IN THE UNITED STATES COURT OF APPEALS
FOR THE EIGHTH CIRCUIT
Appeal No. 95-4253; Cross-Appeal No. 96-1051
UNITED STATES OF AMERICA,
Plaintiff/Appellant/Cross-Appellee,
v.
MERCY HEALTH SERVICES, and
FINLEY TRI-STATES HEALTH GROUP, INC.,
Defendants/Appellees/Cross-Appellants.

 

On Appeal from the United States
District Court for the Northern District of Iowa
(Eastern Division)

MOTION FOR LEAVE TO FILE BRIEF AMICI CURIAE AND
BRIEF AMICI CURIAE OF THE AMERICAN HOSPITAL ASSOCIATION AND
THE ASSOCIATION OF IOWA HOSPITALS AND HEALTH SYSTEMS
IN SUPPORT OF DEFENDANTS/APPELLEES/CROSS-APPELLANTS

Of Counsel: William G. Kopit
EPSTEIN BECKER & GREEN, P.C.
Fredric J. Entin 1227 25th Street, N.W.
Tracey L. Fletcher Suite 700
AMERICAN HOSPITAL ASSOCIATION Washington, D.C. 20037-1156
One North Franklin (202) 861-0900
Chicago, IL 60606
(312) 422-2777 Counsel for Amici Curiae
American Hospital Association and
J. Kirk Norris the Association of Iowa Hospitals
ASSOCIATION OF IOWA HOSPITALS and Health Systems
AND HEALTH SYSTEMS
100 E. Grand Avenue
Suite 100
Des Moines, IA 50309
(515) 288-1955

May 3, 1996
MOTION OF THE AMERICAN HOSPITAL ASSOCIATION AND
THE ASSOCIATION OF IOWA HOSPITALS AND HEALTH SYSTEMS
FOR LEAVE TO FILE BRIEF AS AMICI CURIAE

Pursuant to Rule 29 of the Federal Rules of Appellate Procedure, the American Hospital Association and the Association of Iowa Hospitals and Health Systems respectfully move this court for leave to file the accompanying brief as Amici Curiae in support of Mercy Health Services, and the Finley Tri-States Health Group, Inc., the Defendants/Appellees/Cross-Appellants. The parties to this action have consented to the filing of this Brief Amici Curiae; a copy of the consents of the parties is attached hereto.

Respectfully submitted,

By:
Of Counsel: William G. Kopit
EPSTEIN BECKER & GREEN, P.C.
Fredric J. Entin 1227 25th Street, N.W.
Tracey L. Fletcher Suite 700
AMERICAN HOSPITAL ASSOCIATION Washington, D.C. 20037-1156
One North Franklin (202) 861-0900
Chicago, IL 60606
(312) 422-2777 Counsel for Amici Curiae
American Hospital Association and
J. Kirk Norris the Association of Iowa Hospitals
ASSOCIATION OF IOWA HOSPITALS and Health Systems
AND HEALTH SYSTEMS
100 E. Grand Avenue
Suite 100
Des Moines, IA 50309
(515) 288-1955

May 3, 1996
IN THE UNITED STATES COURT OF APPEALS
FOR THE EIGHTH CIRCUIT
Appeal No. 95-4253; Cross-Appeal No. 96-1051

UNITED STATES OF AMERICA,
Plaintiff/Appellant/Cross-Appellee,
v.
MERCY HEALTH SERVICES, and
FINLEY TRI-STATES HEALTH GROUP, INC.,
Defendants/Appellees/Cross-Appellants.

On Appeal from the United States
District Court for the Northern District of Iowa
(Eastern Division)



BRIEF AMICI CURIAE OF THE AMERICAN HOSPITAL ASSOCIATION AND
THE ASSOCIATION OF IOWA HOSPITALS AND HEALTH SYSTEMS
IN SUPPORT OF DEFENDANTS/APPELLEES/CROSS-APPELLANTS
Of Counsel: William G. Kopit
EPSTEIN BECKER & GREEN, P.C.
Fredric J. Entin 1227 25th Street, N.W.
Tracey L. Fletcher Suite 700
AMERICAN HOSPITAL ASSOCIATION Washington, D.C. 20037-1156
One North Franklin (202) 861-0900
Chicago, IL 60606
(312) 422-2777 Counsel for Amici Curiae
American Hospital Association and
J. Kirk Norris the Association of Iowa Hospitals
ASSOCIATION OF IOWA HOSPITALS and Health Systems
AND HEALTH SYSTEMS
100 E. Grand Avenue
Suite 100
Des Moines, IA 50309
(515) 288-1955

May 3, 1996
TABLE OF CONTENTS

I. INTEREST OF THE AMICI CURIAE 1

II. STATEMENT OF THE ISSUES 2

III. THE DISTRICT COURT PROPERLY HELD THAT THE GOVERNMENT FAILED TO ESTABLISH THE RELEVANT GEOGRAPHIC MARKET 3

A. The Government Has the Burden to Establish the Geographic Market 3

B. The Government Must Use a Dynamic, Not Static, Analysis to Establish Geographic Market 4

C. By Presenting only a Static Elzinga-Hogarty Analysis, the Government Failed to Properly Define the Relevant Geographic Market in this Case 6

D. A Dynamic Analysis Reveals that the Geographic Market Proposed by the Government is too Small 8

E. The Trend Toward Managed Care Is Increasing the Distances that Patients are Willing to Travel for Hospital Care 10

IV. EFFICIENCIES ARE PARTICULARLY IMPORTANT IN HOSPITAL MERGER CASES 14

A. Potential Efficiencies Must be Weighed Against Potential Anticompetitive Effects 14

B. Hospital Mergers Tend to Yield Greater Efficiencies than Other Mergers 15

V. LIKELIHOOD OF ANTICOMPETITIVE EFFECTS 18

A. Higher Concentration Does Not Necessarily Mean Higher Prices 18

B. The Welfare Trade-Off 19

VI. CONCLUSION 20

TABLE OF AUTHORITIES

CASES

Adventist Health System/West and Ukiah Adventist Hosp.,
No. 9234, slip op. (F.T.C. Apr. 1, 1994) 3, 5, 8

Bathke v. Casey's General Stores, Inc.,
64 F.3d 340 (8th Cir. 1995) 5

Eastman Kodak Co. v. Image Technical Services,
504 U.S. 451 (1992) 6

FTC v. Elders Grain, Inc.,
868 F.2d 901 (7th Cir. 1989) 6

FTC v. Freeman Hospital, 69 F.3d 260 (8th Cir. 1995) 3, 4, 5, 6, 7

Hospital Corp. of America v. FTC,
807 F.2d 1381 (7th Cir. 1986), cert. denied,
481 U.S. 1038 (1987) 6

Morgan, Strand, Wheeler & Biggs v. Radiology, Ltd.,
924 F.2d 1484 (9th Cir. 1991) 4

Morgenstern v. Wilson,
29 F.3d 1291 (8th Cir. 1994), cert. denied,
115 S. Ct. 1100 (1995) 3, 4, 5, 8

Spectrum Sports, Inc. v. McQuillan,
506 U.S. 447 (1993) 3

Tampa Electric Co. v. Nashville Coal Co.,
365 U.S. 320 (1961) 4

United States v. Carilion Health System,
707 F. Supp. 840 (W.D. Va.),
aff'd, 892 F.2d 1042 (4th Cir. 1989) 7

United States v. Marine Bancorporation, Inc.,
418 U.S. 602 (1974) 3

United States v. Mercy Health Servs.,
902 F. Supp. 968 (N.D. Iowa 1995) 7, 8, 11, 12

United States v. Rockford Memorial Corp.,
898 F.2d 1278, cert. denied, 498 U.S. 920 (1990) 7, 18

White & White, Inc. v. American Hospital Supply Corp.,
723 F.2d 495 (6th Cir. 1983) 7

MISCELLANEOUS

Baker, Antitrust Analysis of Hospital Mergers in the Transformation
of the Hospital Industry, 51 L. & Contemp. Probs. 93 (1988) 13

Dranove, et. al., Price & Concentration in Hospital Markets: The Switch from Patient-Driven to Payer-Driven Competition, 36 J.L. & Econ (1993). 13

Elzinga, Defining Geographic Market Boundaries,
26 Antitrust Bull. 739 (1981) 4

Elzinga & Hogarty, The Problem of Geographic Market Delineation
in Antimerger Suits, 18 Antitrust Bull. 45 (1973) 4

Elzinga & Hogarty, The Problem of Geographic Market Delineation
Revisited: The Case of Coal, 23 Antitrust Bull. 1 (1978) 4

Fredric J. Entin, Jeffrey M. Teske & Tracey L. Fletcher, Hospital
Collaboration: The Need for an Appropriate Antitrust Policy, 29
Wake Forest L. Rev. 107, 116 (1994) 1, 16, 19

Gloria J. Bazzoli, David Marx, Jr., Richard J. Arnould, and Larry
M. Manheim, Federal Antitrust Merger Enforcement Standards: A
Good Fit for the Hospital Industry?, 20 19

Hewitt Associates, Salaried Employee Benefits Provided by Major
U.S. Employers in 1990 and 1995: A Comparison Study 22 (1996) 10

James T. Halverson & Paul L. Yde, Purpose, Practicability, and
Profitability in Merger Market Definition, in Collaborations
Among Competitors: Antitrust Policy and Economics 553, 562 (Fox
& Halverson eds. 1991) 5

M. Sachs, As HMOs Know, The Key Is Customer Satisfaction,
Modern Healthcare (June 13, 1994) 12


McGuirk & Porell, Spatial Patterns of Hospital Utilization:
The Impact of Distance and Time, 21 Inquiry 84 (Spr. 1984) 13

1992 Merger Guidelines 2, 5, 8, 10, 14, 15, 16

I. INTEREST OF THE AMICI CURIAE

Amici curiae the American Hospital Association ("AHA") and the Association of Iowa Hospitals and Health Systems ("IH&HS") respectfully submit this brief in support of Mercy Health Services and the Finley Tri-States Health Group, Inc., the Defendants/Appellees/Cross-Appellants.

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 advance the health of individuals and communities. The AHA leads, represents, and serves health care provider organizations that are accountable to the community and committed to health improvement. 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.

Amicus curiae IH&HS is a 501(c)(6) organization representing 120 member institutions and systems. A primary function of IH&HS is to take an advocacy role, including the filing of legal briefs, in support of issues on which there exists general consensus of the membership.

The AHA's and IH&HS'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 and IH&HS'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 and IH&HS's members. In addition, in evaluating any hospital merger, it is essential that efficiencies be thoroughly considered and properly weighed against any alleged potential anticompetitive effects. This is especially important given the structure and functioning of hospital markets. Because the government has failed to adequately address either issue, the AHA and IH&HS request permission to file this brief amici curiae.

II. STATEMENT OF THE ISSUES

Hospital markets are dynamic and rapidly changing. Inpatient services -- the only services at issue in this litigation -- are diminishing in importance as outpatient and home health services continue to be substituted. The government points to managed care as an agent for change. However, the government fails to recognize that the increased price sensitivity brought about by managed care itself transforms the markets within which managed care operates.

The immediate issue confronting the Court in this case is whether, under the applicable "clearly erroneous" standard of review, the district court's decision in favor of the merging hospitals should be affirmed. 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 consistently 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 consumers currently obtain services, but also on where they would seek services if the suppliers of the services 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. The district court in this case correctly found that the government had not met its burden.

In addition, hospital markets typically involve substantial overcapacity -- largely due to past government policy. As a result, hospital mergers and consolidations have become common in communities throughout the country. These mergers generally create efficiencies which permit hospitals to rationally reduce this overcapacity.

III. THE DISTRICT COURT PROPERLY HELD THAT THE GOVERNMENT FAILED TO ESTABLISH THE RELEVANT GEOGRAPHIC MARKET

A. The Government Has the Burden to Establish the Relevant Geographic Market

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)).

It is the government's burden to prove the relevant market in any antitrust case. Spectrum Sports, Inc. v. McQuillan, 506 U.S. 447 (1993); FTC v. Freeman Hosp., 69 F.3d 260, 269 (8th Cir. 1995); Morgenstern v. Wilson, 29 F.3d 1291, 1296 (8th Cir. 1994), cert. denied, 115 S. Ct. 1100 (1995); Adventist Health System/West and Ukiah Adventist Hosp., No. 9234, slip op. at 4 (F.T.C. Apr. 1, 1994) ("Ukiah"). Where the government does not meet its burden of proof, a case must be dismissed. Ukiah, slip op. at 4.

B. The Government Must Use a Dynamic, Not Static, Analysis to Establish Geographic Market

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. Freeman, 69 F.3d at 268; Morgenstern, 29 F.3d at 1296; see also 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).

One method often used as the first step in defining a geographic market is the Elzinga-Hogarty test. According to this test, which relies on current usage patterns, a provisional geographic market may be demarcated where 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"). Of course, the primary drawback of the Elzinga-Hogarty analysis is that it provides a static, rather than a dynamic picture of the market. In other words, the test only considers the places where patients currently travel to obtain health care services (a static analysis). Because the real inquiry is how far patients would travel for health care if prices within the area went up (a dynamic analysis), the Elzinga-Hogarty analysis can never be anything more than the starting point in the process of defining the geographic market. Ukiah, slip op. at 8.

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

In summary, the FTC's expert testimony addressed only the question of where patients currently go, rather than where they could practicably go, for acute care inpatient services. The bulk of the testimony from market participants suffered from a similar defect, since it spoke only to present competitor perceptions of the geographic market and present consumer preferences in seeking health care. . . . We therefore hold that the district court did not abuse its discretion when it determined that the FTC had failed to meet its burden of establishing the relevant geographic market.

Freeman, 69 F.3d at 271-72; see also Morgenstern, 29 F.3d at 1296; Bathke v. Casey's General Stores, Inc., 64 F.3d 340 (8th Cir. 1995). Similarly, in Ukiah, the Federal Trade Commission held that evidence presented by Complaint Counsel in that case, which was based on the Elzinga-Hogarty test, was not sufficient to define the relevant geographic market. Ukiah, slip op. at 8-9.

As one court has explained, "[i]n a normal market, sellers establish relations of mutual trust and advantage with particular customers, and the result is that at a given moment different sellers may have different customers," but customers "can be lured away by a better offer." FTC v. Elders Grain, Inc., 868 F.2d 901 (7th Cir. 1989). Thus, the relevant geographic market consists not only of those hospitals that today treat patients in Mercy's and Finley's service area, but also those hospitals that could successfully "lure" a sufficient number of Mercy and Finley's patients away if the hospitals in the market were to act anticompetitively.

Patients who are enrollees of managed care companies and employers that have direct contracts with hospitals require special attention. These companies can create price sensitivity which extends the geographic market for hospital services. In this regard, the amici supporting the government incorrectly assert that the Supreme Court held, in Eastman Kodak Co. v. Image Technical Services, 504 U.S. 451 (1992), that consideration of patient origin data itself was sufficient to define a geographic market. In fact, in that case, the Supreme Court ruled only that summary judgment on Kodak's market theory (unsupported by any record evidence) was improper, because the record indicated that the actual market reaction to the alleged restraint contradicted the theory propounded by the defendant. Id. at 470-72. In contrast, in this case, no restraint has occurred, and there is therefore no "actual market response from which to assess actual" anticompetitive effects.

C. By Presenting only a Static Elzinga-Hogarty Analysis, the Government Failed to Properly Define the Relevant Geographic Market in this Case

As in Freeman, the government's proposed market definition in this case must fail because it focuses only on the present. See Freeman, 69 F.3d at 268. Indeed, the failure of the government to consider what will happen tomorrow -- as opposed to what happened yesterday -- plagues not only its market definition, but also its claims regarding the potential of the merger to create anticompetitive effects. See, e.g., Hospital Corp. of Am. v. FTC, 807 F.2d 1381 (7th Cir. 1986), cert. denied, 481 U.S. 1038 (1987) ("HCA"). While a static inquiry regarding effect may be appropriate in other industries, it has no place in the dynamic and rapidly changing hospital industry.

As the Sixth Circuit has stated:

The "development of the industry" analysis is perhaps nowhere so important as in a "dynamic and constantly changing" business. An awareness that markets themselves are changing in size and product scope may allow a clear inference that a successful defendant is not seeking to monopolize the old, dying, smaller market (established by past sales), but is an emerging competitor in the new, developing, larger market.

White & White, Inc. v. American Hosp. Supply Corp., 723 F.2d 495, 507 (6th Cir. 1983). The government's underlying myopia regrettably is not new and has prompted judicial rejection in other hospital merger cases. Freeman, 69 F.3d at 268; United States v. Carilion Health Sys., 707 F. Supp. 840 (W.D. Va.), aff'd, 892 F.2d 1042, 1989 WL 157282 (4th Cir. 1989).

The Seventh Circuit's decision in United States v. Rockford Memorial Corp., 898 F.2d 1278 (7th Cir.), cert. denied, 498 U.S. 920 (1990), does not support a different result. Definition of a geographic market is highly fact-driven and, therefore, may be different in each case. Freeman, 69 F.3d. at 271. As the district court below correctly noted, unlike the facts in Rockford, the facts here show that:

There is strong evidence of (1) individuals' willingness to travel, given price incentives, (2) patient-doctor loyalty is not strong enough to overcome price differential, and (3) there are options other than the rural hospitals should DRHS raise prices.

United States v. Mercy Health Servs., 902 F. Supp. 968, 986 (N.D. Iowa 1995). The Rockford court held only that these facts were not present in that case. In any event, changes in the industry have obviously continued, if not accelerated, since Rockford, as the district court correctly noted. Thus, more recent health care antitrust cases have found broader geographic markets. See Ukiah; Freeman, 69 F.3d 260; Morgenstern, 29 F.3d 1291.

D. A Dynamic Analysis Reveals that the Geographic Market Proposed by the Government is too Small

The validity of the government's proposed geographic market can be assessed by analyzing whether the hospitals in the market proposed by the government could profitably engage in anti-competitive conduct, either by significantly increasing prices or significantly decreasing quality. If not, those hospitals to whom patients would turn in the face of a price increase must also be included in the market. In this connection, it is undisputed that hospitals today must rely on patients from a wider geographic area, given the decline in inpatient census. Mercy, 902 F. Supp. at 974. Over 47 percent of Mercy's and Finley's acute care patients came from outside the city of Dubuque (Ex. D-410 (A 1130-31)), and the loss of a substantial portion of these patients alone would be sufficient to make a price increase unprofitable. ((Ex. D-433-34) (A 1135(b) - 1135(c)); Harris Tr. at 2409-22). Thus, the argument of the amici supporting the government that patients at Dubuque's "core" must all be willing to be hospitalized outside of Dubuque in order for the district court's conclusions to be correct simply misunderstands the district court's "critical loss" approach.

The "critical loss" approach reflects the principles of the 1992 Merger Guidelines. In this case, both economists testified that the government's Merger Guidelines provide a general standard for analyzing the geographic market issue. (Noether Tr. at 390; Harris Tr. at 2375-76). Thus, the practical alternatives available to purchasers must be determined by analyzing whether a hypothetical monopolist "could profitably impose at least a small but significant and nontransitory increase in price." (Merger Guidelines §1.21; Noether Tr. at 390-91; Harris Tr. at 2376-77, 2388-89).

In this regard, Dr. Harris calculated that a "critical loss" of 8 percent of patient revenues would render a 5 percent price increase unprofitable. This works out to a reduction in average daily census of only 5.2 commercial patients between Mercy and Finley. Using the census average length of stay of four days, this means that a loss of only 1.3 patient admissions per day between Mercy and Finley would render a 5 percent price increase unprofitable. ((Ex. D-433-34) (A 1135(b) - 1135(c); Harris Tr. at 2409-22).

The government has presented no evidence contradicting Dr. Harris' analysis. Indeed, Dr. Noether, the government's expert, agreed with Dr. Harris's general approach (Noether Tr. at 398­401). Patient origin data analyzed by Dr. Harris also showed that a significant percentage of Mercy and Finley admissions are presently at risk of traveling to the regional hospitals. In fact, 23.7 percent of the inpatients treated at Mercy and Finley reside in zip codes from which 33 percent of the hospital admissions already occur at hospitals other than Mercy and Finley. (Ex. D-428 (A 1135); Harris Tr. at 2101-02). If 33 percent of admissions from an area are already to hospitals other than Mercy and Finley, residents from that area obviously have practical alternatives to Mercy and Finley.

In short, if a hypothetical monopolist controlling all of the hospitals within the government's proposed market attempted to increase prices by a small but significant amount, that monopolist would most likely be forced to rescind that price increase because it would cause too many patients residing in "fringe" areas to seek hospital care outside of the government's proposed market. Under the government's own Merger Guidelines approach, this indicates that the geographic market proposed by the government is too small.

E. The Trend Toward Managed Care Is Increasing the Distances that Patients are Willing to Travel for Hospital Care
Significantly, the district court in this case correctly recognized that the growth of managed care is working a profound transformation of the health care industry. In 1990, only twelve percent of employers offered a Preferred Provider Organization ("PPO"); by 1995, this figure had increased to 44 percent. Over the same time period, the number of employers offering a Point of Service ("POS") option increased from zero to 34 percent. Clearly, these arrangements bring increased price sensitivity to hospital markets.

The government sees this increased price sensitivity as nothing more than an additional reason to oppose hospital mergers. In its view, hospitals that presently compete largely with one another must be preserved as separate competitors so that as managed care plans increase the price-driven competition among hospitals, they will have a sufficient number of hospitals to play off against one another in order to obtain discounts.

While it is certainly true that managed care is increasing the degree of price competition among hospitals, it is also expanding the markets in which hospitals compete. This is occurring in several ways. First, by controlling utilization and by increasingly substituting non-inpatient services for inpatient services, managed care is reducing the number of inpatient days in any given population, making it necessary for hospitals to serve patients from greater and greater distances. Second, managed care is giving patients incentives to travel further for hospital care in order to save out-of-pocket costs. Thus, although it was once widely believed that patients were unwilling to switch hospitals if it meant switching doctors, or to travel further than their nearest hospital for care, these beliefs are rapidly being refuted as patients are confronted with financial incentives to use certain health care providers instead of others.

The district court in this case properly recognized that financial incentives could be used to induce patients to travel to the regional hospitals. Mercy, 902 F. Supp. at 982-83. As the district court correctly observed, "patients have only recently added out-of-pocket expenses to the list [of considerations in determining where to receive inpatient care.]" Id. at 972-73. Moreover, the court observed that payors are becoming increasingly sophisticated and capable of inducing their enrollees to receive inpatient care at a specific hospital by "requiring the enrollee to pay a higher percentage of the enrollee's hospitalization cost (a co-pay) if the enrollee chooses to be hospitalized at a non-preferred hospital." Id. at 973. Typically, economic incentives such as these are included in POS plans and PPOs. Dr. Harris, the Hospitals' expert in this case, observed that these plans are now "fairly common throughout the country," and "basically give the holder of the plan, in this case the employee, choice between going to two different hospitals. You can have different charges for in-network hospitals than out-of-network hospitals." (Harris Tr. at 2450-51).

Under managed care, health care consumers do consider their out-of-pocket costs in making hospitalization choices. The district court recognized this, noting that, as patients have moved away from traditional indemnity insurance, they have become much more aware of their out-of-pocket expenses. Mercy, 902 F. Supp. 973-74. Similarly, one commentator has observed:

Today's consumers are a new breed. They're changing their expectations, actions and attitudes as managed care begins to affect them. They're more likely to accept alternative delivery systems, such as HMOs, and are even willing to trade choice of physicians and hospitals for lower costs and benefits such as easier claims processing.

This reflects a dramatic shift in the conventional consumer mind-set. Choosing your own doctor used to be considered an inalienable and non-negotiable right. . . .

[W]hat's driving consumer choice and satisfaction isn't access to an unlimited choice of providers. It's price. The research shows that low deductibles are the primary reason consumers select HMOs.

M. Sachs, As HMOs Know, The Key Is Customer Satisfaction, Modern Healthcare (June 13, 1994).

The government and its amici assume (without any support) that patients would not consider differences in out-of-pocket costs when selecting a hospital. However, this assumption is completely contrary to the reality of managed care today, in which choice of providers is frequently limited in exchange for lower prices.

Amici supporting the government also ignore the district court's reasoning, and the modern trends in health care, by wrongly asserting that, if the merged hospitals raised prices, payors could not respond unless they reformulated their plans to "force" all enrollees to switch physicians and be hospitalized outside of Dubuque. (AAHP Amicus at 8-11).

However, employers are more likely to simply institute POS options, which permit patients to choose between in-network providers (with a lower out-of-pocket cost) and out-of-network providers (with a higher out-of-pocket cost). (Harris Tr. at 2631-32). Clearly, the government and supporting amici are mired in the past, when patients could consume physician and hospital services without regard to cost. Today's reality is that patients are increasingly responsible for a greater share of health care costs and, as a consequence, have economic incentives to travel to low cost hospitals. (Harris Tr. at 2450-51, 2466; Ex. D-435 (A 1136)).

In short, the growth of managed care increases price competition but, at the same time, changes the markets within which hospitals compete. Thus, managed care must be viewed not only as an engine driving increased price competition among hospitals, but also as a force that is continually expanding the markets over which such hospitals will have to compete for patients in the future. In order to remain viable in an environment increasingly influenced by managed care, hospitals of the future will have to eliminate excess capacity and unnecessary duplication on a local level, in order to allow them to compete regionally for a much broader base of patients. The government's failure to recognize the necessary consequences of managed care has led it to repeatedly challenge the wrong hospital mergers and dooms both its geographic market definition and its prediction regarding likely effects on competition in this case.

IV. EFFICIENCIES ARE PARTICULARLY IMPORTANT IN HOSPITAL MERGER CASES

A. Potential Efficiencies Must be Weighed Against Potential Anticompetitive Effects

The 1992 Merger Guidelines indicate that efficiencies can justify a merger that would otherwise be impermissible, stating:
Some mergers that the Agency otherwise might challenge may be reasonably necessary to achieve significant net efficiencies. Cognizable efficiencies include, but are not limited to, achieving economies of scale, better integration of production facilities, plant specialization, lower transportation costs, and similar efficiencies relating to specific manufacturing, servicing, or distribution operations of the merging firms. The Agency may also consider claimed efficiencies resulting from reductions in general selling, administrative, and overhead expenses, or that otherwise do not relate to specific manufacturing, servicing, or distribution operations of the merging firms, although, as a practical matter, these types of efficiencies may be difficult to demonstrate.

1992 Merger Guidelines § 4.1.
However, the Merger Guidelines give little guidance as to how claimed efficiencies are to be weighed against the other factors relevant in a merger analysis, stating only that the "expected net efficiencies must be greater the more significant are the competitive risks . . ." Id. In reality, the antitrust enforcement agencies have paid little attention to the significant efficiencies in the hospital mergers that they have challenged.

B. Hospital Mergers Tend to Yield Greater Efficiencies than Other Mergers

Technological advances and a greater emphasis on cost containment have resulted in more services being rendered in outpatient settings. Between 1983 and 1993, outpatient visits grew nearly 75 percent, from 210 million to over 366 million, and the number of outpatient surgeries increased by over 167 percent. The rapid growth of outpatient care has left many hospitals with excess inpatient capacity. Average hospital occupancy rates declined from 75.9 percent in 1980 to 63.5 percent in 1991. Hospital admissions declined 14.9 percent from 1983 through 1993. During the same period, daily patient census declined 21 percent. American Hospital Association, Hospital Statistics, at xxxviii, table 2 (1994-95 ed.). As a result, many hospitals are now supporting costly and underutilized infrastructures.

Because hospitals today typically have substantial excess capacity, hospital mergers are more likely than mergers in other industries to result in efficiencies, both in terms of costs and quality. 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 inpatient 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. See 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, which, when they began in 1965, 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. In 1983, the Medicare program adopted a new reimbursement system known as the 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 141-42.

While PPS and the recent changes in the structure of health care markets have created 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.

The commercial third party payor system has also contributed to the difficulties that hospitals have had in achieving efficiencies. Before managed care became prevalent, hospitals were selected almost exclusively by physicians or patients. Even today, this remains the case for patients covered by government insurance or by traditional commercial insurance, for whom the cost of the care is of little or no concern, and who select a hospital based primarily on amenities and the range of services provided, rather than on price. This creates an incentive for hospitals to make investments that would not be feasible in a more typical market and results in the persistence of excess capacity. Hospital mergers are often an effective way to decrease this unnecessary excess capacity and duplication and thus to decrease costs to consumers.

V. LIKELIHOOD OF ANTICOMPETITIVE EFFECTS

A. Higher Concentration Does Not Necessarily Mean Higher Prices

The ultimate question in any merger case is whether the merger is likely to harm consumers through higher overall prices or lower overall quality. The inquiry into the size of the geographic market and the extent of the efficiencies is not an end in and of itself, but is, instead, intended to help in the determination of the likely effects of the merger on consumers. In considering this question, it is important to note that hospital markets do not behave like markets in many other industries and that hospital mergers are not directly analogous to mergers of other types of companies.

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. 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. In short, in hospital mergers, the traditional assumption that any transaction that significantly increases market concentration will automatically lead to an increase in price is simply not valid.

B. The Welfare Trade-Off

One important consideration in evaluating the likelihood of anticompetitive effects in a hospital merger case is the fact that an increase in concentration in a hospital market will not necessarily lead to an increase in price. Perhaps equally important is the fact that, even if prices do increase, the merger will not harm consumers unless the increase in price is so great that it off-sets the efficiencies generated by the merger. Ultimately, to accurately assess the likely effects of a hospital merger, it is necessary to undertake a welfare trade-off, which will reveal whether any likely price increase could outweigh the likely efficiencies. At this point, it must be taken into account that even a hospital with monopoly power can only raise prices as to a fraction of its patients -- that is, commercially insured patients. Out of that group, it is managed care -- which is most likely to have negotiated discounts prior to a merger -- that is most likely to experience increased prices as a result of any hospital merger. Once one considers that price increases to government payors (which account about half of all hospitals' revenues) are impossible, and that the primary area of concern is increases in prices paid by managed care payors, the price increases that would be necessary to offset the efficiencies from any hospital merger are likely to be enormous. In this case, there is little reason to believe that any increase in price would outweigh the efficiencies.

VI. CONCLUSION

The government's market definition in this case focuses on present hospital usage patterns and does not properly consider the question of where consumers could and would turn for alternatives in the event of a price increase. The government also fails to consider several important ways in which hospital mergers differ from mergers in other industries. For instance, because only a fraction of a hospital's patients can experience higher prices as a result of a merger, in order to offset the efficiencies from a merger, the price increases to that group must be much larger than would be necessary if, as in other industries, all customers could experience a price increase. 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. The decision of the district court that the government had not met its burden in this case was not clearly erroneous.

The judgment for the defendants must be affirmed.

CERTIFICATE OF SERVICE

I hereby certify that, on this date, I caused a true and correct copy of the accompanying MOTION FOR LEAVE TO FILE BRIEF AMICI CURIAE AND BRIEF AMICI CURIAE OF THE AMERICAN HOSPITAL ASSOCIATION AND THE ASSOCIATION OF IOWA HOSPITALS AND HEALTH SYSTEMS IN SUPPORT OF DEFENDANTS/APPELLEES/CROSS-APPELLANTS and the CONSENT of both parties to the filing of this brief, to be served by overnight delivery on:

David A. Ettinger, Esq.
Howard B. Iwrey, Esq.
Honigman Miller Schwartz and Cohn
2290 First National Building
Detroit, Michigan 48226

Jesse Caplan, Esq.
United States Department of Justice
Antitrust Division
Liberty Place Building
325 7th St., NW
Room 416
Washington, DC 20530

Eugene Cohen, Esq.
United States Department of Justice
Antitrust Division
649 North Second Avenue
Phoenix, AZ 85003

Richard L. Schwartz, Esq.
New York State Department of Law
Antitrust Bureau
Attorney General's Office
120 Broadway, Suite 26-01
New York, New York 10271

David Marx, Esq.
McDermott, Will & Emery
227 West Monroe Street
Chicago, Illinois 60606-5096
Tanya B. Vanderbilt
Date: May 3, 1996.

 

 

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