Is Managed Care Leading to Consolidation in Health-care Markets?

There has recently been substantial consolidation among health-care providers in the United States. In 1980, most hospitals were freestanding, independent organizations. By 1996, 40 percent of all community hospitals were members of a system and 26 percent were members of networks (American Hospital Association 1998). In the mid-1980s, more than 40 percent of all physicians were in solo practice. By 1997, that figure had fallen to 26 percent (American Medical Association 1999). Most physicians now work in settings with several physicians, such as group practices, hospitals, or clinics. It is tempting to suppose that this consolidation is the direct result of the growth of managed care. The two have certainly occurred at the same time. Whereas managed care in 1980 was largely limited to a few staff and group model Health Maintenance Organizations (HMOs) scattered around the nation, today nearly two hundred million Americans are enrolled in Managed Care Organizations (MCOs) spanning a wide range of organizational forms including HMOs, Preferred Provider Organizations (PPOs), and Point of Service plans (POSs) (Aventis 2000). There are two strong reasons to believe that the growth of managed care might cause providers to consolidate. First, managed care rewards efficiency, and providers might achieve economies of scale and scope through merger. Second, in the face of selective contracting by MCOs, providers may consolidate to improve their bargaining power and opportunities to secure contracts at favorable rates. Despite these considerations, it is hardly a prima facie case that managed care is the cause of consolidation; several other changes in the health-care economy might have led to it. The Medicare Prospective Payment System (PPS) rewards hospitals for efficiency, and may have also promoted mergers. At the same time, changes in treatment and management technology, such as advances in diagnostic techniques, and the introduction of computerized information systems, have led to new sources of scale economies that might also encourage mergers. We take advantage of substantial cross-section variation in managed-care penetration to explore the effects of managed-care penetration on consolidation. In this way, our empirical strategy is similar to that used in a handful of other studies linking managed care to the organization of provider markets. For example, Baker and Brown (1999) and Spetz and Baker (1997) link managed care to increased concentration in the provision of mammograms and neonatal intensive care. Chernew (1995) finds that a 10 percent increase in HMO market share results in a 4 percent reduction in the number of hospitals and a 5 percent reduction in beds over the period from 1982 through 1987. Chernew does not explicitly address concentration, but his results are suggestive. This study extends the prior literature in several ways. First, we examine physician markets as well as hospital markets. Second, we account for hospital system membership and examine a longer time series than previous studies. Third, we consider the impact of all forms of managed care, including PPOs and POSs, not just HMOs. Finally, we control for the endogeneity of managed- care. Our results strongly support the initial supposition: Managed care is associated with a substantial increase in concentration in hospital markets and a sharp decline in the number of solo physician practices. In fact, managed-care growth appears to explain essentially all the observed increase in hospital consolidation, as well as the shift away from solo physician practice. The rest of this article: (1) discusses major features of managed care and presents our hypotheses; (2) explains data and methods (because managed care penetration is potentially endogenous, we adopt a two-stage estimation process); (3) reports our results as described above; and, (4) explores possible implications of our findings for market performance and public policy and discuss areas for future research.