MHI 582: Chapter 15

Chapter 15 Notes

highly competitive markets

those with below-average profit margins

less competitive markets

those with above-average profit margins

List the 5 factors profitability depends on

nature of rivalry among existing firms

risk of entry by potential rivals

bargaining power of customers

bargaining power of suppliers

threat from substitute products

List characteristics of firms that have significant market power

muted price competition

little risk of entry by rivals

limited customer bargaining power

few satisfactory substitutes

What do firms with significant market power face?

relatively inelastic demand which results in them getting large markups

List the 3 characteristics of healthcare markets that reduce their competitiveness & increase their market power

healthcare markets have few competitors which mutes rivalry

muted rivalries persist because cost and regulatory barriers limit entry

healthcare products have few close substitutes (makers market demand less elastic and makes demand for an individual firm’s products less elastic)

What do profit-oriented managers usually seek to do?

gain market power

try to change the nature of competition

List 2 options for organizations that can’t change a market’s competitive structure

become the low-cost producer

differentiate its products from those of the competition

List implications of market power

gives firms some discretion in pricing because the market doesn’t dictate what they charge

flexibility in pricing and product specifications means managers must consider a broad range of strategies

managers have to decide what strategy best fits their circumstances

the prospect of market power gives healthcare organizations a strong incentive to differentiate their products

amount of market power an organization has typically depends on how much its products differ from competitors’ in terms of quality, convenience, or some other attribute

market power generally results from a competitors imperfect substitute

consumers have difficulty assessing whether experience products have good substitutes, which increases market power

What does flexibility in pricing and product specifications means?

managers must consider a broad range of strategies (i.e. how to compete)

List reasons that competitors’ products are imperfect substitutes

differences in location

other attributes

product familiarity

Why is comparison of medical goods costly?

medical goods and services are typically “experience” products (consumers must use a product to ascertain that it offers better value than another)

consumers have difficulty assessing whether experience products have good substitutes

What do advertising decisions depend on?

the differences that determine market power

attribute-based differences

usually demand extensive advertising

information-based advertising

often reward restrictions on advertising

perfectly competitive market

buyers are seller are price takers

both believe they can’t alter the market price

offers a baseline with which to contrast other market structures

perfect competition

firms operate under the assumption that demand is very price elastic

List the behavior of firms in perfect competition

they have to realize above-normal profits to be more efficient than the competition

disregard the actions of rivals because potential entrants face no barriers and they have so many rivals

monopolist

a firm with no rivals

monopolistic competitors

firms with different locations, personalities, treatment styles, etc

oligopolists

firms with only a few competitors

also refers to firms with large market shares even if they have many rivals

the decisions of some competitors determine the strategies of others

What do healthcare market structures depend on?

market shares of insurers

number of each (insurer) in the market

List changes underway that may affect negotiations between hospitals and insurers

insurers are merging (increasing concentration in some health insurance markets)

insurers are offering plans that exclude high-priced hospitals (narrow networks)

insurers anticipate selling many more policies to individuals (expect demand for individual policies will be much more sensitive to premium differences)

List conditions that result in the bargaining power of suppliers being high

market has many buyers and few suppliers

supplies are differentiated, high-value products

suppliers can threaten to enter the industry they currently supply

buyers cannot threaten to manufacture supplies

industry is not a key customer for suppliers

Barriers to entry in healthcare markets may be…

market based

regulation based (more effective as they reduce the number of competing providers and make demand less price elastic)

entry restrictions

increase market power

List advantages of letting the government erect entry barriers to gain market power

its’ perfectly legal & eliminates public and private suits alleging antitrust violations

resulting market power is usually more permanent because government-sanctioned entry barriers will not be eroded by market competition

What forms much of the basis for market power in healthcare?

state licensure (prevents entry by supplies with similar qualifications and encroachment by suppliers with lesser qualifications)

patents

enable organizations to establish a monopoly for a limited period

allows holder to exploit it and sell or license rights

gives holder a monopoly for 17 yrs

copyrights

create monopolies that protect intellectual property rights

protect only a particular expression of an idea not the idea itself

lasts for the life of the author plus 70 yrs

trademarks

grant monopoly rights for distinctive visual images that belong to a particular organization

never expire as long as they are used and defended

List barriers to entry for potential competitors

licensure

patents

copyrights

trademarks

List common tactics utilized to prevent or slow the entry of rivals

preemption

limit pricing

innovation

mergers

preemption

building excess capacity in a market to discourage potential entrants

limit pricing

utilized by established firms or those with established products

setting prices low enough to discourage potential entrants

enables organizations to avoid even bigger profit reductions that competition might cause later by giving up some profits now

only works if the firm is an aggressive innovator otherwise competitors will entry with lower costs or better quality

innovation

forces entrants to always play catch-up due to relentless cost reductions and quality improvements

mergers

increase market power by changing market structure

reduce costs or increase market power either of which increases profit margins

What is the publicized goal of most mergers?

cost reductions resulting from consolidation of some functions

What is usually the unspoken goal of mergers?

the anticipation of improvement in the firm’s bargaining position

markups

changes with a gain in market power (i.e. organizations with market power benefit form markup)

What do firms with substantial market power find profitable?

setting prices well above marginal cost

Hirschman-Herfindahl Index (HHI)

used by economists to identify concentrated markets

equals the sum of the squared market shares of the competitors in a market

gets larger as the number of firms gets smaller or as the market share of the largest firms increases

higher HHI results in higher prices

concentrated market

market with few competitors or few dominant firms

List attributes other than market power that result in high markups

having a large market share

providing specialized services

having a good reputation

being a member of a system

List 3 competitive strategies common among firms with market power

price discrimination

collusion

product differentiation

price discrimination

selling similar products to different buyers at different prices

collusion

conspiring to limit competition

profitable because demand is less elastic for the profession than for each individual participant

only increases profits until detected

a secret agreement between parties for a fraudulent, illegal, or deceitful purpose

product differentiation

process of distinguishing a product from others

a process not an outcome

tends to erode although potentially profitable

List the 2 forms product differentiation takes

attribute-based product differentiation

information based product differentiation

*both reduce the price elasticity of demand for a product and create market power

attribute-based product differentiation

customers recognize that two products have different attributes, even though they are fairly close substitutes, and may not respond to small price differences

information based product differentiation

customers have incomplete information about how well products suit their needs

extensive advertising

makes sense for products that differ in attributes that matter to consumers

the more clearly customers see the differences, the less elastic demand will be and the higher markups can be for “better” products

restrictions on advertising

make sense in situations with information-based product differentiation

the harder it is for customers to see that products do not differ in ways that matter to them, the less elastic demand will be and the higher markups can be

What leads to confusing advertising patterns?

the coexistence of attributes-based and information-based product differentiation

What has made advertising more common?

the nature of healthcare products

the nature of healthcare markets

What is increasing price transparency one strategy for reducing healthcare prices?

banning advertising results in higher prices

What is the economic logic behind advertising and innovating?

continue as long as the increase in revenue is greater than the increase in cost

stop when the margin revenue from advertising or product differentiation just equals the marginal costs

Advertising only makes sense for…

products with significant margins

How is the profit-maximizing amount of advertising determined?

by consumer's’ responses to advertising and prices

What is the profit-maximizing rule for advertising costs?

an organization will maximize profits when its ratio of advertising to sales equals -1 times the ratio of the advertising elasticity of demand to the price elasticity of demand

advertising elasticity of demand

the percentage increase in the quantity
demanded when advertising expenses increase by 1%

List things product differentiation can be

clear cut

less distinguishable

barely noticeable

emotional

frivolous

successful differentiation

asks to be copied and generally is

Describe the case against direct-to-consumer advertising for prescription drugs

consumers lack the expertise to make informed decisions about prescription medications

only expensive, branded products will be advertised, creating barriers to entry for generic products

Describe the case for direct-to-consumer advertising for prescription drugs

consumer advertising is that it provides consumers with information about products that have been rigorously reviewed for safety and effectiveness