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HHI Fallacy

The Fallacy of Using Herfindahl-Hirschman Index to Understand Markets Part II – A Primer on the Importance of Markets in a Market Economy

We recently released the inaugural SimilarityIndex™|Markets, a mathematical approach to enable analysis of markets based upon user-selected features. The general reaction of industry experts to the study was no more surprising than the response of the hospital lobby to price transparency in 2019. Why do so many experts fundamentally misunderstand the importance of markets in a market economy? 

Oxford Reference defines a “market economy” as:  

“An economy in which a substantial proportion of goods are allocated by the use of markets. This is contrasted with a planned economy, in which most goods are allocated by a centralized decision-making authority. The advantage of a market economy is that prices fixed by markets convey information about the relative demand for various goods and services and the relative costs of providing them. The prices also provide incentives to increase profitable and decrease unprofitable activities. In the absence of market failure the equilibrium of a market economy is Pareto efficient. In practice most economies are based on varying mixtures of markets and government planning.”1

Clearly, the health economy is “based on varying mixtures of markets and government planning.” Setting aside the ways in which health economy stakeholders influence “government planning” through lobbying activities, which we will address in more detail in Part IV of this series, understanding the concept of markets is essential for health economy stakeholders.  

The 19th-century French economist Antoine Augustin Cournot defined a market this way:  

 "Economists understand by the term Market, not any particular market place in which things are bought and sold, but the whole of any region in which buyers and sellers are in such free intercourse with one another that the prices of the same goods tend to equality easily and quickly.”2 

Stakeholders in the health economy sell their products and services to numerous buyers in numerous regions. Because the buyers within those regions, and the regions themselves, vary widely in America, the characteristics of a particular market influence the products and services that buyers need and the price that those buyers can or are willing to pay. 

The U.S. Census Bureau categorizes population centers using the core-based statistical area (CBSA), which the U.S. Office of Management and Budget defines as follows: 

“a statistical geographic entity consisting of the county or counties associated with at least one urbanized area/urban cluster of at least 10,000 population, plus adjacent counties having a high degree of social and economic integration. Metropolitan Statistical Areas (MSAs) and micropolitan statistical areas are the two categories of CBSA (metropolitan areas have populations greater than 50,000; and micropolitan areas have populations between 10,000 and 50,000).”3 

The definition of a CBSA illuminates the fact that markets differ based upon population, which is a key consideration in understanding the number of potential buyers for a product or service, i.e., the total addressable market. The more markets you visit, the more you understand that markets differ in more ways than population, and those differences are ultimately reflected in the quality of a market. A few markets, like New Albany, Ohio are extraordinary; most markets, like Utah’s Wasatch Front, are rather unremarkable; and a few too many markets are distressingly bleak.  

Given the variability in market quality, it is inevitable that certain markets are more likely than others to produce a return on invested capital, especially in a business as capital intensive as healthcare. In turn, it should be self-evident that understanding the relative strength and weakness of a group of markets is foundational to strategic investment. Yet, in the name of “best practices,” health economy stakeholders repeatedly assume that a strategy or tactic that works well in a single market should be deployed in every market, and they are frequently startled when it doesn’t.

Clinical and operational excellence can be applied in any market. Those things being equal, market quality is the sole explanation of differential financial outcomes. According to Fitch, Ascension Health’s AA+ bond rating is “driven by multiple factors, including its strong financial profile assessment, national size and scale with a significant market presence in several key markets that provide it unique credit abilities not typically seen in the sector.”4 Ascension’s presence in those “key markets” results from savvy real estate decisions made by the Daughters of Charity in the 1970s and 1980s. Likewise, HCA’s financial performance benefits from equally strategic real estate decisions made in the 1970s and 1980s. However, unlike Ascension or any other health system, HCA has never stopped managing its portfolio of assets since spinning off Healthtrust in 1987. 

Put simply, the market is everything. Real estate professionals say it this way: “Location, location, location.” Health economy stakeholders say it this way: “Healthcare is local.”  

Even though health economy stakeholders say the right words, they routinely struggle to put those words into action, often invoking imprecise, if trendy, non-healthcare analogs. For example, dozens (hundreds?) of healthcare providers state that they “follow Starbucks” in selecting urgent care sites, without understanding why Starbucks picked that site and which buyers Starbucks is targeting and – most importantly – whether the characteristics of the typical Starbucks customer have any correlation to the buyers of healthcare goods and services in the market.  

In a negative-sum game, the winners will be those who understand what “healthcare is local” means and, as a result, account for the impact of markets, and the difference between markets, in their strategic planning. 

Having established the fundamental importance of the market in a market economy, the essential question for every stakeholder in the health economy is this: how many markets do you serve? The more markets that you serve, the more important a mathematical approach to benchmarking becomes. 

If you serve one market, then you should both benchmark against the competitors in your market and also analyze how stakeholders in markets similar to your market execute against competitors like your competition. Any other benchmarks are largely irrelevant. 

If you serve more than one market, then it is essential to understand your intra-market strength – how well you compete at the individual market level – relative to your intermarket strength, i.e., your relative market strength in each market as compared to all of your markets. In which markets can you win, and what investment is required to do so? In which markets are you likely to lose, and how do you cut your losses? 

As Kenny Rogers sang, “you gotta know when to hold’em, know when to fold’em, know when to walk away, know when to run.” Only with a zealous focus on market quality can any stakeholder in the health economy make rational, data-driven, evidence-based strategic decisions about capital allocation.

[1] https://www.oxfordreference.com/view/10.1093/oi/authority.20110803100135509

[2] Recherches sur les Principes Mathématiques de la Théorie des Richesses, ch. IV, quoted from Principles of Economics by Alfred Marshall, Book V, Chapter 1: https://oll.libertyfund.org/title/marshall-principles-of-economics-8th-ed

[3] https://www.law.cornell.edu/cfr/text/40/58.1

[4] https://www.fitchratings.com/research/us-public-finance/fitch-affirms-ascension-health-idr-bonds-at-aa-outlook-stable-08-10-2021#:~:text=Fitch%20Ratings%20%2D%20Austin%20%2D%2008%20Oct,or%20on%20behalf%20of%20Ascension

 

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