Hospital competition with heterogeneous patient groups: Incentives and regulation

Competing hospitals may not only use quality of service to attract patients but also their specialization profile. Applying a Hotelling-duopoly and interpreting respectively quality and specialization as vertical and horizontal differentiation, we analyze the optimal allocation in both dimensions for hospitals. To account for heterogeneity in preferences as well as in the health status, two patient groups are introduced. These groups differ in two parameters, (i) treatment costs and (ii) preference for a good match between patients' needs and hospitals' specialization profile. Moreover, we derive the optimal reimbursement scheme a regulator is able to achieve. The results show that the hospitals' specialization decision is determined mainly by two relations: which group is more profitable for hospitals and which group is endowed with the higher preference for a good match. The reimbursement scheme a regulator implements deviates from a pure cost partitioning scheme. In particular, the regulator aims at inducing higher quality by exploiting the heterogeneity in preferences.