"Entry Decisions and Incumbents' Responses: Evidence from the Outpatient Surgery Market"

Ambulatory surgery centers (ASCs) are small-scale facilities that focus on a few specialties of outpatient surgeries. As the number of ASCs increases, hospitals face increasing competition in the outpatient surgery market. Different from other markets, surgery prices are largely based on the Medicare reimbursement rates, which are directly set by the government. Given inflexible prices, hospitals compete with ASCs by investing in surgery quality levels.

The Medicare outpatient facility fee change for ASCs in 2008 provides exogenous variations in ASCs' profitability and ASCs' incentives for adopting different surgery categories. I build a structural model to show how patients choose surgery facilities, how ASCs make entry decisions and how hospitals choose surgery quality levels. A high surgery quality level in a hospital increases the hospital's profit through two channels. First, it attracts more patients to choose the hospital over other facilities, resulting in a higher surgery volume and a higher revenue (effect of direct competition). Second, it could potentially deter ASCs from entering the market by reducing ASCs' expected surgery volume, thus reducing the competition the hospital would face in the outpatient surgery market (effect of entry deterrence). I estimate the model using Markov chain Monte Carlo (MCMC) methods. I find that a higher Medicare reimbursement rate for ASCs can encourage ASCs to enter the market. On average, a one standard deviation increase in the reimbursement rate leads to an 11.6 percent increase in the ASC's entry probability. Hospitals invest in surgery quality levels to compete with ASCs. A one standard deviation increase in the hospital's surgery quality level leads to 5 more patients for surgery in a year. The effect of entry deterrence explains 47 percent of the increase, while the effect of direct competition explains 53 percent of the increase.