

The net cost of practice acquisition is equal to the cost of capital used to acquire the

practice, plus operating costs, minus any costs such as income guarantees the hospital

used to incur to attract independent physicians (Stensland & Stinson, 2002, p. 910).

When tallied, hospital systems can expect to spend twice as much to employ a

physician in comparison to simply aligning with a private practice. These costs are

concentrated around acquisition, salary, benefits and malpractice premiums that are


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typically paid by the hospital and subject to the competitiveness of the market, ex.

another bidder may drive up the price of the practice causing the initial bidder to overbid

in order to prevent the loss of prospective patients (Stensland & Stinson, 2002, p. 910).

In fact, according to Kennedy, Clay and Collier (2009), the direct and tangible costs

associated with acquiring and operating a practice and its physicians are greater than

those associated with the traditional, private practice model and "the hospital is unlikely

to realize a significant boost to the bottom line from direct practice income (p. 76).

At this point, the indirect and intangible costs and benefits play a role in a hospital's

decision to employ a physician practice or new physician.In competitive markets

particularly, the competitive position of a hospital is jeopardize when its alliances with

local physicians is weakened. Increasing competition from group practices, and

especially physician-owned specialty centers, reduces hospital volume and revenues.

In truth, rural markets are the primary beneficiary of the salaried physician model.

Employment effectively increases hospital volume, and ensures the volume of ancillary

services such as imaging and diagnostic, as well as increases bargaining power with

managed care organizations (Stensland & Stinson, 2002). Alternatively, the opportunity

cost of employing physicians should be accounted for in this age of changing technology

and opportunity for sharper capital investments (Kennedy, Clay & Collier, 2009)

Physician-Owned Specialty Hospitals

The increase of physician owned specialty hospitals present a significant threat to

community and general hospitals in competitive markets. Physicians who own specialty

hospitals benefit the most from the free-riding theory, especially when they retain

hospital privileges. These physicians decrease the hospital's free-riding effect by


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changing it's current case mix, referring less profitable patients (public insurance) to the

hospital, and keeping the profitable ones (private insurance) in their own facility

(Mulholland, 2007) (Argue, 2007).

Although individual physician ownership in a facility is relatively small (1%-5%

share), specialty hospitals maintain low fixed costs compared to general or community

hospitals and additionally, an individual investor's profit is a combination of outputs from

the owned portion and the group profit (Argue, 2007, p. 350). These facts have led

hospitals to respond by utilizing their right to decredential physicians, influence managed

care contracting and engage in vertical integration with specialty physician practices or

horizontal integration with competing hospitals with established specialty services.

Integration

Two types of integration prevail in the health care sector, vertical and horizontal.

While most research clearly differentiates between the two, according to Huckman

(2005) that can be difficult. For instance, integration may be considered horizontal

depending on the services impacted, such as the emergency room, while other services

such as cardiac surgery or obstetrics are affected by vertical integration, but all can be

contained in the integration of two hospitals or a hospital and a physician practice or

specialty hospital.

Previous research suggests that there are several reasons for integration, which include,

transaction cost economies and economies of scope, or market bargaining power (Cuellar

& Gertler, 2005), and desire to increase prices or optimize volume.Therefore, hospital

integration affects not only market conditions and transfers market power, but it also

impacts efficiency, price and cost, by joining complements (Huckman, 2006).


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When hospitals and physicians take advantage of the managed care payment system

(capitation and prospective payment), if the economies of scope are taken into account,

the financial gain multiplies. In this situation, vertical integration lowers cost of care and

transaction costs, while improving quality through the coordination of care and use of

shared information, making the integrated entity more attractive to managed care

organizations (Cuellar & Gertler, 2005, p.4).

Additionally, integration results in a complete market for resources. "Both acquirers

and targets may hold critical resources for which markets are incomplete", and "through

integration, the acquirer might gain access to the targets resource of a close attachment to

local patients and physicians, specialized technology, quality reputation and potentially

valuable contracts with managed care" (Huckman, 2006, p. 61).

According to the Robert Wood Johnson Foundation (RWJF) (2006), hospital mergers

and acquisitions are most likely due to the promise of increased efficiency and market

share, not the strength of managed care. Although, it is important to determine the

market size effect by a reasonable measure of variable that indicate maximum impact in

the target market, specifically, the transfer of volume of business from the target market

to the acquirers market (Huckman, 2006).

Even though RWJF found the influence of managed care to be an unlikely

determinant of integration, there are many benefits to integrating, such as increased prices

due to bargaining power, especially among physician practices and hospitals who deal

exclusively, or when an increase in market power is substantial enough after integration

that a hospital can justify increasing prices just under antitrust level. Integration also

reduces the number of firms competing, which could be construed as anti-competitive,


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but often is not far-reaching enough to merit investigation (Gaynor, 2006).

Market Effects

There is some consensus on the effects of integration on market variables such as

market power, price and cost. Hospitals operating under an integrated service model may

charge as much as 18 % to 25% higher prices than independent hospitals (Cilberto &

Dranove, 2006) (Cuellar & Gertler, 2006), and can enjoy a shift in market share that is

statistically significant (Huckman, 2006). Unfortunately, this price increase is not

sustained long past the acquisition stage, as prices eventually return to within an

acceptable range of the former price.

In the context of patient profitability, the increase in volume of procedures that

are initiated in the hospital system does increase profitability in competitive markets.

This increase allows hospitals to, again, subsidize unprofitable procedures and provide

for the common good of the community, by reducing the cost per case (Huckman, 2006).

In rural markets, patient volumes and profitability are subject to distance from the

acquired or closed hospital (Wu, 2008) and largely affected by the increase in physician

loyalty and the reduction in Medicare length of stay (Stensland & Stinson, 2002). Of

note, is the fact that while consolidations and integrations reduce competition, they also

change case mix across the provider spectrum differentiating only in quality and cost, but

remaining inside the newly formed entity (Huckman, 2006). Though this rings of anti-

competitive behavior, litigators have been careful to pursue without evidence of existing

market power help by the acquirer. (Gaynor, 2006)

Conclusion

The overarching goal of hospital-physician and hospital-hospital integration is, at


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the onset, to increase profitability, reduce cost and increase access to the market served.

Whether these goals are effectively met after integration or acquisition will require

further research in markets that can be characterized evenly according to institutional

classification, market size and level of competitiveness. Currently, comparing research

from an urban market such as New York State to combined data from Florida, Arizona

and Wisconsin, cannot provide us with a positive assertion as to the effects of hospital

integration. However, there are several lessons to be learned and expanded upon in

future research.

First, the physician-hospital relationship should be carefully examined for its

long-term financial implications. Many of the studies put forth do not provide a

definitively positive outcome of the recent trend towards physician employment other

than a reduction in cost per case. Financial leaders must take into account the costs of

employing a physician versus the cost of appointing the physician to a medical staff

position. For many positions, the opportunity cost in employing physicians would be

better served in making investments in technology or outpatient surgery centers.

Additionally, financial leaders should demand data that proves that employed physicians

produce care of increasing quality in this era of pay for performance.

Second, the increase in vertical integration, while predicated on increasing access

and reducing costs, does not appear to be a valid long-term view, especially in

competitive urban markets. In 1996, 40% of all hospitals were integrated; whether

through IPAs, PHOs orISMs; by 2000 many of these relationships were dissolved and

for valid reasons (Cilberto & Dranove, 2006).Today, many of these integrations can turn

into bidding wars, forcing the cost of acquisition to far exceed the cost of competing,


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whereas in rural markets, acquisition positively affects competitors within the same

metropolitan statistical area and outlying counties. Additionally, combining the cost of

acquisition with practice management costs long-term makes the idea of vertical

integration a bit dimmer.

In conclusion, the move towards increasing clinical and economic integration in

the health care sector is a double-edged sword. There is much progress being made to

construct a clinical model that is efficient, low-cost and available to the marketplace,

unfortunately, employing physicians and acquiring physician owned practices may only

ensure an increase in market power, further reducing options for competition in the

market served.


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Competition in the Health Care Marketplace

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