More Stinkin’ Barriers, part 2

There are no barriers that discourage new entrants to the hearing aid industry  (previous post at HHTM)

Today’s Econ 202 post continues its contrarian ways by scaling barriers of varying sizes in the US hearing aid manufacturing and delivery system.   Part 1 itemized regulatory requirements for manufacturers, audiologists and providers which pose varying structural challenges to new entries, compared to incumbents.  The economic view of those challenges is:

  • None were sufficiently great to block new entries but all provided at least minimal protection for incumbents.
  • All added to the wholesale and retail costs of hearing aids, but none excessively.
  • All bestowed incumbents with market power, enabling monopolistic pricing and societal costs.

 

Legal, Stringent Definition of Barriers

 

Economic barriers exist when new entries face resource costs that incumbents don’t.   Legal logic uses a pared down quantitative method to decide when a  barrier is worthy of the name and warrants scrutiny:

“…in markets in which monopoly profits are being earned, actual entry disproves the existence of barriers to entry and would be expected to drive prices and profits to normal levels, while the absence of entry reveals the existence of barriers to entry.”(Culbertson & Weinstein, 2004)

In other words, the courts don’t get excited about an industry or a profession so long as there’s the occasional new entry.  We’re not going to be in court anytime soon.  All by itself, Zounds saves the day for the US hearing aid manufacturing industry.

 

Barriers Nevertheless

 

Which does not mean that economic barriers do not exist to slow, if not thwart, entry, while keeping market power in the hands of a few.  Big 6 hearing aid manufacturers, together with affiliates, claim to “manufacture and market over 90% of the hearing technology available to consumers worldwide.” To the extent that they can sustain that control, these firms comprise a price-maker oligopoly.

It is expensive to belong to an exclusive club and oligopolies are no exception.  Only a few firms can afford to compete in an oligopoly market because lots of capital is needed to enter the industry and lots more capital is needed to stay competitive in the market.

 

Start-Up and Fixed Costs

 

A producer wanting to enter the hearing aid market must commit large sunk-cost investments[i] for set-up as a specialty medical device manufacturer. Once capitalized, firms have to build distribution channels and create a qualified workforce (Gerosky & Jacquemin, 1990). 

Economically, a firm’s entry decision hinges on whether it can sell at a price at which it expects to earn more than it can expect from other investment choices (foregone opportunity costs). If entry requires large sunk-cost investments, as is the case with hearing aid manufacturing, firms will enter only if they expect post-entry prices will be high enough to generate total revenues that equal their total costs.

Once invested, the firm faces other fixed current costs in order to allow production (e.g., rent, insurance, fixed assets). [ii]  Fixed costs are a big problem if the firm decides to quit producing, as it would were it to try to exit.

It is reasonable to argue that such costs are not a barrier since they’re faced by all players including incumbents.  That would be so if all firms left the starting gate at the same time but that’s not the case.  Founding firms with long track records have raised effective entry barriers for many smaller firms through the use of competitive response strategies.

 

Competitive Response Strategies Make Good Barriers

 

The number of hearing aid manufacturers … once… almost 100 is now a very few, resulting in little competition and significantly limited choices for consumers. (Gudmundsen FDA Citizen Petition Jan 2015)

The wholesale global hearing aid market is about $5BUS ($15B retail) at present [iii] , with compound annual growth rate (CAGR) expected to exceed 6% over the next few years.  You’d think new competitors would be flocking into such a happy playground and perhaps they are on the cusp of doing so.  But strategic barriers are stumbling blocks that have been in place for some time and seem to have stemmed the flow so far.

In 2012, for example, Sonova and William Demant, respectively, accounted for  24% and 23% of total unit sales in the $5.4B(US) global hearing aid market.  Together with the other four (GN Resound, Siemens, Starkey, Widex),the Big 6 sold 98% of all units in the global market that year.

 

Economies of Scale and Scope

 

Mergers and acquisitions in recent decades grew the market power of a few manufacturers while shrinking the Supplier side from 100 down to our current Big 6, as noted by Gudmundsen in the previous section.  Big is usually better when it comes to high levels of R&D investments, which require large financial reserves; also because they can be expensed across a greater sales volume.

Production costs go down as other factors are centralized (e.g., finance, marketing, licensing), giving large firms, especially incumbents, a competitive advantage over small or start-up firms that might otherwise enter the market.

 

Technology

 

The US patent system grants patent holders a 17-year legal monopoly on the use of the patent.  If firms cannot compete in the market without infringing the patent, then the patent would be a barrier to entry that would allow the patent holder to enjoy a lawful monopoly for the life of the patent (paraphrased from Culbertson & Weinstein, 2004).

Hearing aid industry incumbents have a good lock on hearing aid R&D, not only through mergers and financial reserves, but more importantly through control of specialized patent portfolios owned by individual firms or in consortium.  Patent ownership can be a powerful barrier against other firms, made stronger when incumbents band together to buttress the barrier with “enormous financial resources”  against new entrants.

The Hearing Instrument Manufacturers Patent Partnership (K/S HIMPP) is the incumbent consortium of the hearing aid industry, owned by the Big 6, Intricon (which paid $1.8MUS to join) and two others.  Since 1996, the partnership has acquired 80 patent portfolios from companies that include:

  •  3M
  • Decibel Instruments
  •  NEC Corporation
  • Songbird Hearing, Inc.
  •  Avaya Inc.
  • Hybrid Electronics (HEI), Inc.

HIMPP partners share patent use and  grant favorable licensing agreements to affiliates, who pay a 3% licensing fee.  “In practical terms, this creates market entry barriers for potential new entrants”  (Munari & Oriani, 2011; p 227)3.

HIMPP also patrols its patents, suing for patent infringement on occasion. The entry barrier rises when it or a partner wins; the barrier springs a little leak when they lose.

 

A Few More Barriers Ahead

 

The last post in this series, due in two weeks, looks at incumbents’ strategic use of product differentiation and distribution channels as barriers to protect their market positions from new entries.

 

References

 

  1. Culbertson JD & Weinstein R.  Antitrust Aspects of Barriers to Entry.  Paper presented at the UCLA Law First Annual Institute on US and EU Antitrust Aspects of Mergers and Acquisitions.  Feb 27-28, 2004.
  2. Geroski PG & Jacquemin A.  Barriers to Entry and Strategic Competition.  New York:  Harwood Academic Publ’g (1990).
  3.  Munari F & Oriani R (Eds).  The Economic Valuation of Patents: Methods and Applications. Northampton MA:  Edward Elgar (2011).

Footnotes

[i] Sunk costs are expenses and investments are those that have already been made and cannot be recovered (e.g., mortgage, interest. R&D).

[ii] All sunk costs are fixed but not all fixed costs are sunk. If a fixed cost can be recovered, it’s not sunk (e.g., reselling  equipment).

[iii]  Bernstein Research, personal communication.

 

This is Part 2 of a 5-part series on barriers.  Click for Part 1Part 3Part 4, or Part 5.

 

Feature image from The Treasure of the Sierra Madre

About Holly Hosford-Dunn

Holly Hosford-Dunn, PhD, graduated with a BA and MA in Communication Disorders from New Mexico State, completed a PhD in Hearing Sciences at Stanford, and did post-docs at Max Planck Institute (Germany) and Eaton-Peabody Auditory Physiology Lab (Boston). Post-education, she directed the Stanford University Audiology Clinic; developed multi-office private practices in Arizona; authored/edited numerous text books, chapters, journals, and articles; and taught Marketing, Practice Management, Hearing Science, Auditory Electrophysiology, and Amplification in a variety of academic settings.

2 Comments

  1. Not sure I’d agree that it’s a new distribution channel because regardless of location, the dispensing is still through a state-licensed individual and the item is still under the FDA imprimature. Also, as you point out, the manufacturer is an incumbent. But, the innovation technology is indeed changing the nature of the device and that, in turn, is growing the market which almost by default prompts expanding the distribution system (if not creating a whole new system). In the long run, those market forces create change that does, indeed, invite new competitors to enter. When Apple puts its own device on the market and sells it direct, I’ll agree with you entirely! Thanks for your comment.

  2. “You’d think new competitors would be flocking into such a happy playground and perhaps they are on the cusp of doing so. But strategic barriers are stumbling blocks that have been in place for some time and seem to have stemmed the flow so far.”
    What about Apple’s MFi aids, sold by Costco for $1799.99 a pair? Even if it isn’t a new mfgr (it’s ReSound), it’s a new price benchmark and distribution channel. And potential for a “captive” customer base, because of the proprietary BT protocol with the iPhone.

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