The Role of Financial Management in Health Care: A Critical Analysis

1. Introduction

In modern systems of health care, market relations are being formed with a priority on economic criteria. This imposes a particular view of theorists and practitioners of such systems. The purpose of this essay is to critically analyze the role of financial management in health care from the perspective of different schools of thought in economics. For this purpose, we will first consider the general features of the health care market and the place of financial management in it. Then we will turn to the analysis of various approaches to the study of health care from the standpoint of economic theory. We will single out two main directions – the theory of perfect competition and the theory of health care services. We will also touch upon the question of clinical research as an integral part of modern health care.

2. The health care market

2.1 The structure of the health care market

The structure of the health care market is quite complex and includes a large number of participants with varying degrees of dependence on each other (hospitals, clinics, diagnostic centers, pharmacies, insurance companies, manufacturing companies of medicines and medical equipment, etc.). The place and role of each participant in the system is determined by the type of activity carried out and its position in the chain “from manufacturer to patient” (Hood & Youngson, 1995).

The main types of activity in the health sector can be conditionally divided into three groups:
– provision of medical services (medical institutions);
– manufacturing of medicines and medical equipment (pharmaceutical and medical companies);
– insurance (medical insurance companies).

The most important players on the market are medical institutions that provide medical services to patients directly. The supply side also includes pharmaceutical and medical companies that produce medicines and medical equipment necessary for diagnosis and treatment, as well as insurance companies that reimburse part or all of the costs incurred by patients for medical services. The demand side is represented by patients who need medical assistance (Hirsch & Schlesinger, 1991).

2. 2 Competition in the health care market

Competition is an important feature of any market economy. It determines not only prices but also quality, variety and availability of goods and services produced by different companies. In recent years, competition has become one of the key words in discussion about health policy (Duggan & Yoon, 2006). In general, competition can be defined as a process characterized by rivalry between at least two entities for the same goal or objective (Waldman & Jensen, 2001). The goal can be winning customers, contracts or simply surviving in business environment. Entities can be firms, organizations or individuals. There are different forms or types of competition such as price competition, product competition or even non-price competitions such as advertising campaigns to win customer preference (Duggan & Yoon, 2006). Price competition happens when companies offer similar products but at different prices while product competition occurs when firms offer differentiated products which are either close substitutes or complements to each other (Waldman & Jensen, 2001). Quality can also be used as a form strategy for differentiation hence becoming a source for product competition (Duggan & Yoon). In general terms however, it can be said that price competition dominates most markets including healthcare markets (Waldman & Jensen). Price competitions usually take the form of price wars between companies as each firm tries to undercut the other’s prices while still making a profit for itself (Waldman & Jensen, 2001). As such, this type of competition can lead to lower overall prices for consumers as firms seek to remain competitive and keep their market share. In healthcare markets, this usually happens when new entrants enter the market and start offering services at lower prices in order to gain customers from incumbents (Duggan & Yoon, 2006).

Product competition on the other hand, can take many different forms. In healthcare markets, product differentiation can be achieved through quality, features, or even the brand image (Duggan & Yoon). Quality differentiation happens when firms offer products or services that are perceived by customers to be of higher quality than those of their competitors (Waldman & Jensen). This quality can be in terms of the efficacy of the medicine or treatment, safety, convenience or even affordability. On the other hand, feature differentiation occurs when firms offer products with different features from those of their competitors even though they may be similar in terms of quality and price (Waldman & Jensen). Another form of product differentiation is brand image or reputation. In this case, firms try to create a positive image or reputation for their products in the minds of consumers so that they are perceived to be of better quality than those of their competitors (Waldman & Jensen). Brand image can also make it easier for firms to charge higher prices for their products since customers are willing to pay more for products they perceive to be of higher quality (Duggan & Yoon).

In general, competition in healthcare markets can take many different forms depending on the specific market structure and the nature of the products or services being offered. However, price competition is usually the dominant form since most health care services are undifferentiated and are close substitutes for each other (Duggan & Yoon). This is because most health care services are government-regulated and there is little room for firms to differentiate themselves through quality or features. As such, incumbents usually compete by offering lower prices for their services in order to attract and retain customers (Duggan & Yoon).

3. Health economics

3.1 Theories of perfect competition

The theory of perfect competition is one of the most famous theories in economics. It was first put forward by Adam Smith in his work “An Inquiry into the Nature and Causes of the Wealth of Nations” (1776) and later developed by economists such as J.B. Say, David Ricardo and Karl Marx. The main ideas of this theory were later formalized in the works of Léon Walras and Vilfredo Pareto. According to the theory of perfect competition, market equilibrium is achieved when all firms in the market are producing at minimum average cost and all consumers are satisfied with the current market situation (Becker et al., 1964).

In perfect competition, there are a large number of small firms producing identical products. Each firm has a small market share and is a price taker rather than a price maker. This means that each firm takes the prevailing market price as given and cannot influence it through its own actions. As such, firms compete solely on price and each tries to undercut the prices charged by its competitors in order to gain market share (Becker et al., 1964).

There are several key assumptions underlying the theory of perfect competition. Firstly, it is assumed that all firms in the market are price takers. This means that each firm takes the prevailing market price as given and cannot influence it through its own actions. Secondly, it is assumed that all firms in the market produce identical products. This means that there are no differences in quality or features between the products of different firms. As such, firms compete solely on price and each tries to undercut the prices charged by its competitors in order to gain market share. Thirdly, it is assumed that there is free entry and exit into and out of the market. This means that any firm can enter or exit the market at any time and there are no barriers to entry or exit. Lastly, it is assumed that all firms have perfect information about the market. This means that each firm knows all relevant information about prices, costs, products, etc.

The main implications of perfect competition are that (1) all firms in the market are price takers; (2) all firms in the market produce identical products; (3) there is free entry and exit into and out of the market; (4) all firms have perfect information about the market; and (5) market equilibrium is achieved when all firms are producing at minimum average cost and all consumers are satisfied with the current market situation.

3. 2 Theories of health care services

The theory of health care services is a relatively new area of research that has emerged in response to the increasing importance of health care in modern economies. The main focus of this theory is on understanding how different types of health care services are produced and consumed, and how they are financed. The main theoretical framework for this research is provided by economics, specifically microeconomics.

There are two main types of health care services: curative and preventive. Curative services are those that aim to treat patients who are already ill or injured. They include things like hospitalization, surgery, etc. Preventive services are those that aim to prevent people from becoming ill or injured in the first place. They include things like vaccination, screening, etc.

The production of health care services involves a number of different processes, including diagnosis, treatment, rehabilitation, etc. These processes can be divided into two broad categories: inputs and outputs. Inputs are things like labour, capital, land, etc. Outputs are things like health outcomes, patient satisfaction, etc.

The main economic theories of health care services are the theory of supply and demand, the theory of producer surplus, and the theory of consumer surplus. The theory of supply and demand is concerned with how prices are determined in markets for goods and services. The theory of producer surplus is concerned with how producers can optimize their production in order to maximise their profits. The theory of consumer surplus is concerned with how consumers can optimize their consumption in order to maximise their utility.

The main implication of the theory of health care services is that prices play a vital role in determining how much health care is produced and consumed in an economy. Prices signal to producers how much consumers are willing to pay for health care services, and they signal to consumers how much producers are willing to supply. When prices are high, producers have an incentive to supply more health care services, and when

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