Hospital competition under patient inertia: do switching costs stimulate quality provision?

Abstract

Recent empirical evidence establishes previous use as a strong predictor of patient choice of hospital and indicates that switching costs explain a significant share of inertia in the hospital industry. In a model of competition between two semi-altruistic and horizontally differentiated hospitals with inherited demand, I investigate the effect of lower switching costs on quality provision and show that it depends on the hospitals' production technology and degree of altruism. If cost substitutability (complementarity) between quality and output is sufficiently weak (strong) relative to altruism, lower switching costs reduce quality at the high-volume hospital, average quality, and patient welfare. While milder patient preferences increase the scope for an increase in quality at both hospitals, it can only occur if hospitals are semi-altruistic. Finally, I show that the distribution of patients between hospitals matters. Even if hospital-level quality and patient welfare increase, lower switching costs may lead to lower average quality.