Market structure and competition in the healthcare industry

Health systems in OECD countries have seen a steady increase in health spending over the last 50 years. Expenditure in this sector has tended to grow at a faster rate than Gross Domestic Product (GDP). While health spending accounted for less than 4% of GDP on average across OECD countries in 1960, this share increased to 8.9% in 2013 [1]. The health spending share of the GDP grew particularly rapidly in the United States, rising from about 5% in 1960 to 16.4% in 2013. A similar tendency can be seen in Central European countries, where healthcare services today represent one of the most important sectors of the modern economy (with 11.0% of GDP in Germany, 10.1% in Austria, 7.6% in the Slovak Republic and 7.1% in the Czech Republic, for instance). The size of these industries and their long-run trends suggest that understanding their structure, conduct and performance is important not only for the performance of the healthcare industry, but also for understanding the economy as a whole.

The present paper is based on, and extends, an approach pioneered by Bresnahan and Reiss [2]. According to Bresnahan and Reiss [2], the relationship between market structure (i.e., the number of firms) and market size (e.g., population) speaks to the nature and intensity of competition between firms. This approach uses a simple, general entry condition to model market structure. It postulates that if the population (per-firm) required to support a given number of firms in a market grows with the number of firms, then competition must be getting tougher. Intense competition reduces profit margins. A larger population is, thus, necessary for generating sales required to cover entry costs.¹ Thus, the key data required for applying the Bresnahan–Reiss (entry-threshold) approach are both minimal and commonly available: market structure (i.e., the number of firms) and population in several local markets.

Note, however, that the entry-threshold approach assumes local markets to be fully isolated. The equilibrium in one market must be independent—in terms of demand and competition—of other markets. While this might be a plausible assumption in some sparsely populated (rural) regions,² the high population density in many European countries raises doubts concerning the assumption of perfectly isolated regional markets. Aguirregabiria and Suzuki [4] conclude: ’Focusing on rural areas makes the approach impractical for many interesting retail industries that are predominantly urban’ (p. 26). Spatial spillover effects between different regions might be particularly important for healthcare industries, since the costs of travelling are small relative to the value of the service. Consumers might thus be willing to travel larger distances to patronise a specific service provider. The present paper aims at extending the entry-threshold approach by modelling spatial interaction effects explicitly.

The second novel feature of this paper is that we will provide first empirical evidence on (changes of) market conduct and competition in the healthcare industry of a transition economy (the Slovak Republic). The structure of a planned economy as well as the behaviour of firms (or production units) in this environment differs from the structure and conduct of firms in a market economy in many dimensions [5]. Given the very specific structure of a centrally planned economy, as well as the significant economic and institutional changes during the process of transition, an empirical analysis can provide novel insights into the evolution of market structure and firm conduct in the healthcare industry for a transition economy.

This paper is organised as follows. The next section provides a short overview of the existing empirical literature. This is followed by a section reviewing the relevant changes in the economic environment in Slovakia. Subsequently, the data and empirical framework are presented. The section “Entry threshold analysis” discusses the changes in competitive behaviour across periods. This is followed by a section detailing counterfactual scenarios, both in terms of regulatory frameworks and in terms of overall economic conditions. The paper concludes with a summary of the main findings and proposes possible extensions of the research agenda.

Given the increasing significance of the healthcare sector, it is not surprising to find a large number of empirical studies analysing the determinants of market structure (i.e., the location and the number of suppliers in a specific market) as well as the effects of market structure on competition and economic performance.³ A substantial share of this literature focuses on the relationship between market size (population) and the number of suppliers (firms) in different local markets.

The relationship between population and market structure (number of suppliers) for the market of physicians was first investigated empirically by Newhouse et al. [7], who found that the size of a town affects the probability of a physician being located there. They also make use of the fact that the number of specialists in the U.S. increased dramatically over the decade of the 1970s. Towns that did not previously have a specialist experienced a larger increase in the number of specialists than those that did.

Rosenthal et al. [8] revisit this issue using data from the 1980s and 1990s. They examine 23 states with low physician to population ratios. The total number of physicians in these states doubled from 1970 to 1999. They find that communities of all sizes gained physicians over this period, but growth rates were larger for smaller communities. A recent paper by Isabel and Paula [9] examines some of these issues using data for Portugal from 1996 and 2007. Over this period, the total number of physicians in Portugal grew by approximately 30% and the number per capita grew by approximately 22%. They estimate a static model using 2007 data and find that population size has a large and significant impact on the number of physicians per capita located in an area. They also test a dynamic model and find that areas that had more physicians per capita in 1996 had lower growth in the number of physicians per capita. This is consistent with the results reported in Newhouse et al. [7]. Brown [10] also confirms this relationship for the Canadian province of Alberta, although the evidence is not overwhelming. A study by Dionne et al. [11] also found this to be true for the province of Quebec, Canada.

A recent paper by Schaumans and Verboven [12] examines the determinants of entry in physician service markets in Belgium. A novel feature of this study is that the authors consider the entry decisions of pharmacies simultaneously with those of other professions. Pharmacies and physician practices provide complementary services. Consequently, each type of firm benefits from the presence of the other. Both prescription drug prices and physician service prices are heavily regulated in Belgium. Therefore, both pharmacies and physician practices engage in non-price competition (convenience, quality of service, quality of care, etc.). While the entry of physicians into local markets is free from restriction, pharmacy entry is regulated: there is a maximum number of pharmacies allowed in an area, based on the local population. Schaumans and Verboven adapt the models of Bresnahan and Reiss [2] and Mazzeo [13] to allow for entry restrictions for pharmacies as well as the fact that products sold by the two types of firms (pharmacies and physicians) may be strategic complements. They find that the population necessary to support a given number of firms increases more or less proportionally with the number of firms. According to Bresnahan and Reiss [2], this implies that entry does not lead to tougher competition. These results suggest that pharmacies and physicians do not engage in more intense price competition as more firms of their own type enter a market. The authors also find that the population necessary to support another physician practice decreases with the number of pharmacies, and vice versa. This supports the hypothesis of strategic complementarities. Schaumans and Verboven then use the parameter estimates from the model to simulate the impacts of policy reform in the pharmacy market. They consider easing entry restrictions by increasing the maximum number of pharmacies allowed in an area, and reducing pharmacies’ regulated markups. They find that simply allowing free entry (no change in markups) would increase the number of pharmacies by 173%. The complementarities between pharmacies and physician practices lead to a 7% increase in the number of physician practices as a result of the entry liberalization for pharmacies.

Abraham et al. [14] specify a static entry model modified from Bresnahan and Reiss [2] to better understand the nature of competition for hospitals. They augment the Bresnahan–Reiss approach by quantity data. Their method allows the separate identification of changes in the fixed costs of entry and changes in the toughness of competition. Their estimates imply that the threshold per-firm population required to support one hospital is approximately 7000, increases to 12,600 to support two hospitals, is approximately 19,000 for three hospitals, and just under 20,000 for four or more hospitals. They also find that a rise in the number of hospitals in the market dramatically increases the number of patients up until there are three hospitals, by 23% with the entry of the second hospital and 15% with the entry of the third hospital. This implies a substantial increase in the toughness of competition with the entry of a second or third firm, but not thereafter. These results point to considerable effects on competition, even from having only a second firm enter the market. However, the magnitude of the effects (23% increase in quantity associated with moving from a monopoly to a duopoly) seems extremely large.

Note that the existing empirical literature considers market structure and competition in developed market economies only. Similar microlevel studies for transition economies are lacking. In view of the series of structural changes inherent in transition process, a close examination of the process is likely to contribute to a better understanding of how healthcare providers react to adjustments in the economic climate (both in terms of changes in demand characteristics, and in terms of remuneration schemes and general regulatory conditions). The following section provides a short description of structural changes in the healthcare sector in Slovakia during the transition period.

The transition process in Slovakia has included a number of changes to the regulatory environment of healthcare professions. An overview of the main regulatory changes is provided in Table 1.

Slovakia⁴ entered the transition from a centrally planned economy to a market economy as a part of Czechoslovakia. Until 1989, the regulatory framework did not allow independent decisions of firms on prices; free entry and exit was impossible, and the entire production process was governed by central and regional governmental units and state-owned institutions. The state was responsible for healthcare coverage and took full responsibility for financing (through general taxation), planning, management and provision of healthcare. Basic services were granted free of charge to all citizens. The pre-1945 social insurance system was abolished. All healthcare providers were nationalised and incorporated into Regional and District Institutes of National Health. Regional Institutes consisted of regional healthcare centers (large hospitals). The  District Institutes of National Health consisted of small- or medium-sized hospitals and polyclinics, along with pharmacies, centers of hygiene, emergency, first aid services and nurseries. The centrally planned economy and healthcare system led to inefficiencies and inaccurate resource allocation decisions. The system was not able to deal with the growing incidence of lifestyle diseases and hospitals were equipped with outdated technology. The lack of improvements in technology was compensated for by increasing numbers of health workers and hospital beds, which resulted in a healthcare system with a surplus of ambulatory physicians.

A social insurance system (based on the Bismarck system) was reintroduced after 1989. In 1993, Slovakia gained independence and the National Insurance Fund was established to fund health, social and pension insurance. Social health insurance was legally defined in 1994 by the Act on Health Insurance, which enabled the establishment of other health insurance funds. The reintroduction of social health insurance suffered from problems created during the previous regime and the macroeconomic environment that went along with the transformation process. The Slovak economy was in a deep recession and public finances were seriously constrained. This led to a situation in which the state did not have the capacity to make health insurance contributions for the inactive population. The health system that was based on a new institutional and regulatory framework with privatised healthcare providers was marked by weak budget constraints and corruption, which led to increasing debts and bankruptcies in the health insurance market. Hospitals remained technologically underdeveloped with an oversupply of health personnel and ineffective management. Even though nearly all hospitals were owned by the state (they existed under the control of the Ministry of Health as state contributory organizations) during the 90s, most pharmacies and ambulatory physicians went into private practice. The hierarchical healthcare structure was broken down and the healthcare system became fragmented, with a high number of specialised healthcare providers. The functioning of the healthcare system became unsustainable and required another set of reforms.

The first set of institutional changes was introduced by the new government in the 1999–2002 period as part of a broader set of macroeconomic stabilization measures. However, the major problems were tackled only partially and the structural deformation of the system’s supply deepened. The state lost control of 14 healthcare facilities that were privatised and transformed to non-profit organizations. The management was transferred to regional and local governments in most of the other state-owned healthcare facilities (with the exception of the biggest hospitals and specialised institutions). This restructuring and the migration of doctors and nurses abroad led to a continuous fall in the number of physicians and nurses in relation to the population after 2001.

Key reforms to the healthcare system were introduced in the 2002–2006 period, with major legislative changes taking place in 2004. The health reform was based on a set of structural and functional changes which were supposed to transform the centralised system into a decentralised system; from the state as a provider of healthcare services to the state as a supervisor setting the “rules of the game”; from the hierarchical functional structure to a contractual structure; and from the state as a bearer of risk to a situation in which every player bears the risk (providers, patients, purchasers). The key objective of the reform was to increase the independence and financial responsibility of healthcare providers. During this period, hard budget constraints were introduced; health insurance companies were transformed into joint stock companies; the Health Care Surveillance Authority (HCSA) was established (to split the legislative and control function in the healthcare system); user fees were introduced; flexible prices, contractual relations with selective contracting and flexible basic benefit packages were decentralised to health insurance companies; a flexible healthcare network (with the definition of a minimum network) and drug policy measures accompanied by the liberalization of ownership of pharmacies were implemented. The reform aimed to make the process of entry into the healthcare provision market more transparent and to remove barriers to entry.

After the 2006 elections, some of the pro-market reforms were discarded (selective contracting was restricted, health insurance companies were no longer allowed to make a profit, user fees were scaled down or completely abolished), but key reform acts remained unchanged. A new government in 2010 reversed the trajectory of reforms again and declared plans to continue to bring new market mechanisms into the healthcare system.

As of 2010, the social health insurance system was based on solidarity, provided universal coverage for a broad range of benefits and guaranteed an annual free choice of one of three nationally operating health insurance companies (one of which was state-owned and covered 66% of the insured, and two privately owned). Pharmacies, diagnostic laboratories and almost 90% of outpatient facilities were in private hands. Ambulatory care was provided mostly by privately organised physicians and people were free to choose their general practitioner and specialist. The system was administered by the Ministry of Health, the HCSA and the self-governing regions which, besides other responsibilities, issued permits to healthcare providers. Chambers and professional associations kept registers of health professionals, issued opinions on ethical issues, issued or revoked licences and monitored the management of healthcare facilities.

For providers to enter the Slovak healthcare provision market, several criteria needed to be fulfilled. Healthcare professionals had to obtain a licence from the Slovak Medical Chamber and a permit from the self-governing region or the Ministry of Health (depending on what type of provider it was). Then, providers were supposed to submit a request for a contract with a health insurance company, although providers could also provide services without a contract with a health insurance company. A minimum network of providers was determined by the government which defined the density and structure of healthcare providers across Slovakia. In primary care, general practitioners were entitled to a contract as soon as a patient registered with them. In ambulatory secondary care and in inpatient tertiary care, the minimum network was defined as a minimum number of specialists by type in each region. Health insurance companies then had the option to contract more providers if they had enough resources. Certain state-owned hospitals which were deemed crucial in guaranteeing geographical accessibility of specialised services were required to be contracted even if the quality and price did not match those of their competitors. Exit from the market was usually caused by the lack of contracts with health insurance companies and/or resulting from a negative financial situation.

Dental care was provided either by contracted or non-contracted dentists. But direct payments from patients for dental procedures were necessary in most cases even to contracted dentists, because social health insurance covered only basic dental costs (under the condition of regular preventive dental examination each calendar year).

Besides the described institutional changes, the pharmacy market in Slovakia was influenced by specific regulatory changes. Until 1998, it was regulated by the Act No. 13/1992 on the Slovak Medical Chamber, the Slovak Chamber of Dentists and the Slovak Chamber of Pharmacists. The entry of new pharmacies was not explicitly regulated by demographic or population criteria, but the Slovak Chamber of Pharmacists had the right to comment on the request for establishment of a new pharmacy that had to be approved by the Ministry of Health of the Slovak Republic. A new Act No. 140/1998 from 1998 on drugs and medical facilities gave the Slovak Chamber of Pharmacists an explicit right to approve the request for establishment of new pharmacies in Slovakia. Without its approval, new pharmacies could not enter the market. Later, the Slovak Chamber of Pharmacists approved the directive on Declaration of professional and ethical competencies for the operation of pharmaceutical care in the public pharmacy [16], which explicitly introduced demographic and population criteria for the establishment of new pharmacies. The minimum distance between pharmacies was set to 500 m and the minimum population per pharmacy was regulated to 5000 inhabitants. Based on several decisions of the Antimonopoly Office of the Slovak Republic against the Slovak Chamber of Pharmacists [17‐19], these restrictions were abolished. The ownership regulation changed in 2004. The revision of the Act on Drugs and medical facilities from 2004 (633/2004) allowed (after fulfilling some specific requirements) any individual or legal entity to own a pharmacy (only pharmacists could own a pharmacy previously). The liberalization of the pharmacy market in 2002 and 2004 led to the entry of new pharmacies thereafter.

Table 4 reports the parameter estimates from the spatial ordered probit model. Population exerts a positive effect on the likelihood of entry across all industries and time periods. Despite the observed variation in the parameter value of \(\alpha\), one would expect an extra consumer to have the same additional value regardless of the number of other patients in the municipality. With this in mind, we constrain \(\alpha\) by dividing all parameters by the estimated value of the population coefficient in order to calculate the break-even population:Changes in competitive pressure due to entry are measured by the ordered probit parameters \(\theta _N\). All values are significant, suggesting that market structure plays an important role in determining profitability.

Based on these estimates, we calculate the entry threshold population (Table 5) and entry threshold ratios (\(s_7/s_N\)) for all occupations (Table 6). The results are summarised in Fig. 2.

In the values reported below, means are used for the variables capturing market characteristics (\(\bar{X}\)) and the spatial weights matrix W is replaced by a zero matrix to mimic the usual assumption of isolated markets.¹³

Our overall results point to very small changes in firm behaviour on the market for physicians and dentists, and significant changes in the pharmacy market. In order to determine to what extent the results are driven by “behavioural effects” rather than changes in external market conditions (such as demand and cost characteristics or changes in the regulatory framework), we implement two counterfactual scenarios. The first generates predictions for the number of entrants using the parameter estimates from each of the three periods, while holding constant the distribution, income level and demographic structure of the population in each market. As such, this analysis shows how much of the change in the equilibrium number of firms was driven by “behavioural effects” as opposed to adjustments in consumer characteristics. The first part of this section details the predicted entry behaviour in each regime.

The second counterfactual scenario focuses instead on the possibility of changing the regulatory framework. Since our data include a period of self-regulation in the pharmacy industry, we explicitly model the restrictions imposed by the Chamber of Pharmacists and predict how the distribution of firms would have been altered by a reduction in the imposed standards. The results from this analysis are summarised in the second part of this section.

The present paper documents the changes in competitive behaviour in markets for professional healthcare services during the transition of Slovakia from a centrally planned to a market economy. An entry model is estimated with a cross section from each stage of the transition (1995, 2001, 2010) to quantify the changes in entry barriers and competitive pressure. The data from 1995 characterise the initial period of transition, which was largely pre-determined by decisions made prior to liberalization. By 2001, the results of the first set of reforms of the sector are visible, especially in those industries where regulation was outsourced from the government to representatives of the profession. The data from 2010 reflect the final outcomes of the transition process.

We find that firm entry became easier during the transition. However, this effect is much smaller than the one estimated for retail industries outside healthcare.¹⁸ By 2010, approximately 1500 inhabitants were required for the first physician to enter a market and around 2500 (3300) inhabitants were necessary in a local market for the first dentist (pharmacist) to break even. The relatively modest change in entry thresholds may reflect the government’s policy of providing medical services in regional centres where they are accessible to the largest possible number of customers, which biases entry behaviour towards very large towns and therefore results in high monopoly thresholds, even in the context of a growing economy.

The effect of entry differs across professions. For physicians and dentists, the effect of entry has changed very little over time. Furthermore, it seems that new entrants do not depress the per-capita profitability of incumbents (or do so very modestly). As such, one would conclude that on these markets differentiation and regulatory intervention alleviate the effects of market structure.

This is not the case in the pharmaceutical industry, where we find very strong effects of market structure in 1995. The data suggest that monopolists made significantly higher profits directly after the beginning of the transition. This effect becomes more pronounced during the period of self-regulation. The estimates for 2001 show that a monopoly position resulted in even higher profitability in this phase. The sharp decline both in entry barriers and in profit differences across market structures by 2010 seems to suggest that the policy reforms (the decisions of the Antimonopoly Office of the Slovak Republic against the Slovak Chamber of Pharmacists) were effective. The removal of entry restrictions and the liberalization of ownership rights led to a reduction in the break-even population, more entry and an intensification of competition. There does not seem to be a large premium on having a monopoly position in a healthcare profession in the modern Slovak economy.

Further research is necessary to determine the precise channels by which these outcomes were influenced. In particular, information on the actual number of patients and the payments which the practitioners received per-capita would make a more in-depth analysis possible. This information would also allow for a more precise market delineation, as it would provide information on the true distribution of consumers.

This analysis would also benefit from an extension which identifies each individual pharmacy and hence analyses not only the equilibrium outcomes but also the entry and exit decisions upon which they are founded. In this context, it may be important to also take into account complementarities across different types of practitioners, as outlined in Schaumans and Verboven [12].