Yesterday I noted that competition is key to driving down prices in health insurance markets. Competition is about expanding the number of suppliers available for a given product. Now let’s think about the demand side. Does reducing the number of purchasers increase or decrease price? One could think that price would fall because buyers would have more leverage. In fact, the economic theory of a monopsony predicts that prices will be lower under monopsony compared to a competitive market but the equilibrium quantity supplied will also be lower. This quantity supplied reduction could be offset somewhat if sellers could take advantage of some economies of scale to reduce their selling costs.
Now consider the case of hospital purchasing drugs. Hospitals may decide to buy drugs on their own or form coalitions or group purchasing collectives to increase their bargaining power and drive down price. In fact, this is what Toulemon (2018) finds when she examines the market for drug purchases by hospitals.
Based on a new database providing the average annual prices paid for all innovative and high‐priced medicines in public hospitals, I use a two‐way fixed effects model that controls for hospitals’ medicine‐specific bargaining power and medicine‐specific price trends. I find that group purchasing slightly reduces the overall prices of medicines but has no impact on the prices of medicines that have no alternative on the market. On the contrary, prices of medicines in oligopoly markets are extensively impacted.
So, in short, are hospital purchasing groups a good thing? In the short run, prices fall. This benefits either hospitals and their owners (either shareholders or the government) and potentially patients (if cost-savings are passed on to patients). However, monopsony theory predicts that supply will fall. This could mean that drug companies will be less likely to supply drugs to group purchasing collectives paying lower prices compared to individual hospitals paying higher prices in the case of a drug shortage. More importantly, is the potential dynamic effect whereby pharmaceutical R&D may decline in response to the lower hospital payments. Thus, the supply of future drugs available to patients may fall. The French hospital market has a relatively small effect on life science firm revenue so the innovation effect may be small, but the effect could be larger if replicated across the globe.
In short, the value to society of hospital group purchasing collectives depends on whether short-run gains in terms of lower prices offset decreased future innovation. Based on monopsony theory, hospital group purchasing is likely to be welfare destroying in the long-run.
- Toulemon, Lea. “The effect of group purchasing on prices hospitals pay for medicines.” Health Economics (2018).