This report was funded by Last Choice for Patient Choice, a 52 Associate Professor of Economics, Robert Morris University

3 The Department of Justice touts the protection of competition on its website www.justice.gov in a number of places.

ptimal social welfare without the inherent costs of regulation. 5 Most intermediate micro theory books, managerial economics textbooks, and regulatory theory books, provide analysis of the natural monopoly situation. This is merely a summary of the content of such books.

6

See Ekelund and Saba (1981). 7 See Williamson (1976), page 82.

The concept of competitive bidding sounds great on its surface, but as with so much in the policy arena, taking an idea from theory to application changes things. The first and most obvious problem with the current DME bidding plan is that the market for DME is not one in which natural monopoly characteristics are evident. All research on competitive bidding agrees that it is relevant only when a single large firm can serve a geographic area at lower cost than multiple small firms. Market competition would likely prove a more efficient cost‐price tracking system than the system enshrined by politically‐involved bilateral bargaining between regulators and regulatees.6 The most telling failure of the DME plan is that it is being applied in the wrong kind of market.

d the like, [cause] price‐cost divergences and/or indeterminacies to develop.7A bidding plan needs to provide an incentive for firms to bid low, and a long‐term contract can help incentivize low bids by preventing the losing firm from reentering the market in the near future. However, if the re‐bidding opportunities are too far apart you drive the competition permanently out of business. Setting the correct contract price should be done over shorter intervals. Even if you wanted to average the first few rounds of bidding, a till leave you with far fewer firms bidding in later rounds.

8

See Williamson (1975), page 81. 9 See Viscusi, et al. (2005), and Katzman and McGeary (2008).

prolonging a patients hospital stay. Service concerns are further exacerbated by heterogeneity. If service is not the same, or if expectations of service are not consistent then the race to the bottom in price yields a less than optimal social outcome. Since quality is more difficult to measure than price, the results of the bidding process may be worse than the initial state of the world as the only options for consumers are low price, low quality. This may cause the need for ncreased regulation to monitor quality.9

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10 See Viscusi, et al. (2005).

essarily be fewer bids in future rounds. When the next round of bidding occurs it is likely that prices will rise to be sure, but there is also the possibility of opportunistic hold‐up. The firms who stay in the market are at a distinct advantage over those who would like to enter. They understand the way things work, not to mention, they already have the facilities in place that are necessary to run the business. The key is to be the winning firm from the outset in order to be around in the future. If price has to be raised, as so much in the literature shows, regulators have little incentive to say no. DME is an inelastic good. People will pay higher prices if need be as they need testing supplies and oxygen. If the franchise owner has made an effort to establish their firm through capital investment, the regulator will almost always approve an increase in price, especially if the alternative is television coverage of people who cannot access t

heir medical supplies. The flip side of opportunistic behavior poses the question for the winning bidders. How far is CMS willing to go to drive down prices? Put another way, what happens if CMS, knowing how vital being a winning bidder is, imposes other conditions on winners to keep their fr

11 See Viscusi, et al. (2005).

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WHAT IS THE MEANING? What is the purpose of this? Basic economic reasoning tells us that decreasing competition leads to a concentration of an industry and higher prices. Research shows us that regulated industries are not immune to increases in prices, some of which occur at a rate faster than inflation. The observed failure or flat out refusal to provide a good in a category by some winners in the first round of bidding confirms that bidding was conducted with at best imperfect information. At worst, however, bids were submitted under the pretense of getting ones foot in the door with no intention of fulfilling the contract. After the franchise was aw

arded, winners could simply push for price hikes So what is the purpose of this plan? Cost savings is most often touted, but surely the regulator has a responsibility t the public beyond the bottom line. This is known as the

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public interest theory of regulation. We are, after all, told repeatedly that private firms have such a role to play in society. In the case of DME, savings might indeed accrue, but at what cost and for how long? Theories of regulation seek to explain why regulatory action would yield a better outcome than a market. Other than the potential for making it easier to monitor the regulated firms by reducing their number, there appears to be no honorable explana

t apply. In theory, value for society is created by an auction for a franchise. The monopoly income that could be earned by the firm is transferred to the government, which it is assumed, uses such revenue to improve societal welfare. When no money changes hands for the awarding of the franchise, as in the case with DME, prices are reduced which also should benefit consumers. Yet, when the product being provided is coupled with a significant service component we should take pause. The outcome of this bidding plan will be to reduce price for a time, but also to reduce the quality of service provided to patients to whom service matters a great deal. In some cases, the service itself becomes a life or death issue. DME is not an industry characterized by natural monopoly features. It is not like

cable television. If your cable service goes out in the middle of the night you have alternatves. If your oxygen supply does the same, service is of paramount importance.

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Congress mandated the implementation of the competitive bidding program and as such CMS is merely doing its job, however, alternatives must be considered. Yet, from the outset predictions by CMS about the impact on the market have been incorrect. For instance, the distribution of winning firms in the initial phase of bidding did not yield the predicted breakdown between large and small firms. If economies of scale existed, large firms should have won the majority of bids. However, 64% of bid winners were small providers. This raises the question of whether economies of scale in this industry are as prevale

nt as initially believed. If the regulators do not understand the market a bidding plan will not provide the proper incentives. More problematic is when a competitive bid plan is put in place for an industry that is already competitive. This would, it seems, defeat the purpose of the bidding.