I. Three Decades of Hospital Merger Enforcement
Loosely speaking, each of the last three decades marked a distinct era of hospital merger enforcement and litigation outcomes. In the 1990s, the FTC and Department of Justice (DOJ) lost six successive hospital merger cases. In the 2000s, the agencies largely halted prospective hospital merger enforce- ment—neither agency would challenge a prospective hospital merger until 2008, when the FTC challenged one in Northern Virginia. The parties aban- doned that deal shortly after the FTC sued, marking the first agency win in over a decade. The FTC’s successful challenge in that case set the stage for the 2010s, when the FTC launched a series of prospective hospital merger challenges, as well as three primary care physician merger challenges, and ultimately prevailed in each fully litigated case.
A. The 1990s—Seven Straight Government Losses
In the late 1980s and early 1990s, the DOJ and FTC won several hospital merger challenges, including United States v. Rockford Memorial Corp. In so doing, the agencies set a precedent for using the Elzinga-Hogarty (E-H) meth- odology to define relevant geographic markets in hospital cases. The E-H methodology, originally developed for commodity markets, relies on the flows of sales into and out of a region to determine the relevant geographic market. Applied to hospital mergers, this methodology indicated that relevant geographic markets should be defined as areas from which few patients leave and into which few patients enter. Notably, the DOJ and FTC, and not just defendant hospitals, used E-H to define markets. In this respect, the agencies’ initial successes sowed the seeds of their future losses.
Indeed, between 1994 and 1999, the federal agencies lost six successive hospital merger cases. In addition, in 1999, California sued to enjoin a merger of two hospitals in San Francisco’s East Bay and lost, and the Ninth Circuit upheld that outcome. The predominant reason for all of these losses was that courts rejected the relatively compact geographic markets—and thus the high shares—alleged by the government. For instance, in Freeman, the FTC proposed a 27-mile radius around Joplin, Missouri, but the court adopted the 50-mile radius area the merging hospitals advanced. Likewise, in Mercy, the DOJ proposed a 15-mile radius around Dubuque, Iowa, but the court like- wise rejected that as too narrow. E-H tends to identify broad geographic markets because it is common for a fraction of patients to travel for hospital care. Consequently, accepting the E-H methodology led courts to adopt broad geographic markets and, ultimately, to rule against the government.
B. The 2000s—The Influence of Economic Research
After the string of losses in the 1990s, the federal agencies did not chal- lenge a hospital merger for nearly a decade. Meanwhile, economic research on hospital competition continued. An influential 1993 paper by David Dra- nove, Mark Shanley, and William White observed that, with the spread of managed care and selective contracting, hospital competition had shifted from being patient-driven to payer-driven. Prior to selective contracting, patients had largely unfettered choice of provider and were insulated from hospital prices by insurance. Hospital reimbursement was based on cost. This gave hospitals little incentive to set low prices. However, as the industry transi- tioned to payer-driven competition, selective contracting created a real incen- tive for hospitals to lower their prices: managed care organizations stood to benefit from lower hospital prices and could use network exclusion to direct patients away from high-priced hospitals and cause them to lose patients.
Gregory Vistnes extended the work of Dranove et al. by introducing the theory of two-stage competition, wherein hospitals first compete on price for inclusion in payers’ networks and then compete with other in-network hospi- tals on non-price factors to entice patients. Vistnes’ framework provided in- sight into why patient flows were not a reliable basis for defining geographic markets and drawing competitive inferences:
[The] two-stage model also helps explain several otherwise puzzling fact patterns associated with anticompetitive hospital mergers. [A] merger can significantly reduce first-stage price competition even when patient flow data show that multiple hospitals draw patients from the same region . . . .
[W]hile those fact patterns may suggest significant second-stage competi- tion, they shed little light on the magnitude of first stage competition.
The problem with using patient flows to judge pricing power—whether in the context of merging parties or a hypothetical monopolist test—is that pa- tient flows reflect the wrong stage of competition. The analysis of pricing and market power should focus on the stage in which price outcomes are actually determined: stage-one negotiations between payers and hospitals.
Two papers published in the early 2000s—one by Robert Town and Greg- ory Vistnes and the other by Cory Capps, David Dranove, and Mark Satter- thwaite—introduced empirical techniques to quantify the bargaining leverage of a hospital or system in stage-one negotiations with payers. Both papers analyzed the difference in the value of health plans’ networks with and with- out a particular hospital (or system), which Capps et al. labeled “willingness- to-pay” (WTP). The two papers showed that hospitals and systems with greater bargaining leverage (i.e., higher WTP) had higher prices.
In addition to theoretical and methodological progress, a body of empirical research into the effects of hospital consolidation and case studies of specific hospital mergers was developing. A survey published by the Robert Wood Johnson Foundation (RWJF) in 2006 summarized the general conclusion from several dozen papers published mostly between 1995 and 2003: “The average metropolitan resident saw a reduction in hospital competition, effectively, from six to four local competitors. The balance of the evidence indicates that the 1990–2003 consolidation in metropolitan areas raised hospital prices by at least five percent and likely by significantly more.” The study also reported that research findings on quality changes and cost savings were mixed and limited, with the bulk of the available evidence indicating that (1) consolidation is more likely to lower quality than raise it and (2) combining hospitals under a single license likely produces cost savings.
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