What is the Theory of Industrial Organization? Industrial economics is defined as the study of sufficiently large-scale economic activities, regardless of the type of activity and especially the analysis of imperfect markets.
In this context, industrial organization is a field or area of knowledge of business theory that deals with production systems and the relationship and limits between company structures and the markets in which they operate. It could be defined as the part of the economy that studies how producers organize in markets.
The Austrian school, represented by Schumpeter's thinking, maintains that the economy is a process not a state, and that the relevant variables are not prices and quantities, but the rate of introduction of new products, the improvement of production processes, etc. Therefore, it is a process of creative destruction, in which new companies with new products, or new production methods, replace and bankrupt the old ones, gaining a dominant position in the market. In this way, expectations of reaching a dominant position in terms of market share or market share serve as an incentive for companies to improve
Within this, the Theory of Industrial Organization established by Bain in 1968 from the systematization of contributions made by numerous authors, is based on the study of the functioning and performance of imperfectly competitive markets, and the behavior of the companies that make them up as subjects. study. Basically, he is interested in antitrust policy and the rules and regulations dedicated to promoting it. For its analysis, the industrial organizational model is interpreted from the paradigm known as Structure-Behavior-Results (ECR).This is nothing more than a special market analysis scheme, which incorporates its configuration, the behavior adopted by the companies that constitute it allows a systematization and articulation of the various relevant aspects that occur in a certain industrial production structure, expressed by a series of indicators that measure the performance or results of a particular market. All these aspects, linked to each other, are a function of a number of exogenous conditioning factors to its dynamics.
Such a functional evaluation scheme is a basic element to understand the logic of the markets and the associated behavior of the companies that make it up. In the specific field of the healthcare market, this ECR model can be applied to investigate the relationships in the production structure of each subsector (medicines, technology, human resources, and insurers and providers) and among themselves, and the final results obtained by each corresponding subsector. regarding their relative participation in said market.
Figure 1 shows the necessary conditions to establish Market Power, which has to do with its concentration level, relative R&D capacity of each component. Dominant position that a particular company can acquire, the level of static and dynamic efficiency, the market share available to each member and the number of competitors
Determinants of market power
According to the ECR paradigm applied to the health field, it should initially start from the study of the variables that make up the structure of the health care market or health care: number of "buyers" and "sellers" as demand and supply, degree of differentiation of the products analyzed, barriers to entry, level and complexity of the technology used and degree of vertical integration. These structural characteristics oblige companies present in a particular sector (pharmaceutical industry case) to develop a specific competitive behavior (in this case on certain therapeutic bands or specific molecules) that ultimately affects their profit rate through your sales volume.
The analysis of the ECR paradigm has been little applied to the health sector as it is a sector with a large number of production units (companies, hospitals, health centers, insurers) and relative levels of concentration according to the analyzed sub-market. Although, if it has been used from the point of view of competition between companies that produce certain final products, such as drugs and technology or services (insurance companies or prepaid medicine companies), analyzing mainly horizontal competition problems and devoting little attention to vertical integration problems.
This paradigm, in the industrial field, evolved towards the so-called New Industrial Organization, a model where a long-considered debate between two positions has taken hold:
- The Efficiency Approach: considers that the structure of a certain market is modified from a business conduct that appears to be guided by technical and economic efficiency. To justify this, recourse is made to the minimization of production costs, the economy of scale and the reduction of transaction costs. The repercussions that efficiency establishes on each analyzed sector structure are assumed assuming the existence of passive adaptation behavior by companies. Strategic Behavior Approach: the reference point resides in the productive agents as active decision makers, who deliberately try to influence the structure of the sector with their behavior. This behavior includes in some markets issues of information asymmetry, monopoly and oligopoly due to collusion, product differentiation and associated niche, among others. The purpose is to increase the relative imperfection of the market, which allows them to obtain greater power from the appropriation of a certain market share and thereby obtain extraordinary income.
In both cases, the behaviors go beyond the classic integrated one-way ECR trilogy, recognizing the distorting effects that the behavior of companies can have on the particular structure of the market being analyzed, and considering the paradigm as bidirectional (the Results provoke modifications of the Structure).
The components that make up the ECR paradigm are
- Structure: Dynamic and static aspects: number and relative size of companies, degree of concentration, degree of product differentiation, available technology, cost structure, vertical integration and entry conditions. Conduct: Competitive behavior in prices, advertising and marketing, degree of research and development. Results or Performance: Static and dynamic efficiency level: distribution of the surplus between consumers and producers, economic profit rate, market share reached and rate of introduction of new innovative products. Exogenous conditions: Determinants of demand, level of technology and regulatory policies
The existence of companies that have to do with health has always shown particular characteristics according to different approaches, whether they belong to the input industry, to the medical-industrial complex itself, to the dynamics of the insurers-financiers and to the supply and demand within the human resources submarket.
- From an organizational perspective: there is a growing need for greater integration to the starting point of a highly complex and imperfect market, with high levels of division of labor, information asymmetry, externalities and specific goods such as drugs, technology and medical supplies From a behavioral approach: given the uncertainty and risk associated with health, health care activities from the economic point of view assume and manage risk from professionals who act as discriminating monopolists whose actions are related by various mechanisms to income either by production or by salary. From a technological approach: companies seek to achieve greater efficiency through generating economies of scale, through the best use of certain productive factors.
In the Industrial Organization, the size of the companies is a key structural variable related to the degree of market concentration. And also its dominant position. One of the problems that the health sector has, based on its particular regulations, is the presence of artificial monopolies or oligopolies due to collusion that face the oligopsony of funders grouped in chambers or associative entities, or due to the condition of quasi insurers. public or private.
The Paradigm Structure - Conduct - Results
The first part of the ECR analysis tries to determine the importance of the different establishments or companies of an industry or sector, classified according to their size, in two or more instants in time. This level of importance is measured in the percentage of the sales / production volume of each company with respect to the total of the specific market. If a certain company has increased its share or market share or if certain companies have associated their share increased, we could be facing artificial monopolistic or oligopolistic positions. However, this can also derive from the evolution that the company may have had in a period considered due to its technological progress, technical efficiency, price dynamics, etc.The works carried out from the theory of industrial organization allow us to understand the existence of other factors, in addition to the decisions of the companies and the equalization of their cost and income functions that influence the performance of profitability. Among these factors, the market itself, its structure, regulations, imperfections and characteristics of each sector analyzed must be considered.
One of the problems that the ECR paradigm tries to objectify is the presence of monopolies or oligopolies due to collusion of interests. Monopolies in the healthcare market appear fundamentally linked to certain specific activities, such as the use of a certain technology, the dominant position in a healthcare market niche or the possession of protection over a certain product or process (in the case of the pharmaceutical industry) where the Patent acts as a barrier to competitiveness.
In the latter case, it is assumed that the monopolist produces and markets only one product.for a certain therapeutic band - for example, the case of sofosbuvir for the treatment of Viral Hepatitis C - protected by a patent on intellectual property that prohibits copying by third parties - unless approved by the owner - and whose price is uniform (same price for all consumers and for all product units) regardless of their cost of production and final profitability. The demand curve for this good (the medicine) has a markedly negative slope, the patient is captive of the product through the indication of the other discriminating monopolist (the doctor), the marginal cost is not negative and with this the original monopolist maximizes benefits depending on the sales volume you get.
In the construction of market power, as in the case mentioned, it is appropriate to consider the First Fundamental Theorem of the Welfare Economy: If such power does not exist, (along with other conditions), the equilibrium solution is efficient, so there would be no need for state intervention (except that aimed at obtaining a better distribution of the good, without exclusions for reasons of price / income.
The ability of a company to move the market price of a good with its production or sale decisions established by some condition (patent), is called market power, which it achieves through monopolistic status. At that point the company faces all the market demand, knowing that the variation in the quantity consumed also varies the price. Market power consists of the decision-making capacity of a company regarding the price at which it sells or buys. This depends directly on the production cost structure and the price elasticity of demand. It is also defined in economics as the ability of companies to set sales prices above the cost of production of each last unit (marginal cost)
Consequently, market power results from shifting the equilibrium point in perfect competition E c to the new equilibrium point in a situation of market power E m. In this way, in the area originally A, given the transition from E ca to E m, a transfer of resources occurs to other sectors of the economy but especially to area B, which results from the transfer of consumers (patients) to the company with market power. Finally, area C is the result of the decrease in the surplus of the consumed in an equilibrium situation that is not compensated by any gain from the other economic sectors. (Figure 2)
Consequences of Market Power
This area C is the value of inefficiency in the allocation of resources, a space where those responsible for the monopoly company have less incentive to minimize costs. Having a monopoly position is advantageous because companies can use sometimes not directly productive resources to achieve them. Potential monopolists will always be ready to take refuge in regulatory issues (patents) to get that place whenever it brings them an extraordinary benefit. This is the case of a drug whose monopoly position gives it sales of over a trillion dollars, thereby transforming it into a blockbuster that in turn ensures market dominance for the term of the patent.
The problems of dynamic efficiency linked to the conduct of the company occur in intensive R&D sectors, where they spend their own resources on researching new products or processes with the expectation of achieving greater benefits in the future (extraordinary income), normally associated with achieving greater market power (or a specific niche). In this case, market power is not only a necessary but a desirable evil.
Oligopolies and collusion. Artificial distortions
The Oligopoly is a market structure in which the decision made by each company affects the market price and therefore the benefits of the others. There is interdependence between the actions of sellers or strategic interdependence. When making their decisions, companies take into account not only the current market situation, but also the foreseeable reaction of their rivals to their own decision. It is a strategic behavior based on placing a barrier to entry to the competition. Stigler defines entry barriers as any cost that an incoming company willing to compete has to face, which is not incurred or incurred by established companies and which allows them to have extraordinary profits in the long term.
Collusion between firms is recognized as one of the most damaging practices for free competition, introducing artificial barriers that increase the market power of the participating firms and causing a loss of well-being for both suppliers and consumers. Collusion is understood to be that a group of firms in an industry coordinate their prices and / or quantities, in order to raise prices and thus obtain higher profits. The association of firms that sign up to an agreement of this nature is called a cartel.
Two types of collusion are generally recognized: explicit and tacit. Explicit collusion occurs when firms communicate directly and share information that enables them to sustain their agreement. Tacit collusionIt results from coordination without direct communication between those involved. It occurs when a less competitive result is understood as beneficial given the possible participants, and the leading price firm gives common signals using valid and legal market instruments that do not necessarily involve direct communication with its competition. Once a collusive agreement is established, the survival of the cartel is only assured if the incentives of each firm to deviate from the agreement are not high enough, compared to the profits they obtain within the agreement. Cartelization is considered to produce an average price increase of around 25% (Connor & Lande, 2004), representing a considerable loss of well-being.Hence the need for relevant detection of cartelisations.
It is estimated that a high market concentration, high product differentiation or the existence of entry barriers facilitate the installation of an agreement, as well as a high predictability of demand, excess installed capacity, high multi-market contact or transparency in prices and costs, facilitate the durationof collusion. There is a general idea that the higher the market concentration, the greater the probability of generating collusion and cartelizing the offer. For example, the supply and distribution of drugs or surgical prostheses is capitalized by a market structure that in many countries is concentrated in similar companies that represent the interests of industrial groups of different origin and composition of sales. In this market, there is a highly predictable operation of demand patterns, homogeneity of marketed products, a high degree of price transparency and contact with final distributors, which lead to the formation of a collusion price structure. Also,This cartelization faces a stable inelastic patient demand that conditions its captive funders through medical prescription. In general, cartels stop competing on prices, fixing up certain products that present almost no substitution for consumers, in the most inelastic part of demand. Precisely, if the cartel sets high collusion prices, there is not too much risk of losing the market as a whole, since health demand always behaves as quite inelastic.since the demand in health always behaves as quite inelastic.since the demand in health always behaves as quite inelastic.
Oligopolization involves an analysis of market power, not only from the side of producers or their commercial representatives, but also from that of buyers. In many countries, the buyer - funders who act as insurers of the demand make up a Monopsony. This appears when in a market there is a single buyer, who thus has special control over the price of the products. This is what happens with the large Institutes of health insurance. Producers have to adapt in some way to the demands that the monopsony proposes in terms of price and quantity, a situation that allows it to obtain the products at a lower price than they would have to buy it if it were in a competitive market.. Other times, what is established is the Oligopsony, where there is not a single consumer, but a small number of consumers over whom control and power over the prices and quantities of a product are placed on the market. An example is the strategic alliances between funders for common purchases, which allow for lower prices.
Instruments for the dynamic analysis of the Health Market
The vast majority of markets are located between the extremes: perfect competition (minimum concentration) and monopoly (maximum concentration). There are two reasons why precise concentration measurements are needed:
- To be able to compare different markets (inside and outside the country) For the purposes of market regulation.
Market concentration, also called horizontal concentration, refers to the concentration or reduction of the number of companies participating in a given market. In either case, the regulatory body must adopt an intervention measure to establish whether a market is or will be competitive, or will definitely cease to be. The purpose of this evaluation is to determine if the concentration reinforces a dominant position and is capable of generating anti-competitive effects in a previously defined reference market. In the United States, the analysis of the level of concentration in the relevant market is also an important step and is established in the Merger Guidelines, issued jointly by the Antitrust Division of the Department of Justice (DOJ) and the Federal Trade Commission (FTC).
Assessing the violation of legitimate competition rules by one or several companies is essential to avoid distortions in prices and behavior, for which it is a matter of measuring market concentration, that is, the degree of real competition that it has. Precisely, the main characteristic of the ECR paradigm is that it directly relates market power to its level of concentration, since concentration as an industry structure determines greater market power (conduct). By means of concentration measures, the aim is to measure, in a simplified way, the proximity of a market to both extremes, free competition or monopoly, whose parameters are respectively (0 and 1, and the presence of oligopolies. A highly concentrated market structure, with a value close to 1,necessarily determines anti-competitive behavior.
There are two reasons why precise concentration measurements are needed:
- To be able to compare different markets (inside and outside the country) For the purposes of market regulation.
Concentration indicators thus play a fundamental role in the analysis of the existence of market power that must be carried out by competition agencies. The desirable characteristics to determine a Concentration Index must be:
- Ease of calculationIndependence of market sizeDetermination of range between free competition (0) and monopoly (1)
Concentration measurements are related to concentration curves. These describe the relationship between the accumulated percentage of product and the accumulated number of companies in the market, ordered according to their size. The inequality in the size of the companies is expressed in the concavity of the concentration curve. According to Hannah and Kay (1977). the desirable criteria of a Concentration Index are to be able to establish a classification according to the concentration curve (Example: the Index must be able to indicate if market A is more concentrated than market B) and at the same time allow analyzing the Impact of the Transfer Principle Sales (a transfer of sales from a small company to a large one by absorption should show an increase in the Concentration Index)
The indicator most used by competition agencies in the world is the Herfindahl - Hirschman Index (HHI), established by the United States Department of Justice (DOJ) to assess concentrations. Starting to square the market share of each company (market share) in whole numbers and making the sum of the parts, a value is obtained that ranges between 0 and 10 000, being lower when the distribution of the shares is more equitable and higher when few companies concentrate higher market percentages. In this way, the competition authority of the United States classifies market concentrations according to the HHI level
HHI <1,000 = Market not concentrated
HHI 1,000 <1,800 = Moderately concentrated market HHI> 1,800 = Highly concentrated market
It can also be calculated by squaring the decimal corresponding to the percentage of market share of each company (20% = 0.2), so that after the sum the IHH will be between 0 and 1.
Example:
(0.5) 2 + (0.35) 2 + (0.25) 2 + ………. (n) 2 = IHH
In the case of sales or mergers, where this Index is applicable, for values between 1000 and 1800, the merger may be approved if the increase in HHI with respect to the values of the pre-merger index is less than 100. HHI values are higher to 1800 are - a priori - indicative of market power and therefore the merger should not be approved without thorough investigation. The exception is that the increase in HHI with respect to its value before the merger is very small (less than 50).
The advantage of the IHH is that it combines information between the number of companies and their distribution of market shares, making a higher HHI represent a higher level of concentration. It also takes into account the total number of companies in the industry, so it can capture changes in the smallest companies.
The HHI can also be plotted through the use of Concentration Curves, which allow to quickly identify the market profile: These are built based on the market share percentage of each company in the analyzed market. The closer the slope of the concentration curve is to the isodistribution line (zero value), the more competitive the market is. The opposite occurs the closer the curve gets to the vertical, considering it as the monopoly curve whose value is equal to one.
Concentration curves
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