Matthew Grennan on Concentration in Medical Supply Markets: Considerations from the Coronavirus Pandemic

The coronavirus pandemic caused a huge shock to demand for medical devices, including ventilators and personal protective equipment (PPE). The resulting shortages put a spotlight on risk in the hospital supply chain and raised questions about the supply side of medical device markets.

In this Q&A, Professor Matthew Grennan discusses how his research in industrial organization and the economics of medical devices can provide a lens through which to view disruptions to the hospital supply chain and the evolution of medical device markets in recent months. Professor Grennan, who is Associate Professor of Economic Analysis and Policy, and Faculty Co-Director, Robinson Life Science, Business, and Entrepreneurship Program, Haas School of Business at the University of California, Berkeley, spoke with Analysis Group Managing Principals Dov Rothman and Aaron Yeater about market structure, efficiencies, and risk in the medical device industry.

Some economists have questioned whether shortages of ventilators and other medical equipment during the coronavirus pandemic have illuminated a systemic problem with the functioning of medical device markets. What is your perspective on this?

Matthew Grennan: Associate Professor of Economic Analysis and Policy, and Faculty Co-Director, Robinson Life Science, Business, and Entrepreneurship Program, Haas School of Business at the University of California, Berkeley

Many medical devices are manufactured or distributed by a small number of firms. Recently, there have been suggestions that this is a problem that stronger antitrust laws should address, and that antitrust actions could help avoid device shortages like those seen during the pandemic. This level of concentration always merits a close and careful look. However, my own research suggests that the answer will not be a simple one, as there are some economic efficiencies underlying the medical device industry’s structure.

What would be an example of the economic efficiencies you have found in your research on medical devices?

One of the interesting findings is evidence of economies of scope, which is consistent with the industry being increasingly dominated by “multi-category” firms that produce and sell multiple types of medical devices. Hospitals tend to purchase different medical devices from the same medical device manufacturers in part because there are contracting efficiencies associated with “one-stop shopping.” Such efficiencies are valuable to hospitals, but they can create challenges for some device manufacturers and prospective entrants if they need to offer multiple products to be viable competitors. This is just one factor that contributes to a smaller number of medical device manufacturers competing to be suppliers to hospitals.

Are there other forces at work?

Yes, there are a number of other forces. Another example of an efficiency is economies of scale. For instance, larger manufacturers may be able to leverage their R&D, sales, and marketing capabilities. Medical device manufacturing is also highly regulated, and there are significant startup and fixed costs associated with complying with these regulations and with training physicians to use new products. All of these factors will tend to favor large incumbents, to the detriment of prospective entrants and smaller manufacturers.

Does having a smaller number of medical device manufacturers contribute to the device shortages we have seen during the coronavirus pandemic?

Unfortunately, that may be the case. A consequence of the scope- and scale-driven consolidation I just described is that manufacturers are able to operate at relatively high levels of capacity utilization. This may be efficient during normal times, but it can have negative consequences under extreme circumstances such as recalls or demand spikes – and the pandemic has resulted in unprecedented demand spikes. If the industry had a larger number of manufacturers, each operating with greater excess capacity, it might have been better able to cope with this sort of shock. However, during normal times manufacturers have little incentive to build excess capacity, as that undercuts the efficiencies that are designed into the system.

Dov Rothman: Managing Principal, Analysis Group

What you are describing seems to be a tradeoff between having an efficient supply chain during normal times and the risk of not being able to meet demand during a global pandemic or other major shock.

Exactly. What we have seen most immediately is that hospitals, physicians, and patients – who might normally benefit from lower costs associated with an efficient supply chain – have had to bear some of the risk by forgoing protective and life-saving equipment when they needed it. This is not an entirely new phenomenon, as device shortages have occurred before, usually as a result of recalls. With the pandemic, however, the scale and stakes have been amplified, leading to some innovative policy responses, such as coordinated state-level efforts to share ventilators, relaxed standards on coordination between manufacturing firms, fast-tracking regulatory approval of new manufacturers, and guidelines for hospitals to stockpile a certain amount of PPE. Such measures are needed to help mitigate the direct health risks to physicians and patients from ongoing shortages.

Pandemic responses across different sectors of the economy are being shaped by the question of who bears the residual risk. How do you see this unfolding in the medical device industry in the longer term?

In a regulated market such as the medical device industry, the answer is determined partly by law and regulation, and partly by the nature of the relationships. Over the longer term, some of the creative policy approaches born during the pandemic might become standard tools for how agencies like the FDA [Food and Drug Administration] help deal with shortages. We could also see shifts in the relationships and contracts between hospitals and device manufacturers.

Some of our recent research shows that there is high dispersion in medical device prices across hospitals, which is driven by a number of factors, including brand preferences, search and contracting costs, and differences in bargaining ability across hospital administrators. The current crisis may change hospitals’ preferences and affect how they negotiate with device manufacturers, ultimately leading to higher or lower prices and more or less one-stop shopping. Device manufacturers may also face pressure and have greater economic incentives to increase capacity and avoid shortages in the future. We will have to wait and see whether this results in any long-term structural change.

Aaron Yeater: Managing Principal, Analysis Group

Thinking more broadly about medical devices as technology for health care, do you see any parallels between large multi-category device manufacturers and large technology platforms?

It’s an interesting question, especially given some of the allegations made recently about large tech firms. I do see some parallels between the evolution of large tech firms and certain phenomena we see among large med tech firms.

Broadly speaking, firms with advantages in production and distribution in one product may have the ability to control or affect access to other related products. At the same time, there can be efficiencies for firms and customers from vertically integrating production and distribution, or from products that can be designed to work together. All of this needs to be weighed when assessing any claim that certain aspects of competition might be impaired.

These issues have come up in questions about tech platforms’ ability to control digital advertising and how that may affect other firms’ ability to compete. We have seen similar issues of alleged foreclosure in medical device cases like Lenox MacLaren Surgical Corp. v. Medtronic, Inc., in which Lenox claimed that Medtronic interfered with its ability to compete by entering into an exclusive deal to sell Lenox’s devices and then failing to distribute them.

Of course, there are differences, too. For example, it’s not clear who in medical devices is analogous to the content providers in digital ads. But as tech antitrust issues continue to evolve, it will be interesting to see what other parallels may exist between tech and med tech providers, and how economic research in both the tech and medical device spaces can inform these issues. ■