No. 95-1448





Stuart M. Gerson
William G. Kopit
Tanya B. Vanderbilt
1227 25th Street, N.W., Suite 700
Washington, D.C. 20037-1156
(202) 861-0900
Counsel for Amicus Curiae
American Hospital Association
Of Counsel:
Fredric J. Entin
Tracey L. Fletcher
One North Franklin
Chicago, IL 60606
(312) 422-2777
August 10, 1995

I. Interest of the Amicus Curiae.

Amicus curiae the American Hospital Association ("AHA") respectfully submits this brief in support of the Defendants-Appellees. The parties have given written consent to the filing of this brief and the statements of consent are being filed simultaneously with this brief.

Founded in 1898, the AHA is the primary organization of hospitals and health systems in the United States. Its membership includes 5,000 hospitals, health care systems, networks, and other providers of care.

The AHA's corporate mission is to promote the quality of health care for all people through leadership and assistance to hospitals and other health care organizations. To fulfill this mission, the AHA regularly participates in the judicial and legislative arena to address important issues concerning federal and state health care reform in general and hospital regulation in particular.

The AHA's members believe that, in appropriate cases, mergers and consolidations can reduce hospital costs, improve the quality of care, and benefit consumers. Recent changes in health care delivery have led to an increasing number of hospital mergers and other types of consolidations within the health care industry, making all of the AHA's members potentially subject to investigations and challenges under the antitrust laws./

Correctly defining the relevant geographic market is crucial to correctly analyzing hospital mergers and consolidations. The establishment of a consistent, predictable, and economically sound standard for geographic market definition in hospital merger cases is important to the AHA's members.

II. Statement of The Issue.

The immediate issue confronting the Court in this case is whether, under the applicable "abuse of discretion" standard of review, the District Court's determination should be upheld. It is the government's burden to establish a properly defined geographic market. Because the government has failed to satisfy that burden, the District Court's decision should be upheld.

The Eighth Circuit has previously held -- and even the government's own Merger Guidelines acknowledge -- that a proper definition of a geographic market must be based not only on where patients currently obtain hospital services, but also on where they would seek hospital services if the hospitals within the proposed geographic market raised prices above competitive levels. In other words, the analysis must be "dynamic" rather than "static." By failing to present any significant evidence relevant to a dynamic analysis of the geographic market, the government failed to establish a properly defined geographic market.

III. Proper Definition of the Geographic Market is Extremely Important in Hospital Mergers.

A. The importance of market definition in general.

The first step in analyzing the potential of any merger to affect competition involves the definition of the relevant geographic and product markets. As the Supreme Court has explained:

Determination of the relevant product and geographic markets is "a necessary predicate" to deciding whether a merger contravenes the Clayton Act.

United States v. Marine Bancorporation, Inc., 418 U.S. 602, 618 (1974)(citing United States v. E.I. Du Pont De Nemours & Co., 353 U.S. 586, 593 (1957); Brown Shoe Co. v. United States, 370 U.S. 294, 324 (1962)).

B. Market definition is particularly important in hospital merger cases.

Hospital markets differ in several important respects from other markets, and appropriate antitrust analysis must take these differences into account. Because only a fraction of most hospitals' business is price sensitive, any overly restrictive market definition in a hospital merger case greatly exaggerates the transaction's potential to harm consumers, and is likely to result in the prevention of many procompetitive mergers. Moreover, hospital mergers typically present a much greater potential for efficiencies than mergers in other industries. These efficiencies must be weighed against the potential for harm to consumers.

1. Hospital markets often do not behave like other markets.

A great deal of research suggests that, in hospital markets, simply increasing the number of competitors does not necessarily decrease prices or raise quality -- and may even have quite the opposite effect. As Rashi Fein, the Harvard health care economist, has observed, "[i]n health care, the invisible hand of Adam Smith is all thumbs." Lee & Lamm, Europe's Medical Model, N.Y. Times, March 1, 1993.

In United States v. Rockford Memorial Corp., 898 F.2d 1278 (7th Cir.), cert. denied, 498 U.S. 920 (1990), Judge Posner acknowledged that it made sense to consider studies regarding the impact of hospital concentration on price, but explained that such studies were still in their infancy:

If the government is right in these cases, then other things being equal, hospital prices should be higher in markets with fewer hospitals. This is a studiable hypothesis, by modern methods of multi-variate statistical analysis, and some studies have been conducted correlating prices and concentration in the hospital industry. . . . Unfortunately, this literature is at an early and inconclusive stage . . .

Id. at 1286.

Since Rockford, however, most new studies have demonstrated that, in hospital markets, there is no correlation between higher market concentration and higher costs and prices. The reasons for this counterintuitive result are relatively clear: in hospital markets, price sensitivity is less important and potential efficiencies are greater. The government should, but does not, take these factors into account.

The government asserts that the merger is presumptively illegal because, based on its expert's calculations, market concentration exceeds the standards articulated in the government's merger guidelines. Brief of Plaintiff-Appellant at 34 and n.22. But the government itself does not use that standard. In 70 to 80 percent of the communities with more than one hospital, any merger of two or more facilities would presumptively violate the government's merger guidelines. Entin, et al. (1994) at 115-116; Bazzoli, et al. (1995) at 149. However, the government itself proclaims that "challenges to hospital mergers are relatively rare." U.S. Department of Justice and Federal Trade Commission, Statements of Enforcement Policy and Analytical Principles Relating to Health Care and Antitrust, September 27, 1994, at 14. Indeed, the antitrust "Agencies often have concluded that an investigated hospital merger will not result in a substantial lessening of competition in situations where market concentration might otherwise raise an inference of anticompetitive effects." Id. at 13-14. Unfortunately, the government has never fully articulated the analysis it will (or should) employ. As a result, the hospital industry is generally unable to determine in advance whether a given merger is likely to be challenged. See Bazzoli, et al. (1995). For this reason, it would be extremely useful for this Court to discuss the elements of a proper analysis of hospital mergers, and the reasons why the government's efforts in this case fall short.

2. In hospital mergers, any error in the analysis is magnified by the fact that only a subset of payors can experience higher prices as the result of a merger.

In hospital markets, as distinguished from most other markets, only a subset of consumers can experience higher prices as the result of a merger. As a general rule, government payors such as Medicare and Medicaid cannot experience higher prices as a result of a hospital merger. These payors, which are typically a hospital's largest source of revenue, set their own payment schedules and offer hospitals a "take it or leave it" deal on prices. Virtually no hospital can afford to leave it.

Another group that cannot not experience higher prices as a result of hospital mergers consists of indemnity payors that do not have direct contracts with hospitals. Since these payors do not have contracts with hospitals, they cannot effect discounts and must pay whatever the hospital charges. Since there are no competitive constraints on what hospitals can charge these payors, a merger will not increase the prices paid by this group. Of course, this type of insurance is being replaced, in many areas of the country, with various types of insurance involving direct contracts between insurers and hospitals. Nonetheless, where traditional indemnity insurance remains a part of the market, it should not be ignored.

In short, hospitals do not have market power as to government payors -- and have virtually unlimited market power as to traditional indemnity payors -- regardless of the hospitals' market shares. Thus, any price increases resulting from a merger can only affect a subset of payors -- i.e., commercial payors that have direct contracts with hospitals. See Entin, et al. (1994), at 128. Because only some of the hospital's customers are price sensitive, any analytical error that improperly limits the market will necessarily exaggerate any increase in market power, and overstate the welfare loss. Clearly, in hospital markets, the possible adverse price effects of mergers are significantly reduced.

3. The overcapacity common in hospital markets makes efficiencies much more likely in hospital mergers than in other types of mergers.

Because hospitals today typically have substantial excess capacity, hospital mergers are more likely than mergers in other industries to result in efficiencies. At least one Federal Trade Commissioner has publicly recognized this, stating that the unique factors inherent in hospital mergers require that efficiencies be carefully considered:

There are two unique aspects of hospital mergers that virtually mandate that antitrust enforcers carefully examine asserted efficiencies before determining whether to challenge a particular hospital merger. The first relates to the peculiarities of the industry. The second relates to the peculiarities of the 1992 Horizontal Merger guidelines' analysis as applied to hospital markets.

Prepared Remarks of Commissioner Christine A. Varney before the Health Care Antitrust Forum, at 1-2 (May 2, 1995).

Commissioner Varney went on to explain that, largely as a result of former policies of the federal government, many hospitals have excess capacity, which makes efficiencies more likely to result from hospital mergers than from mergers in other industries. She also stated that, because sufficient data to permit a conclusive definition of the market is often lacking in hospital merger cases, it is especially important in these cases to consider the efficiencies likely to result from the merger. Id.

The excess capacity that is chronic in the hospital industry has several causes. Indeed, as noted by Commissioner Varney, much of the existing overcapacity is directly attributable to past programs of the federal government, which began to subsidize hospital construction during the Great Depression. After World War II, these efforts intensified when the government enacted the Hill-Burton Program, which subsidized the development of hospital services and facilities. By 1978, the Hill-Burton Program had used $4.4 billion in federal funds as leverage to get an additional $9.1 billion in state and local government funds. This money funded the construction of 500,000 beds -- almost half of the beds in use in 1985. Entin, et al. (1994), at 139.

Even more significant than the federal government's capital contributions to construction has been the impact of the federal health care financing programs, Medicare and Medicaid. Medicare is the largest source of funding for most hospitals, and has had a great impact in shaping the hospital market. When they began in 1965, Medicare and Medicaid paid hospitals based on costs, giving hospitals an incentive to spend more, rather than less. This payment system fueled a huge expansion in hospital services and encouraged hospitals to invest heavily in capital resources. Id. at 140.

During the 1960s and 1970s, a number of programs were instituted in an attempt to contain the trend toward over-utilization of hospitals and over-investment in hospital facilities. These efforts focused on government planning regarding appropriate hospital expenditures. Eventually, this approach was largely abandoned in favor of a new reimbursement system adopted in the Social Security Amendments of 1983. These amendments implemented the Medicare prospective payment system ("PPS"), which, for most hospitals, replaced the cost-based reimbursement system for inpatient hospital care with a set of fixed prices established by the government. Under PPS, if a hospital's costs exceed Medicare's payment, the hospital must absorb the difference. Conversely, if the hospital's costs are less than the payment, the hospital keeps the excess. Id. at 141-142.

Due largely to the implementation of PPS, hospital admissions declined 14.9% from 1983 through 1993. During the same period, daily patient census declined 21%. American Hospital Association, Hospital Statistics, 1994-95 ed. at xxxviii, Table 2. While PPS does create incentives for hospitals to be efficient, many hospitals have been unable to fully achieve efficiencies. In large part, the difficulty in realizing these efficiencies has resulted from the pressure on hospitals to duplicate services offered by nearby hospitals in order to compete for patients. Id. at 142-143.

IV. The District Court's Finding that the Government Did Not Meet its Burden of Proof Must Be Upheld.

The government's brief completely disregards the unique elements of hospital markets, as well as the appropriate standard of review, and dwells instead on supposed limitations of the opinion of the court below, particularly with respect to geographic market definition. However, "it is always possible to take pot shots at a market definition." Rockford, 898 F.2d at 1285. Indeed, a casual reading of the government's brief would give the impression that the government, not the defendants, was victorious below. The simple truth, however, is that the government failed to meet its burden with respect to market definition.

A. It is the government's burden to establish a properly defined geographic market.

It is the government's burden to prove the relevant geographic market in any antitrust case. Adventist Health System/West and Ukiah Adventist Hosp., No. 9234 (F.T.C. April 1, 1994)(available on Westlaw)("Ukiah") at 4. Where the government does not meet its burden of proof, a case must be dismissed. Ukiah.

B. The government could not meet its burden because it only offered a static geographic market analysis.

1. The Elzinga-Hogarty test is a proper starting point for a market analysis, but is not conclusive since it provides only a static picture of the market.

One method often used as the first step in defining a geographic market is the Elzinga-Hogarty test, elements of which were employed by both of the experts in the present case. According to this test, a geographic market -- albeit a static one -- has been correctly defined if little of the product produced within the area is exported from the area ("little out from inside" or "LOFI") and little of the product produced outside of the area is imported into the area ("little in from outside" or "LIFO"). Elzinga & Hogarty, The Problem of Geographic Market Delineation in Antimerger Suits, 18 Antitrust Bull. 45 (1973)("Elzinga & Hogarty (1973)"); Elzinga & Hogarty, The Problem of Geographic Market Delineation Revisited: The Case of Coal, 23 Antitrust Bull. 1 (1978)("Elzinga & Hogarty (1978)"); Elzinga, Defining Geographic Market Boundaries, 26 Antitrust Bull. 739 (1981)("Elzinga (1981)").

Elzinga and Hogarty initially proposed that a geographic market be deemed correctly defined if LOFI and LIFO ratios were each at least 75%. Elzinga & Hogarty (1973), at 73-75. However, they acknowledged that the 75% figure was "somewhat arbitrary," and noted that those objecting to the figure could "readily substitute a higher (or lower) one into the estimate procedure." Id. at 75. In a subsequent article, which responded to criticisms of their first article, Elzinga and Hogarty stated that, rather than 75%, the required showing probably should be 90%. Elzinga & Hogarty (1978).

The primary drawback of the Elzinga-Hogarty analysis is that it provides a static, rather than a dynamic picture of the market. See James T. Halverson & Paul L. Yde, Purpose, Practicability, and Profitability in Merger Market Definition, in Collaborations Among Competitors: Antitrust Policy and Economics 553, 562 (Eleanor M. Fox and James T. Halverson, eds. 1991). In other words, the test only considers the places where patients currently travel to obtain health care services (a static analysis). The real inquiry is how far patients would travel for health care if prices within the area went up (a dynamic analysis). Current usage patterns are a factor to consider when trying to predict how usage would change if price went up, but they represent only the beginning of the geographic market definition process, rather than the end.

Many courts, including this Court, have recognized that the geographic market must include not only those areas (and those suppliers) to which consumers currently turn to obtain a product or service, but also those areas and suppliers to which consumers would turn if the price charged by local suppliers increased. Morgenstern v. Wilson, 29 F.3d 1291 (8th Cir. 1994), cert. denied, 115 S. Ct. 1100 (1995); see also, e.g., Tampa Elec. Co. v. Nashville Coal Co., 365 U.S. 320, 331-32 (1961)(defining the relevant geographic market as "the market area in which the seller operates, and to which the purchaser can practicably turn for supplies"); Morgan, Strand, Wheeler & Biggs v. Radiology, Ltd., 924 F.2d 1484, 1490 (9th Cir. 1991).

In Morgenstern, this Court rejected the geographic market proposed by the plaintiff because it was static rather than dynamic. The Court stated:

Morgenstern's expert focused upon where Lincoln and Omaha residents actually went, as opposed to where they could practicably go, for their cardiac surgery services, and specifically presented insufficient evidence regarding whether or not CVTS patients could practicably turn for alternative sources of the product to Omaha or other more distant heart programs.

Id. at 1296 (emphasis in original). Similarly, in Ukiah, the Federal Trade Commission itself held that evidence presented by Complaint Counsel in that case, which was based on the Elzinga-Hogarty test, was not, standing alone, sufficient to define the relevant geographic market. Id., slip op. at 8-9.

Clearly, an Elzinga-Hogarty test cannot be the end of the geographic market definition process. The next step in the analysis must be to determine what would happen if the firms within the proposed market raised their prices. While such future changes may be difficult to predict, the government cannot simply ignore the issue.

Several sources of data are relevant in making such a prediction. Historical examples, if any, of patient reaction to changes in price or other variables are one type of information that would be helpful in this determination. The distances that patients now travel to go to the merging hospitals is also relevant in that it is highly probative of how far they could travel to go to alternative hospitals. Other factors that should be considered include things such as the ease of transportation for patients and the importance to patients of the quality of care.

Statements of those who participate in the market can also be relevant. However, it must be remembered that such statements themselves often reflect static information. For example, if an annual report lists the organizations that a hospital considers its competitors, this typically represents, at most, the hospital's competitors at the time of the statement -- it generally does not take into account the possibility that, if the hospital were to raise its prices, patients would go further distances for services.

In this regard, patients who are enrollees of companies that have direct contracts with hospitals require special attention. As previously stated, these companies typically are particularly price sensitive. At the same time, these companies tend to extend the geographic market for hospital services because they are often willing to send their enrollees longer distances in return for better prices for hospital services. Significantly, the government's expert failed to even address this issue.

2. In defining the geographic market, the government's expert conducted only a static Elzinga-Hogarty analysis.

The government's expert economist, Professor Leffler, conducted only a static analysis. In both his written declaration and his hearing testimony, Professor Leffler limited his inquiry to the question of where patients currently go for inpatient hospital care. He failed entirely to determine where patients (and particularly managed care patients) would go if the hospitals within his proposed market attempted to exercise market power. Thus, the government's expert did not comply with the government's own 1992 Merger Guidelines, which require a dynamic, rather than a static analysis. The District Court correctly recognized that expert testimony that included only a static market analysis failed to meet the government's burden of proof in defining the geographic market.

3. The government's reliance on declarations and testimony that were not relied on by its own expert is misplaced because that evidence is unscientific and irrelevant.

In its brief, the government points to several pieces of additional evidence, apparently in an attempt to salvage Professor Leffler's insufficient market definition. It seems that the government is attempting to engage in post hoc rationalization by showing that, even if Professor Leffler had considered where patients would go if prices within the proposed market increased -- rather than merely where they currently go -- his results would have been the same.

In its attempt to rehabilitate Professor Leffler's market definition, the government relies primarily on statements of hospital administrators and employer representatives. However, the declarations of hospital administrators and other evidence on which the government relies are unscientific and irrelevant, and fall far short of transforming Professor Leffler's insufficient market analysis into a sufficient one. These statements fail to establish that a proper dynamic analysis would not have yielded a broader market than did Professor Leffler's static analysis.

Specifically, the government points to written declarations, included in the appendix to its brief, from administrators and officers of four hospitals located outside of Joplin. The issue that these declarations are apparently meant to address is whether a small but significant increase in price within the proposed relevant market would cause consumers to seek care outside of the proposed market. However, the statements of the individuals selected and interviewed by the government for purposes of litigation -- in most cases on an ex parte basis -- are not a reliable predictor of the future actions of market participants. In fact, the government does not even propose any explanation or theory as to why the statements of these individuals should be considered reliable predictors of the future actions of consumers within the market.

The declarations relied on by the government suffer from an even more fundamental flaw: they are based on the assumption that the geographic market is limited to the Joplin hospitals, yet even the government's own expert (using a static rather than a dynamic analysis) concluded that there were additional hospitals in the market, outside of Joplin. Once a dynamic analysis is applied, the geographic market can only get larger, not smaller.

The relevant issue for the hospital administrators questioned by the government -- assuming, arguendo, that these were the right people to ask -- would have been whether they believed that an increase in price by all the hospitals within the government's proposed market -- including an increase by the declarants' own hospitals -- would lead enough consumers to switch from using hospitals within the proposed market to hospitals outside of it to make the price increase unprofitable. Instead -- at best -- these individuals were asked whether they believed that an increase in the prices of hospitals located in Joplin itself would lead more people to use hospitals located outside of Joplin (even if those hospitals were located within the market defined by the government's own expert). The extent to which patients would switch from Joplin hospitals to hospitals located outside of Joplin but within the government's proposed markets says virtually nothing about the extent to which patients would switch from hospitals within the government's proposed market, including hospitals outside of Joplin, to hospitals outside of the government's proposed market. The government simply never asked the right questions.

As was previously noted, even if the government had asked the right questions of these individuals, there is nothing in the record to explain why their statements could be expected to be predictive of the responses of market participants. Setting that aside, however, there are other problems with the declarations. For example, one of the declarations addressed only the question of whether patients from Joplin would switch hospitals in response to a price increase; a proper inquiry must address not only whether Joplin residents would switch hospitals, but also whether residents of outlying communities within the market who currently travel to Joplin would switch to hospitals outside the market in response to a price increase.

In fact, the hospitals in Joplin, and the immediate area around Joplin -- St. John, Freeman, Freeman/Neosho, Oak Hill, and McCune-Brooks -- get a majority of their patients from "outlying" areas, with only 47.19 percent of their patients coming from Joplin and its nearby neighbors of Neosho and Carthage. Defendant's Exhibit 13. Therefore, the response of these patients from "outlying" areas to a price increase could have a significant effect on hospitals within the static geographic markets proposed by Professor Leffler.

The government also attempts to rely on the testimony of employer representatives. Once again however, this evidence does not address the right question. Specifically, the government points to the fact that John Hale, of the Tri-State Health Care Coalition, testified that, for certain services, it would not be feasible to switch Joplin residents from Joplin hospitals to hospitals such as Mt. Carmel and Baptist in response to a price increase. Brief of Plaintiff-Appellant at 24. However, Mr. Hale did not address the question of whether, for these services, it would be feasible to switch patients residing in outlying communities who currently use Joplin hospitals to their local hospitals in response to a price increase.

Moreover, Mr. Hale did testify that for certain services -- including "orthopedics, cardiology, and the like" -- it would be possible to steer patients (presumably Joplin residents as well as others) to outlying hospitals. Plaintiff's Appendix at 000328 - 000329. Thus, Mr. Hale's testimony actually suggests that an increase in prices in Joplin could lead to a loss of enough patients to force the hospitals to rescind the increase.

The District Court reasonably concluded that the declarations offered by the government were not sufficient to rehabilitate the static market defined by the government's expert. The District Court's judgment must be affirmed.

V. Conclusion.

Hospital markets differ in several significant ways from other markets and antitrust analysis must take these differences into account. Because only some of a typical hospital's business is price sensitive, any overly restrictive definition of the geographic market exaggerates a merger's potential to harm consumers. Furthermore, hospital mergers generally have much more potential for efficiencies than do mergers in other industries. Because hospital mergers are more likely than other mergers to benefit consumers, courts must be particularly wary of allowing sloppy market definition to skew antitrust analysis so that procompetitive hospital mergers are prevented.

In the present case, the government's expert witness used only a static analysis and the declarations offered to rehabilitate the expert were methodologically flawed. The government did not meet its burden of proof. See Ukiah. Given this critical omission, the defendants were not required to present any evidence, and the District Court properly denied the government's request for a preliminary injunction. See, e.g., Capital Imaging Assocs., P.C. v. Mohawk Valley Medical Assocs., 996 F.2d 537, 547 (2d Cir.), cert. denied, 114 S. Ct. 388 (1993)("Only after a plaintiff has successfully met its initial burden under the rule of reason must an antitrust defendant offer evidence to exonerate its conduct").

In its brief, the government attempts to muddy the waters by taking pot shots at the defendants' geographic market definition. However, the validity of the defendants' proposed geographic market is irrelevant because the government failed to meet its initial burden of proof. The District Court had no obligation to choose between the competing markets offered by the experts. The judgment for the defendants must be affirmed.


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