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CHAPTER

UNDERSTANDING MARKET STRUCTURE AND STRATEGY

Learning Objectives

After reading this chapter, you will

• have an overview of the societal environment and its effect on the healthcare market,

• recognize the effect of technology on the demand for and provision of healthcare,

• know the components of an external environmental analysis, • understand the basic concepts of the market structure of an industry, • comprehend the principles of market position as it relates to market

structure and competitors, and • be familiar with two methods of measuring market concentration.

2 Since the Affordable Care Act was signed into law, the American healthcare sector has experienced a frenzy of mergers and acquisitions. Regulators are currently reviewing two proposed mergers that, if approved, would reduce the number of top national health insurers from five to just three gigantic companies. Among hospitals, this trend is even more pronounced and could lead to significant price hikes. . . . Markets where hospitals have a monopoly are exposed to massive price hikes. Hospital prices in monopoly markets are 15.3 percent higher than in markets with four or more hospitals. Hospitals in duopoly markets charge prices that are 6.4 percent higher, and treatment in markets that have a hospital triopoly is 4.8 percent more expensive. . . . There are increasing signs that federal regulators are beginning to worry about the recent wave of hospital mergers.

—Asher Schechter, “The True Price of Reduced Competition in Health Care: Hospital Monopolies Drastically Drive Up Prices,” 2016

Walston, Stephen L.. Strategic Healthcare Management : Planning and Execution, Health Administration Press, 2018. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/westernkentucky/detail.action?docID=5517312. Created from westernkentucky on 2021-09-17 01:59:43.

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A ll organizations operate in an open system that involves continuous interaction with an external environment that directly and indirectly influences their success. The external environment comprises many

components, including communities of people of different ages and cultures; governments and regulatory bodies; and competitive and collaborative indus- tries and companies comprising numerous products, services, and providers. These influences generally fall into one of two categories: (1) societal factors and (2) market factors. The context in which an organization operates heavily influences its strategies and its ability to achieve its mission and vision. Orga- nizations developing a strategic direction must recognize and understand their external environment to be successful.

The Societal Environment

The societal environment encompasses general economic conditions, popula- tion demographics, cultural values, governmental regulations, and technology. Healthcare is highly influenced by these factors. General economic conditions have a significant impact on healthcare. As economic conditions improve, people have more disposable income and insurance coverage, which can be used to obtain healthcare services. In the United States, more than half of health insur- ance policies for persons under age 65 are provided by employers. When the unemployment rate rises, many families lose their insurance coverage along with their jobs. As a result, people cut back on medications, preventive care, and visits to their doctor (Kaiser Family Foundation 2015). For example, the 2008 recession slowed the growth of healthcare spending to the lowest rate in almost 50 years (Hartman et al. 2010).

Population demographics are also important in healthcare. Healthcare spending varies dramatically by age, race, and gender. People older than 65 spend 3.6 times more on healthcare than those between the ages of 19 to 44. (Centers for Medicare & Medicaid Services [CMS] 2016). Across the world, the number of individuals 65 or older is increasing dramatically. There were more than 46 million older adults in the United States in 2014, or 14.5 percent of the population, but this figure is expected to grow to 98 million and 21.7 percent by 2060 (Administration on Aging 2015). Worldwide, 20 percent will be elderly by the middle of the twenty-first century. However, in developed, wealthy countries in Asia and Europe, this number is already much higher. For instance, in 2015, 33 percent of the population in Japan and 28 percent of the population in Germany were older than 60 (United Nations 2015). See exhibit 2.1 for more information.

As people age, they contract chronic conditions that require intensive treatments from acute care providers. In the United States, about half of all

Societal environment The public and socioeconomic factors surrounding and influencing an organization, such as general economic conditions, population demographics, cultural values, governmental regulations, and technology.

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adults and 90 percent of all persons aged 65 or older have at least one chronic condition with more than 22 percent of older people having diabetes (AARP 2017). Chronic diseases are estimated to account for more than 75 percent of US health expenditures (Centers for Disease Control and Prevention 2016a). Spending on healthcare is highly concentrated in specific population groups. Half of the US population accounts for only 3 percent of healthcare costs, while 1 percent spend 20 percent of healthcare expenditures (Schoenman and Chockley 2012).

Racial and ethnic minority groups also tend to use healthcare services differently and experience higher rates of disease. For instance, 12 percent of African Americans have diabetes and 8 percent have had a heart attack. The comparable figures for white people are 7 percent and 4 percent, respectively. African Americans are also 10 times more likely to be diagnosed with AIDS (Ubri and Artiga 2016). Likewise, American Indians suffer from diabetes twice as often as whites do.

Minority groups have less health insurance coverage and often lack a primary care provider; about one-third of Hispanics and American Indians and 20 percent of African Americans are uninsured versus 12.5 percent of whites. Similarly, half of Hispanics and one-fourth of African Americans do not have a regular doctor, compared to one-fifth of whites (Halle, Lewis, and Seshamani 2009). Furthermore, minority populations often express different cultural and lifestyle preferences—such as choice of foods, level of participation in sports,

Source: United Nations. World Population Prospects: The 2010 Revision. Available at: http:// esa.un.org/unpd/wpp.

EXHIBIT 2.1 Young Children and Older People as a Percentage of Global Population: 1950–2050

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use of tobacco, and openness to discussing disease—that affect incidence of illness and rates of healthcare use. An understanding of healthcare utilization differences among segments of the population is critical to evaluating the external environment.

Consumption of healthcare varies by gender as well. Women use 32 percent more healthcare services, including visits to primary care providers, emergency and diagnostic services, and specialty care, than men do (Bertakis et al. 2000; Cylus et al. 2010). The number of females between ages 15 and 44 in the population affects birth rates; however, birth rates also are linked to economic and cultural factors. For instance, some have attributed the declining birth rate in the United States to the 2008 recession, and women are having babies significantly later in life. In 1990, mothers older than age 35 accounted for only 9 percent of all births, whereas in 2008 they accounted for 14 percent (Livingston and Cohn 2010). By 2016, the US national birth rate had dropped to an all-time historic low of 59.8 births per 1,000 women, less than half of its peak of 122.9 in 1957. The average age for a first birth was 26.3 years in 2016, as compared to 24.9 in the year 2000 (Park 2016).

To understand health issues in the external environment, healthcare organizations should identify their customers. Those planning should recognize the significant segments and concentrations and examine the relevant trends. Identifying where patients come from and where they go to for care is vital. Market knowledge helps hospitals understand and improve their competitive position, target their services, and better address community healthcare needs. Data or spatial (geographic) analysis, such as a patient origin study, can be used to locate the communities in which customers reside and provide important information to ensure that residents have appropriate access to healthcare ser- vices (Office of Statewide Health Planning and Development 2016; Ricketts et al. 1997). Exhibits 2.2 and 2.3 provide an example of this type of study. The proportion of patients residing in different zip codes can be determined and graphed to show primary and secondary service areas.

To create a patient origin study, divide the percentage of total admis- sions by zip code and sort them from the highest to the lowest percentages. In exhibit 2.2, the percentages arrayed on the map graphically show where patients originate. The zip codes that encompass 60 percent of total admissions are shaded differently in the second map to denote the organization’s primary service area. As further discussed in chapter 10, populations can be segmented by many other characteristics, such as age, payer type, and race.

In healthcare, the identification of intermediate organizations—those between the patient and the provider—is likewise important. As shown in exhibit 2.4, patients may not have the freedom to select a provider of their choice. Physician practices and managed care contracts may significantly influence or

Patient origin study Data that describe the proportion and number of an organization’s customers (patients) who come from different geographic locations. These data can be arrayed and graphed to display the provider’s primary and secondary service areas.

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direct where a patient goes for care. Organizations should break out use pat- terns by important intermediaries to determine dependencies and trends. Such segmentation will enable an organization to better understand the location and type of customers it serves; both are important factors to consider when crafting strategic actions.

Governmental regulations highly infl uence the healthcare fi eld. Regu- lations require licensure, training, inspection, and approval of physicians and nurses, healthcare institutions, healthcare fi nanciers, drug and medical products, research bodies, and public health agencies. The US healthcare system is one of its most regulated sectors; almost every aspect of it is subject to federal or state scrutiny (Field 2007).

In most developed countries, the government pays for most of health- care; in the United States, the government funds about two-thirds of overall

Source: Reprinted from Ricketts et al. (1997).

EXHIBIT 2.2 Use of Medical Geography and Patient Origin to Determine a Patient Service Area

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healthcare costs (CMS 2015). As a result, governments’ legislation and resultant regulations that almost always influence funding and costs influence the demand for healthcare and the way it is provided. For example, the Patient Protection and Affordable Care Act of 2010 (ACA) significantly affected the healthcare field. The government forecast that the proposed expansion of insurance cov- erage would increase the demand for healthcare products and services while negatively affecting organizations’ profitability and research efforts (Nexon

Zip Code Percentage of

Total Admissions Cumulative Percentage

34237 14.4 14.4

34226 10.9 25.3

34240 7.5 32.8

34227 7.3 40.1

34225 7.1 47.2

34228 6.4 53.6

34229 6.4 60.0

34234 5.9 65.9

34238 5.1 71.0

34218 4.2 75.2

34222 3.5 78.7

34230 3.3 82.0

34224 3.1 85.1

34235 2.5 87.6

34221 2.2 89.8

34219 1.9 91.7

34232 1.8 93.5

34233 1.8 95.3

34241 1.5 96.8

34236 1.1 97.9

34231 0.9 98.8

34220 0.7 99.5

34239 0.2 99.7

34223 0.2 99.9

EXHIBIT 2.3 Percentage of Hospital

Admissions by Zip Code

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and Ubi 2010). Likewise, Donald Trump’s repeal of the ACA will alter the governmental rules and regulations on which US healthcare is organized to drastically alter Medicare, Medicaid, and private insurance (Wasik 2016).

Technology also has a significant influence on healthcare. Advances in technology, including prescription drugs, have been identified as a leading contributor to the increase in overall healthcare spending. Medical technol- ogy is broadly defined as the procedures, equipment, and processes used to deliver medical care. Examples are new medical and surgical procedures, such as implantation of cardiac defibrillators; new drugs; new medical devices; and new support systems. New technology can profoundly change the nature and process of care, which in turn may significantly influence organizations’ strate- gies. Advances in cardiovascular treatment have reduced the rate of death from heart attack by almost half. Declining cardiovascular disease, although wonderful for the public, has a major impact on the number and type of providers required to care for this population. Similarly, the use of cardiac stents appears to have significantly reduced the number of coronary bypass surgeries performed in the United States—decreasing patient volume for surgeons but placing greater demand on cardiologists (Cayton et al. 2012). As shown in exhibit 2.5, new technology will continue to alter the provision of healthcare radically.

Market Structure

Organizations exist in markets—places, systems, and processes through which goods and services are exchanged. A basic knowledge of the concept of market structure is important. To understand the principles of market structure, one first should learn the difference between industries and markets. An industry is a particular category of business or economic activities. It is composed of groups of sellers whose products are close substitutes. For example, there is a pharmaceutical industry, a computer industry, and an aviation industry.

Medical technology The procedures, equipment, and processes used to deliver medical care.

Markets Places, systems, and processes through which buyers and sellers exchange goods and services.

Industry A particular category of business or economic activity; an aggregation of sellers whose products are close substitutes.

$ $

Patients

Providers

Insurance Companies

Businesses Buy insurance

Pay deductible/coinsurance

Choose providers and give payment

Provide set of benefits and network

EXHIBIT 2.4 Intermediaries to Patients

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However, no hard boundaries distinguish the industry in which a busi- ness belongs. For instance, one could argue that home health services should be considered distinct from the pharmaceutical drug and the nursing home sectors because they are not direct substitutes and complement, rather than compete with, each other. Yet in some situations they are substitutes; for example, drugs may reduce the demand for other healthcare services. Therefore, home health, prescription drugs, and nursing homes could be subsumed in a global industry that includes all aspects of healthcare.

The boundaries of nonhealthcare industries are similarly difficult to define, especially as technologies advance and competition changes. For instance, Nokia and Blackberry dominated the cell phone industry in the first decade of the twenty-first century, when simple texts and e-mail complemented phone services. With the advent of the iPhone (Apple), competition over apps ensued and the cell phone industry expanded. Today, the phone industry offers such features as cameras, global positioning systems, movie players, data storage, maps, and games in addition to voice and text transmission.

Healthcare technologies are advancing radically and will have far-reaching implications “in terms of diagnostics, treatments, and delivery of care in the future.” Some of the major technologies predicted to disrupt healthcare by the year 2020 include the following:

• Artificial intelligence (AI). “By 2020, chronic conditions, such as cancer and diabetes, are expected to be diagnosed in minutes using cognitive systems that provide real-time 3D images by identifying typical physi- ological characteristics in the scans. By 2025, AI systems are expected to be implemented in 90% of the U.S. and 60% of the global hospitals and insurance companies.”

• Immunotherapies in cancer care. “The market for check point inhibitors was valued at $3 billion in 2015 and is expected to reach $21.1 billion by 2020.”

• Liquid biopsy. This innovation will noninvasively monitor for cancer cells, eliminating the need for physical biopsies.

• CRISPR gene editing. This technology will make targeted modifications to DNA. “It holds the promise of transforming the way R&D is conducted and products are developed across major sectors of the global life science economy.”

• 3-D printing. Medical practitioners will create customized “3D-printed scaffolds or prosthetics (orthopedic implants) and medical devices, such as dental implants and hearing aids. The game changer for 3D printing will be in human tissue printing: printed livers, hearts, ears, hands and eyes, or building the smallest functional units of tissues, which can lead to the fabrication of large tissues and organs.”

EXHIBIT 2.5 Advancing

Technology, Improving

Healthcare

Source: Das (2016).

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In markets, services and goods may be exchanged for other products and services (barter) or, more commonly, for money. Retail markets may be physical (e.g., shopping centers, malls) or electronic (e.g., eBay). People also sell their labor to companies. Stock markets exchange company shares. Illegal markets for illicit drugs and other unlawful products also exist. An established market facilitates trade by establishing rules and expectations to regulate dis- tribution and pricing.

The number, concentration, and relative strength of organizations in an industry compose its market structure, and the market structure exerts a strategic influence on the intensity and form of competition in the industry. As a result, organizations vary their strategies according to the structure of the market in which they exist. Organizations most often seek market power—the ability to influence prices by exercising control over supply and demand—which is directly related to their market’s structure and their relative position in that market (Hitt, Ireland, and Hoskisson 2016).

There are four basic types of market structure, each of which reflects the number of organizations in the market and their degree of market influence:

1. Perfect competition 2. Monopolistic competition 3. Oligopoly 4. Monopoly

Exhibit 2.6 graphically displays the four market types and their rela- tionship to the number of competitors and competitors’ degree of market influence. Markets’ structure rarely adheres strictly to one of the types but rather exhibits characteristics of the types to differing degrees. For example,

Market structure The organizational characteristics of a market that exert a strategic influence on the intensity and form of competition.

Perfect Competition

Monopolistic Competition

Oligopoly

Monopoly

Degree of Market Influence

Number of Competitors

Total

One

None

Many

EXHIBIT 2.6 Market Structure by Degree of Control and Number of Competitors

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true perfect competition rarely exists, but some markets more closely resemble this structure than others do. Likewise, few markets are true monopolies; rather, they approach a monopolistic structure. The market for Microsoft’s main products is one example of a near monopoly, with almost 90 percent of the operating system market in 2016. Android’s dominant 80 percent global market share of smartphones is another (Dans 2016; Hruska 2016). In some states the health insurance market approaches monopolies in the individual healthcare insurance market, with about 90 percent controlled by one insurer in Alabama, New Hampshire, Vermont, and Rhode Island and approximately 80 percent in Arkansas, Maryland, North Carolina, and North Dakota (Kaiser Family Foundation 2014b).

Perfect Competition Exhibit 2.7 identifies characteristic differences among the market types. The first type, perfect competition, exists when many small organizations produce an undifferentiated, homogeneous product. Consumers may struggle to differenti- ate the products in such markets, so organizations compete on the basis of price and seek low-cost production solutions. There are few barriers or impediments to entering the market, so new competitors move in and incumbents move out frequently. In ideal perfect competition, consumers have enough information to make informed choices, and the prices they pay are close to production costs. Gasoline, generic drugs, currency markets, and agricultural commodities (e.g., wheat, rice, corn) are examples of markets that closely approach perfect competition. Because consumers often fail to distinguish companies’ products in such markets, price often drives consumers’ purchasing decisions. Therefore, low cost is the primary strategic focus in perfect competition.

Monopolistic Competition Similar to perfect competition, monopolistic competition is a market involving many organizations. However, this structural type differentiates its products, so differentiation is the organizations’ strategic focus; they seek to distinguish their products from competitors. Differentiation can be achieved by offering products with better or exclusive features, enhancing service, employing more helpful and friendly personnel, boosting distribution channel performance, creating attractive packaging, raising product quality, changing location, or improving the organization’s image (McGuigan, Moyer, and Harris 2017). Many products are available to consumers, and competition increases as products and their perceived quality become more diversified. Competition is typically vigorous in monopolistic competition. However, each organization, depending on its degree of differentiation, has some control over the prices of its products. Organizations with greater product differentiation have more power to raise prices over those of their competitors.

Perfect competition One of the four basic types of market structure. Perfect competition exists in markets composed of many small organizations that produce an undifferentiated, homogeneous product.

Monopolistic competition One of the four basic types of market structure. Monopolistic competition exists in markets composed of many organizations offering differentiated products.

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Entry into and exit from monopolistic competition is easy. Restaurants, manufacturers of breakfast cereals, and most private physician services in the United States operate in monopolistic competition structures. In the case of private physician services, for instance, physicians differentiate themselves by office location, specialization, and personal relationships with their patients. Because of these and other factors, price generally is not a major consideration when people are choosing physicians (Walston and Chou 2012).

Oligopoly Oligopolies are market structures dominated by a few large organizations that offer similar or identical products. Organizations in oligopolies focus their strategies on capturing market share, unless they can collude to increase profits by fixing prices or reducing supplies. A global example of collusion by organizations in an oligopoly is the formation of the Organization of Petro- leum Exporting Countries (OPEC). In 1960, the large oil producers banded together to restrict the supply and raise the price of oil (Said 2015). Laws exist in many countries to prevent such anticompetitive behaviors (Hawk 2010).

Organizations seeking to enter or exit an oligopoly face substantial bar- riers. The cost of entry is often great, and the specialized nature of business in oligopolies makes leaving difficult. Consumers have limited choices because the producers of a product or service are limited in number, and buyers often choose services or products on the basis of location or personal preference. For instance, the construction of a new tertiary hospital may cost millions of dollars, require multiple permits, change referral patterns, and necessitate hiring a medical staff. Therefore, generally speaking, few tertiary hospitals compete in a market. Patients have limited choices for tertiary care. They may choose the tertiary hospital closest to their home, referred by their insurance company, or preferred by their personal physician. Examples of oligopolies in healthcare include tertiary hospitals, healthcare insurance companies, drug companies, and group purchasing organizations. Nonhealthcare oligopolies include airline, steel, aluminum, automobile, oil, tire, and beer companies.

Monopoly A monopoly, on the other hand, involves just one organization. As a result, the monopolist has the power to control the type and quality of products and services provided. Competition is almost nonexistent, so the monopolist spends much of its time and strategic efforts creating and maintaining barriers to keep potential competitors out of its market. The service customers receive is often expensive and of marginal or poor quality. For example, as stated in the introduction to this chapter, hospital markets with monopolies charge more than 15 percent more than markets that have 4 or more hospitals.

Oligopoly One of the four basic types of market structure. Oligopolies exist in markets dominated by a few large organizations that offer similar or identical products.

Monopoly One of the four basic types of market structure. Monopolies exist in markets that are dominated by a single organization.

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Another example of monopolistic pricing in the United States is the high cost of pharmaceuticals allowed by the so-called monopoly rights given indi- vidual prescription drugs by governmental agencies. The monopoly and other factors make the US per capita spending on prescription drugs more than twice what other developed countries spend ($858 vs. $400) (Kesselheim, Avorn, and Sarpatwari 2016). Drug companies have greater ability to raise costs, with prices increasing at a rate eight times that of inflation. Patients with chronic diseases can spend more than $11,000 per year on prescription drugs. This situation sometimes results in clearly abusive business strategies—for example, when the cost of Daraprim, used to treat serious parasite infections, was raised 5,000 percent in 2015 (Tuttle 2016). Prices appear higher in monopolistic conditions in other healthcare sectors as well. Other examples of monopolies include utility companies, and the National Football League.

Because of the influence concentrated markets (monopolies and oligopo- lies) have on price and supply, the US government has passed antitrust laws and formed agencies such as the Federal Trade Commission (FTC) to restrict anticompetitive behavior and curb potential predation. (For more information, see the FTC’s website at www.ftc.gov/tips-advice/competition-guidance/ industry-guidance/health-care.)

Measuring Market Structure

A common measure of market concentration is the Herfindahl-Hirschman Index (HHI). Federal regulatory agencies examine the HHIs in markets where mergers and acquisitions are proposed. If a market is highly concentrated, the government may deny the merger or acquisition or apply restrictions.

The HHI is calculated by squaring the market share percentage of each organization in a market and then summing the numbers:

MS MS MS MSHHI i

2 2 2 2 Σ( ) ( ) ( ) ( )= + + +

For example, if a market included six organizations—one with 50 percent market share, two with 20 percent, one with 6 percent, and two with 2 percent—the HHI would be calculated as follows:

HHI = (0.50)2 + (0.20)2 + (0.20)2 + (0.06)2 + (0.02)2 + (0.02)2 = 0.25 + 0.04 + 0.04 + 0.0036 + 0.0004 +0.0004 = 0.3344.

The HHI approaches zero when many organizations of relatively small size compose a market. Conversely, the HHI for a monopoly is 1.0. The US

Herfindahl- Hirschman Index (HHI) A measure of market concentration calculated by squaring the market share percentage of each organization in a market and then summing the numbers.

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government multiplies this number by 10,000, which changes the range from 0 (perfect competition) to 10,000 (monopoly). Using the latter conversion, the guidelines of the US Department of Justice states that HHIs lower than 1,000 denote unconcentrated markets; HHIs between 1,000 and 1,800 denote moderately concentrated markets; and HHIs higher than 1,800 identify mar- kets that are highly concentrated and promote negative market behaviors (US Department of Justice 1997). On the basis of this index, the example in the previous paragraph would be considered a highly concentrated market (3,344).

The HHI examines organizations’ market share only for a common product or service at only one point in time, so its usefulness is limited. Orga- nizations may offer multiple products and services in distinct market areas. Likewise, technology and market share may shift radically over time, rendering point-in-time HHI analysis almost meaningless.

Markets in healthcare tend to be highly concentrated. Most urban hos- pital and healthcare insurance markets are oligopolies with HHIs greater than 4,000 (Luke, Walston, and Plummer 2004). Healthcare providers have often effectively implemented strategies to increase their market share and gain greater negotiating power to increase the prices paid by consumers and health insurance companies. Some believe that current legislative efforts to promote integrated care through accountable care organizations could lead to even greater market concentration in healthcare (Berenson, Ginsburg, and Kemper 2010).

A simpler, less sophisticated measure of market concentration is the four-firm concentration ratio (FFCR). The FFCR is calculated by adding the market shares of the four largest organizations in a market to find their cumulative total output:

FFCR Firm Firm Firm Firm i 1

1 2 3 4Σ ( )( ) ( ) ( )= + + + =

For example, the FFCR for the six-organization market used earlier in the HHI calculation would be

FFCR = (0.50) + (0.20) + (0.20) + (0.06) = 0.96, or 96 percent.

A market with a four-firm ratio of 40 percent or less is considered unconcentrated, while markets with ratios greater than 90 percent are highly concentrated. Urban hospital markets and health insurers tend to be highly concentrated; urban hospital markets typically have FFCRs greater than 90 percent, and state insurance markets are generally dominated by one or two large insurance carriers (Cutler and Morton 2013; Furnas and Buckwalter- Poza 2010; Luke, Walston, and Plummer 2004). On the other hand, the top

Four-firm concentration ratio A measure of market concentration calculated by summing the market shares of the four largest firms in a market.

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ten world pharmaceutical companies controlled only about 30 percent of the global pharmaceutical drug market in 2015 (Dezzani 2016).

The four-firm ratio does have drawbacks. The four-firm ratio’s main limitation is that it considers only the four largest organizations in a market. Urban markets often include far more than four organizations.

Product Life Cycle

Markets also tend to go through cyclical changes. Most products and services go through phases or a life cycle that relates to the rate of sales, number of organiza- tions in the market, and consumer demand. For decades managers and business researchers have seen the product life cycle as a useful framework for analyzing dynamic market conditions and applying more relevant, appropriate strategic alternatives (Day 1981). As shown in exhibit 2.8, it is typically depicted as four stages: emerging, growth, maturity, and decline. Product sales follow an S curve: They begin slowly in the emerging stage, rise precipitously in the growth period, flatten during the maturity stage, and decrease throughout the decline phase.

Emerging markets can be a difficult environment for organizational growth. Sales in emerging markets are limited because customers often lack adequate product knowledge and must be induced to try the merchandise.

S al

es /M

ar ke

t D

em an

E m

er g

in g

G ro

w th

M at

u ri

D ec

li n

Time

EXHIBIT 2.8 The Product Life Cycle

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Few standards exist, and product quality can vary dramatically, further con- fusing potential buyers. The few companies initially present in an emerging market spend significant monies on research, advertising, and marketing. As a consequence, the sale of products in emerging markets produces little profit, and companies face a substantial risk of product failure.

Entry into emerging markets can be strategically important. Organiza- tions in emerging markets anticipate the ultimate market structure and position themselves accordingly. Strategic risks are high in emerging markets, but—if the organization can find the correct strategic position—so is the potential for great rewards. Innovative organizations may participate in many emerging markets simultaneously, hoping for big returns in at least some of their ventures. One example is the company Google. Its top-secret laboratory, X, formally Google X, is pursuing “shoot-for-the-stars ideas,” including drone delivery service and driverless cars (Dougherty 2016).

During the next stage—growth—sales increase rapidly. Overall, this stage is the best time for an organization to enter a new market. Competi- tion is relatively low, customers are more forgiving, and businesses can obtain greater profits (Porter 1985). As more products sell, standards are set, cus- tomer acceptance increases, and the average cost of products drops because of economies of scale. At the same time, more competitors enter the market, eventually instigating greater price rivalry.

Rapid growth slows at some point, however, and a product enters the maturity stage. In this stage of market saturation, many organizations may consolidate and merge as profits decrease because of price competition and flat sales. Organizations increasingly compete for market share by differentiat- ing their products and discounting their prices. Cost management becomes a critical competency, especially at the end of the maturity stage.

Ultimately, the demand for a product decreases because of changing consumer preferences, technological obsolescence, or availability of more effective substitutes. Many popular products have disappeared and faded into obscurity as the demand for them diminished. For example, the Sony Walkman, pagers, the PalmPilot, videocassette recorders, answering machines, and Atari game systems all were prominent products in the past. As consumers modi- fied their preferences and technologies advanced, each product vanished and was supplanted by more effective substitutes (Grobart and Austen 2012). As demand drops, overcapacity leads organizations to exit the market or merge, leaving a smaller number of competitors. Again, cost and price competition dominate strategies in the decline stage.

The product life cycle, although helpful in strategic thinking, has some limitations as a framework for analysis. The S curve is not necessarily a sequential function. Some products skip stages or move back to a previous stage when new markets arise, new uses for the products are discovered, or technology advances.

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In addition, the duration of each stage and of the transition to another stage is unpredictable. Fad products might grow rapidly, while durable products may experience extended, slow growth. For instance, the sales of Procter & Gamble’s laundry detergent Tide grew consistently from its introduction in 1947 through 1976. Over that period, the company modified the formula 55 times to better match consumer preferences (Day 1981). On the other hand, product life cycles are extremely short in the semiconductor, computer, and telecommunication industries today as a result of constantly changing tech- nologies and consumer demand (Goktan and Miles 2011).

Chapter Summary

The external environment of all organizations profoundly affects their ability to operate and prosper. An understanding of the context in which one operates is critical to strategic planning and strategic thinking.

The external environment consists of consumers, suppliers, buyers, competitors, and regulators. The powers and pressures emanating from these sources influence the strategic choices that organizations need to make. These components can be categorized as societal factors or market factors. The societal environment comprises general economic conditions, population demograph- ics, cultural values, governmental regulations, and technology. Market factors include the number of organizations in a market and their degree of market influence. Common market structures include perfect competition, monopolistic competition, oligopoly, and monopoly. Oligopolies exist in many healthcare markets. The degree of market concentration can be determined by calculating the Herfindahl-Hirschman Index or the four-firm concentration ratio.

The product life cycle also is useful for analyzing markets. It identifies the stages through which products progress and illustrates the effects that changes in technology, markets, and consumer demand have on product growth.

Chapter Questions

1. How does a change in population demographics alter the use of healthcare?

2. Which components of population demographics have the most significant impact on healthcare?

3. What is a patient origin study, and how can it inform strategic thinking?

4. Which of the four market structures would be most preferable to consumers? To organizations’ owners? To governments? Why?

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5. What intermediaries exist between patients and their providers in the United States? What purpose do they serve?

6. How have technological advancements changed the provision of healthcare, and how might they affect healthcare in the future?

7. What are some of the exchanges that occur in the healthcare market? 8. What is the major difference between perfect competition and

monopolistic competition? 9. Why do so many oligopolies exist in healthcare?

10. What are the main barriers to entering the healthcare market? Do they vary by type of organization? How?

11. What are two measures of market concentration? Why might one be preferred over the other?

12. How might healthcare services pass through the product life cycle? How do the size and number of organizations in a market affect the product life cycle?

13. What must a firm do to succeed in the declining product market stage? 14. How should the strategic actions of an organization whose product is

in an emerging market stage differ from those of an organization whose product is in the mature stage?

Chapter Cases

Case Studies Either “The Struggle of a Safety Net Hospital” or “The Battle in Boise,” both found in the case studies section at the back of this book, can be used to explore concepts in this chapter.

Herman and Market Structures Herman has been working in healthcare administration for ten years. He has finally taken a health strategy course and learned about different market structures. He wondered why different segments of healthcare respond dif- ferently in negotiations. One of his responsibilities is negotiating with physi- cians, insurance companies, and hospitals in his company’s managed care unit. He has found that his ability to exact price concessions from different groups varies dramatically. Primary care physicians’ market structure is a monopolistic competition, while prominent hospitals seem to hold monopoly power. Insurance markets, on the other hand, often are oligopolies. He now believes that the introduction of national quality standards for primary care physicians may make outcomes among physician offices easier to compare

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Chapter Assignments

Identify the market shares for general acute care services, by organization, in a city of your choosing. Determine the HHI and the four-firm concentration ratio for this area. How much monopoly power exists in this market? Would the index vary significantly if you calculated it for a specialty, such as obstetrics or cardiovascular surgery? What if you expanded the area under evaluation to a larger region or state? How would the index change?

Write a one-page paper on the problems of monopolistic power in healthcare. How might the proposed changes in the ACA affect the market power of healthcare providers? What can the government and other stakehold- ers do to moderate monopoly power?

and thus reduce their differentiation. As a result, he may be able to gain greater price concessions from physicians in the future. Often, however, he almost has to beg prominent hospitals to join his system’s network, and in turn he pays full prices. In insurance markets of only three or four major companies, each organization seems to offer the same terms. Herman thinks he now understands better what is happening with each group.

Questions 1. How are Herman’s perceptions regarding his negotiations and

market structure correct? Incorrect? 2. How would specialist physicians fit into the market structure, and

how would Herman negotiate with them? 3. Could perfect competition exist in healthcare? How would one

negotiate in this type of market?

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