Provider Consolidation and Potential Efficiency Gains: A Review of Theory and Evidence

In health care, as in other industries, merging parties frequently cite potential efficiencies as the impetus for their transaction. It is well established in the economic literature that consolidation has the potential to yield productive efficiencies generated by greater scale or scope of the resulting combined firm. Depending on the nature of these efficiencies, they may outweigh the increase in market power created by the transaction and improve overall consumer welfare. In assessing whether to challenge a transaction, the Federal Trade Commission and the Department of Justice, therefore, evaluate the potential efficiencies generated by the transaction against the potential harm to customers. The FTC and DOJ credit only “cognizable efficiencies,” which are defined as merger-specific efficiencies that could not be accomplished through alternative means, are verifiable (both in their existence and in their likely pass-through to consumers in the form of lower prices or higher quality), and are not the result of anticompetitive reductions in output or service. The FTC and DOJ will not challenge a merger if cognizable efficiencies exceed the harms from consolidation.

Whether consolidation between health care providers results in cognizable efficiencies has become an increasingly vexing question for antitrust enforcers. Health care market concentration has increased in recent years, with a growing number of geographic areas meeting the federal definition as highly concentrated. Some recent instances of vertical integration between hospitals and physicians also have become a concern for antitrust enforcement.

This article summarizes the theoretical efficiencies from provider consolidation and reviews the empirical literature assessing the evidence of scale and scope efficiencies in the context of provider market structure changes. Theoretically, economies of scale occur when increased production of a particular output decreases the average cost of each output unit. Economies of scope exist when it is less costly to combine production of two or more outputs within one firm than to produce both outputs separately. While microeconomic theory defines these concepts purely by production cost, we define scale and scope efficiencies broadly—including cost reductions and clinical efficiencies, both related to utilization changes and quality improvements. This broad definition of efficiencies allows us to capture ways in which consolidation may affect patient welfare directly (i.e., changes in quality of care) or through the channel of health insurance premiums and benefit design (i.e., changes in cost and utilization). We present evidence separately for scale and scope efficiencies, though the distinctions in many cases are unclear and a single merger may expand the scale and scope of an organization simultaneously.

Research on the efficiency effects of provider consolidation can be categorized along several dimensions, including efficiency type (i.e., scale or scope), provider type, payment system (i.e., fee-for-service or alternative payment models), level of analysis (i.e., market-level or provider-level), and research design. When possible, we focus on studies that employed quasi-experimental research designs, rather than descriptive analyses, though we discuss observational results in the absence of other evidence. We review the body of literature examining consolidation at the provider level, highlighting studies specifically focused on provider mergers or acquisitions and noting areas with a particularly thin or weak evidence base. We also highlight relevant research on the relationship between market-level concentration and cost and quality, though much of this literature has been synthesized elsewhere.

We organize our review by type of efficiency. We first examine empirical evidence of efficiencies resulting from greater health care provider scale, distinguishing by provider type. Within each type of consolidation, we examine the relationship between scale and outcomes of interest, including cost, utilization, and clinical quality. Next, we review evidence of efficiencies resulting from expanded provider scope, again distinguishing by provider type and outcome of interest. Moving beyond the empirical evidence in a fee-for-service environment, we discuss scale and scope efficiencies in the specific context of alternative payment models.

In total, the literature suggests that consolidation among health care providers—whether horizontal or vertical—does not, on average, result in welfareenhancing efficiencies. While our findings do not preclude the existence of merger-specific efficiencies in specific transactions, they do suggest that antitrust enforcers and policymakers should apply considerable scrutiny to claims of such efficiencies.

I. Scale Efficiencies

In microeconomics, scale efficiencies arise when increased production of a particular output decreases the average cost of each output unit. This concept dates back at least as far as Adam Smith’s writings on the division of labor in The Wealth of Nations, where he conjectured that specialization allowed a large pin factory to achieve greater output and lower average cost per pin than a small pin factory. Economies of scale are illustrated in Figure 1, where a hypothetical physician’s practice has a u-shaped long-run average cost curve in relation to the quantity of office visits produced. Economies of scale exist for any quantity of output less than Q*, the quantity at which the firm minimizes its average cost of production. After Q*, each additional unit of output increases the average cost of production and the firm experiences diseconomies of scale. These diseconomies of scale may arise for reasons including managerial inefficiencies and communication breakdowns.

Continue reading the full text of this article in PDF format.