Bureau of Competition Federal Trade Commission ANTITRUST ENFORCEMENT AND HOSPITAL MERGERS: A CLOSER LOOK ROBERT F. LEIBENLUFT, ESQ.

Assistant Director, Health Care Presented at the "First Friday Forum" of the Alliance for Health Grand Rapids, Michigan

INTRODUCTION
I appreciate the opportunity to be here today to discuss federal antitrust enforcement involving hospital mergers. Members of my staff spent considerable time in and around this city two years ago when we challenged the merger between Butterworth Health Corporation and Blodgett Memorial Medical Center. As you all are aware, of course, we did not prevail in that challenge, and the merger has in fact taken place.(1) I do not intend to discuss that case specifically at any length, but to step back and take a look at the bigger picture -- to explain how we view hospital competition, and address some of the concerns we have heard expressed about the appropriateness of applying merger law to hospitals.(2) The increasing consolidation of hospital markets -- and the federal antitrust response to those consolidations -- are issues not only of significant interest in this community, but also of national concern. As we all are aware, antitrust enforcement in this area can raise complex and difficult issues. I know that some observers believe that we have not been sufficiently sensitive to some of these issues. On the other hand, I believe that many of the criticisms that have been leveled at our enforcement program are oversimplified, do not sufficiently acknowledge the range of consumer benefits that can flow from hospital competition, and do not recognize the breadth of our analysis or acknowledge the extent to which the facts of hospital competition in each market can differ. I would like to spend my time today examining some of these misconceptions. I am particularly happy to be able to speak to this group, not only to explain why we think preservation of competition among hospitals is important, but also to encourage you to continue to be actively involved in the changes taking place in the Grand Rapids health care market. Each hospital market is different, and in every case federal antitrust enforcement agencies have to analyze in depth the particular facts relating to the nature of hospital competition in that market. It is important for members of the local community to keep abreast of issues and developments affecting health care delivery in their communities, and to make their knowledge, experience, and views known to the enforcement agencies.

Before I get to the heart of my talk, I need to lay some groundwork by first briefly reviewing some of the changes that have marked hospital competition in recent years, and then summarizing the basic steps in the analysis that applies to all mergers the agencies consider, including hospitals.

THE NATURE AND IMPORTANCE OF HOSPITAL COMPETITION

As you well know, changes in both public and private reimbursement systems over the past few decades have led to a dramatic transformation of health care markets. These changes have promoted price and quality competition among hospitals, and have prompted unprecedented consolidation in the hospital industry. Much of the consolidation is designed to achieve substantial efficiencies in a sector that for many years was shielded from vigorous price competition. On the other hand, as the number of competing hospitals or hospital systems dwindles to only two or three in many local markets, including some major metropolitan areas, additional consolidation may lead to higher prices and to the dampening of further efforts to achieve efficiencies. Such consolidation also may erect barriers to entry or further development of managed care, which has been a primary force in creating a more competitive environment for hospitals and other health care providers.(3) The substantial and persistent increases in the cost of health care services that began in the late 1960s and have continued since then have led directly to the changing market realities for hospitals. U.S. aggregate annual expenses for health care passed the trillion dollar mark in 1996, while the percentage of the Gross Domestic Product accounted for by health care rose steadily from 5.1% in 1960 to 13.6% in 1993 (where it stayed through 1996). Hospitals account for a substantial share of such increases, as they represent the single largest category of health care expenditures (almost 40% of all personal health care expenditures).(4) These increases in health care costs have a number of causes, including increased demand flowing from private and government health benefits plans, the development of new and expensive technologies, and the aging and growth of the population. However, payment systems that rewarded volume rather than efficiency in providing services, and that promoted patient indifference to price, also helped fuel health care cost inflation. Comprehensive indemnity health insurance coverage imposed minimal, if any, out-of-pocket costs on patients, and afforded them an unrestricted choice of providers. Insured patients therefore had little incentive to select lower cost or more efficient providers. And until relatively recently, insurance companies and government payers generally reimbursed hospitals on the basis of charges or costs. In such an environment, hospitals found it most profitable to provide expensive, high-intensity services, and faced little constraint on incurring costs. Because neither patients nor their referring physicians were price sensitive, hospitals had little incentive to compete on price or efficiency. The pressure of rapidly increasing costs caused employers and governments to search for new ways of structuring and managing their purchases of services in order to reduce the rate of increase in the costs they bear. Enactment of the Medicare Prospective Payment System in 1983 and the development of managed care plans have dramatically changed the environment within which hospitals operate. Increasingly, managed care plans are stimulating price and quality competition among health care providers or systems of providers by negotiating contract rates, selectively contracting with hospitals and other health care providers offering the best value for the dollar, and using financial incentives (such as lower co-payments and deductibles) to encourage patients to choose lower-priced hospitals. In addition, managed care plans increasingly are attempting to use payment methodologies that involve more comprehensive payment units -- such as per day, per case, or per capita rates -- that shift more financial risk for overutilization and the cost of services to hospitals, and thereby create incentives for more efficient operation. Employers and other payers have been able to capitalize on their position as volume purchasers to gather price, quality, utilization, and outcome information, and thus to make better-informed purchasing decisions.(5) Thus, increased competition has put pressure on many hospitals to find ways to reduce their operating costs and excess capacity, reap economies of scale, and develop broader-based structures that are large enough to accept payment arrangements that place the hospitals at financial risk. There is a variety of evidence that increased reliance on price competition in health care benefits consumers. Perhaps most compelling is the dramatic decline in health care inflation rates over the past four years, which has

occurred in the absence of any substantial government health care reform program and which has been generally attributed to market forces. Health care spending as a share of gross domestic product (13.6%) remained unchanged from 1993 through 1996. The rate of growth of those expenditures in 1996, 4.4% (or 1.9% after adjustment for inflation), was the lowest in 37 years.(6) The rate of growth in employer health care costs, which in the view of many threatened the ability of U.S. firms to compete in global markets, has been curtailed, and costs increased only slightly in 1997.(7) Industry observers credit the increased presence and activity of managed care plans (and the resulting competition in the insurance and provider markets), and the greatly increased enrollment of workers in such plans, for the slowdown in health care cost inflation.(8) Moreover, there appears to be growing empirical evidence that increased managed care penetration and increased managed care competition are associated with lower health care (including hospital) costs; that increased hospital concentration is associated with lower managed care penetration; and that increased hospital concentration is associated with higher hospital prices and a higher rate of increase in hospital costs.(9) Despite competitive pressures, most hospitals are in good financial condition. In fact, hospital profits increased significantly last year. According to the most recent data available from the American Hospital Association, aggregate hospital industry profits rose 24.7% in 1996 to more than $21 billion, setting new industry records. Total hospital revenues increased 4%, while expenses rose only 2.9%.(10) Data reported by the Prospective Payment Assessment Commission show that as a result of the financial pressures they face, hospitals have been able to reduce costs enough to improve their financial performance in recent years.(11)

OVERVIEW OF MERGER ANALYSIS

The increased pace of hospital consolidation, promoted by the factors discussed above, has raised the specter, and sometimes the reality, of antitrust enforcement involving hospital mergers. Before I go on, let me offer, as briefly as possible, some necessary background information concerning the legal standard for challenging hospital mergers, and about how we analyze particular fact situations pursuant to that standard. Analysis of mergers generally takes place in the context of Section 7 of the Clayton Act, which was designed to preserve competition by prohibiting mergers or acquisitions likely to substantially reduce competition or to tend to create a monopoly in any market.(12) The Department of Justice and Federal Trade Commission have jointly issued guidelines that describe the analytical framework they use in analyzing mergers among firms that operate in the same market.(13) The ultimate question is whether the transaction is likely to create or enhance market power or to facilitate its exercise, market power being the ability of a seller profitably to maintain prices above competitive levels for a significant time, or to lessen competition concerning other dimensions such as quality, service, or innovation.(14)

Merger analysis generally encompasses the following factors:

Market definition. This phase of the analysis identifies alternative suppliers to the merged firm to which consumers could turn.(15) The purpose of this inquiry is to tell us whether the merged firm could successfully raise prices (or diminish quality or service), or whether, if it attempted to do so, it would lose so much business to other providers of the same service, or to providers of other services, as to make that action unprofitable. The loss of business can occur at the fringes of the market, even if consumers in the market core have no practicable alternatives, if the loss would be sufficient to keep the merged firm from raising prices. This would be the case, of course, only if the firm does not have the ability to charge higher prices to buyers who do not have good alternatives, and lower prices to buyers who do have choices. Product market. In hospital merger cases, the product market under consideration often is the cluster of general acute care inpatient services, which includes the range of services and capabilities necessary to meet the medical, surgical, and other needs of patients. While individual components of this cluster are not substitutes for one another for any individual patient, these are the core services that hospitals provide, for which there are no adequate substitutes. In some cases, depending on the capabilities of other firms in the geographic market, the effects of a

merger may be felt in a narrower product market, such as primary care services, or the market for particular specialized services, such as obstetrics. Geographic market. Defining the geographic area within which competition takes place often is a difficult issue in hospital merger cases. Because employer health plans generally determine the price options that consumers face -both because the plans negotiate the prices, and because many plans incorporate financial incentives for patients to use certain providers -- we have to look at the likely responses of the health plans to a possible price increase, and at the effect their actions are likely to have on patient choice. Patients' choices, in turn, often are based on a number of factors, including the perceived quality of providers, distance to alternative suppliers, traditional loyalties, physician practice patterns, and the price (or effective cost to the patient). Market concentration and competitive effects. Market concentration is a function of the number of firms in the market and their respective market shares. The Merger Guidelines set market concentration thresholds at which concern about potential anticompetitive effects may arise that clearly are below the level at which we normally bring an enforcement action in hospital merger cases.(16) However, as the Guidelines themselves make clear, concentration is only the beginning of the analysis. First, factors such as changing market conditions, and the degree to which other suppliers are close substitutes for the merging parties, affect the extent to which changes in concentration resulting from the merger adequately predict the competitive significance of a merger.(17) Moreover, the critical question is whether the merger, in light of other market characteristics, is likely to have anticompetitive effects.(18) The analysis of this question includes examination of the nature of current and likely future competition in the market and the views of customers regarding the effects of the merger. In many cases, these factors will indicate that a hospital merger is not likely to threaten competition. Accordingly, most mergers that increase concentration are not challenged, or even extensively investigated, by the Commission staff. Likelihood of entry or repositioning of firms already in the market. The agencies also consider whether, if market prices were to rise as the result of a merger, new firms would be likely to enter the market, or to reposition themselves in a market they already serve, in a timely manner so as to deter or counteract the anticompetitive effects likely to flow from the merger.(19) In the case of hospitals, timely entry often is not likely because of certificate-ofneed restrictions and the delays associated with hospital construction. Efficiencies. The agencies also consider whether the merger would produce efficiency gains that could not practicably be achieved by the parties by other means and, if so, whether those gains likely would reverse the merger's potential to harm consumers. This could occur if the efficiencies generated by the merger would enhance the merged firm's ability and incentive to compete, resulting in lower prices, improved quality or service, or new products. For example, a merger might permit two weak hospitals to become a more effective competitor, or reduce costs in a way that lessens the hospital's incentive to raise price. However, where the potential adverse competitive effects of a merger are particularly large, extraordinarily great efficiencies would be necessary to prevent the merger from being anticompetitive. Under the Horizontal Merger Guidelines, efficiencies almost never would justify a merger to monopoly or near-monopoly.(20) Failing Firm. Finally, the agencies consider whether either party to the merger would be likely to fail in the absence of the merger, thus removing it from the market in any event. If so, the merger is not likely to impair competition that otherwise would exist.(21)

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The merger of the Blodgett and Butterworth hospitals clearly raised significant concerns under the standards just discussed. The two hospitals were the major institutions in the area, they were vigorous competitors of one another, and we thought the costs of lost competition would outweigh whatever efficiency benefits might result. Indeed, Judge McKeague in his opinion acknowledged that the Commission had established its prima facie case that the proposed merger would violate Section 7 of the Clayton Act, and that the hospitals would have substantial power over price in the market after the merger.(22) His refusal to enjoin the transaction was based on his belief that the merged entity,

because of its nonprofit status and the presence of community leaders on its board of directors, would not use that power to the detriment of consumers. I will address those issues in a moment. While my purpose today is not to reargue the Butterworth decision, I would like to briefly address one area of confusion that arose concerning the procedures involved in that case. In establishing the Federal Trade Commission in 1914, Congress intended that the Commission issue and adjudicate complaints, including complaints challenging mergers, through an administrative proceeding, rather than through the courts. Congress adopted this system on the premise that an expert agency would be best suited to adjudicate the variety of matters the Commission was authorized to consider, including particularly, difficult antitrust issues.(23) In 1973, Congress expanded the Commission's authority by allowing it to seek a preliminary injunction in federal court to prevent threatened violations of the law pending completion of administrative proceedings before the Commission. The injunction is intended to maintain the status quo and avoid the "scrambling" of assets, and thus to protect the Commission's ability to order effective relief, pending full resolution of the issues in the administrative forum, and to prevent interim harm to competition. The preliminary injunction is an aid to the administrative process rather than a substitute for it, and the hearing is not intended to be the vehicle for a definitive resolution of the underlying issues. Judge McKeague's opinion reflects a full understanding of this standard, and an expectation that administrative litigation could follow denial of the preliminary injunction. And the FTC's appeal of Judge McKeague's decision to the 8th Circuit involved only the propriety of his denial of the preliminary injunction; its decision did not purport to finally adjudicate the merits of the underlying case. Thus, the Commission's challenge to the merger in administrative litigation after the preliminary injunction was denied was not an effort to get a "third bite at the apple," but rather simply to seek, as Congress had intended, a full hearing on the merits which would allow for a more detailed consideration of the complex issues in the case. The Commission also has implemented rules, however, that allow it to reconsider whether it should proceed in a matter after a preliminary injunction has been denied.(24) As you know, in this case, after careful consideration, the Commission concluded that a further hearing would not be in the public interest, so it dismissed the administrative complaint, thereby allowing the merger to proceed.(25)

SOME MISCONCEPTIONS ABOUT APPLICATION OF ANTITRUST LAW TO HOSPITAL MERGERS

With that background behind us, I would like to focus on several misconceptions about the application of federal merger law to hospitals. As I have stated, every merger case requires a fact-specific analysis of the nature of competition in the market and the likely impact of the particular merger in question. Hospital mergers are no different; the distinctive features of each hospital market must be taken into account in analyzing the potential competitive effects of a proposed hospital merger in that market. I am concerned, however, that in pointing out some of the distinctive aspects of hospital competition, opponents of hospital merger enforcement have painted with too broad a brush -- leaving the impression that hospitals are so unique that a different antitrust standard should be applied to the industry, or that hospital merger antitrust enforcement should even be abandoned altogether. As I will describe below, such views are based on what I believe are a number of serious misconceptions.

Misconception #1: The federal government has no legitimate interest in local hospital mergers.
Hospital mergers generally are distinctly local in nature, and some have argued that the federal government has little interest in such matters, and should leave whatever review is appropriate to the local community or to state officials. However, the federal agencies have several compelling reasons for taking an active part in ensuring vigorous local hospital competition.

The federal government's interest as a buyer. The federal government, of course, has a direct interest in hospital competition as a buyer: in 1996 it paid just over 50% of all hospital care expenditures (up from 17.3% in 1960 and 41.4% as recently as 1990), amounting to $181.6 billion.(26) With respect to Medicare, while prices are to a large extent set administratively under the traditional fee-for-service program (whereby hospitals are paid under a prospective payment system), Medicare beneficiaries derive direct benefits from hospital competition on quality, and from the ability to choose the hospital that best services their needs. Moreover, the government is attempting to move Medicare increasingly toward a competitive model. Medicare now offers beneficiaries in many areas the option of enrolling in HMOs that are paid by the government on a fixed, per-enrollee-per-month basis, and that generally offer more extensive benefits than the standard Medicare program. The level of benefits offered, if not the cost of the program in the short run, is directly determined by competition among health plans, which in turn requires competition among hospitals and other care providers. Medicare enrollment in such managed care plans increased 132% from 1992 to 1997, and now represents 14% of the total Medicare population.(27) The Congressional Budget Office has projected that Medicare beneficiary enrollment in managed care plans will increase from less than six million in 1998 to almost 11 million in 2002.(28) And competition among hospitals and other providers may be an important factor in the decision of Medicare HMOs to enter particular geographic markets.(29) The federal government likewise bears a major portion of the cost of state Medicaid programs. The states increasingly are moving Medicaid recipients into managed care plans paid on a per person or fixed-budget basis in an effort to provide better service at a lower cost. Enrollment in Medicaid managed care plans increased 170% from 1992 to 1997, and accounted for 40% of the total Medicaid population in 1997.(30) The federal government's interest in the overall economic impact of health care costs. More broadly, the federal government, and consumers throughout the nation, have a stake in hospital competition. Hospitals have a major impact on competition and costs in health care markets generally. Hospital costs are a large part of the overall health care costs, and hospitals often have additional competitive significance as the hub of health plans' provider networks. Aggregate health care costs and rates of increase in the past few decades are without question a national concern, as well as a concern of each local community. In the aftermath of the recent Congressional consideration, and rejection, of various nationwide health care reform proposals, it appears that we as a nation, at least for the present, have decided to rely on market forces, rather than extensive government oversight or operation of the health care system, as the principal means of regulating the hospital and other health care industries. The only alternatives to competition are private, unregulated market power or comprehensive government regulation. The latter course has been rejected; and the former course holds serious dangers for consumers and for the health of the economy generally. The federal government's interest in protecting consumers. The overriding national policy is that competition will govern the economy unless Congress creates a specific exemption from the antitrust laws, or a state clearly decides to displace competition with regulation and commits to actively reviewing private conduct undertaken pursuant to the regulatory scheme. Congress has not created an antitrust exemption for hospitals, and only a few states have adopted a regulatory system that might allow merging hospitals to seek state review that would preempt federal oversight.(31) It is sometimes suggested that antitrust enforcement concerning hospitals should be left to the states, on the assumption that state authorities are closer to the needs and concerns of the affected population. It is, indeed, our policy to cooperate with state enforcement officials whenever possible, and on a number of occasions we have brought antitrust actions jointly with state authorities. In general, however, state attorney general offices do not have the resources necessary to conduct an independent legal challenge to a proposed hospital merger. Consequently, responsibility for protecting the public interest in competition must, in most cases, fall to the federal authorities.

Misconception #2: Competition for Managed Care Contracts Does Not Benefit the Public.

In the Butterworth case, Judge McKeague stated that the price concessions obtained by managed care plans as a result of the competition between the two hospitals were "illusory" because they resulted in a shifting of costs to other payers, and that they were not entitled to the protection of the antitrust laws. (32) I strongly disagree with Judge McKeague's view that managed care contracting is simply a device to obtain favorable prices for a few selected groups of buyers, and is not of benefit to the public at large. On the contrary, it is primarily through managed care contracting that market forces currently are brought to bear on hospitals.(33) The existence of large, knowledgeable, and price-sensitive buyers, willing and able to shift patients among available providers, prompts hospitals to engage in a full range of activities to respond to these buyers, including finding ways to operate more efficiently, adopting innovative payment arrangements, and doing whatever is necessary to attract and retain business. In many areas, managed care plans are growing rapidly, and in some places cover a large percentage of the commercial population. And as I noted earlier, managed care techniques also are being applied increasingly to the Medicare and Medicaid programs. Moreover, the activities that hospitals undertake to improve quality and efficiency in response to managed care may very well create benefits for the rest of the population. I believe it is seriously short-sighted to dismiss managed care plans as the beneficiaries of favorable discounts at the expense of the rest of consumers. On the contrary, selective contracting is the mechanism that forces hospitals to operate more efficiently and to innovate. The very process of competing for customers against market rivals forces firms to become more productive, to increase product quality and service, and to reduce costs and margins -- to the benefit of the public as a whole. Clearly, existing managed care organizations have given rise to some criticisms and concerns. Many plans are evolving rapidly in response to these concerns, and to customer demands; those that do not will be forced out of the market by competitive forces. But managed care exists only because of the demand from employers, the ultimate payers, and it is increasing rapidly because it appears to have succeeded in significantly reducing the rate of increase in employers' health benefits premiums. The remedy for imperfections in existing managed care arrangements is to make the market work better, by providing more and better information to consumers, thereby permitting them to make better informed choices among providers and health plans. You in this audience are in the best position to demand the development of plans that address all your concerns (and those of your employees), including quality and service as well as price. Finally, competition among hospitals stimulates competition based on quality. As is recognized in the recent report of the President's Advisory Commission of Consumer Protection and Quality in the Health Care Industry, ongoing progress in developing mechanisms to measure and report quality differences among providers will permit competition based on quality to become a more important factor in choices made by health plans, other purchasers, and consumers.(34) Noting that increased value-based purchasing by health plans has the potential to stimulate quality improvement by providers generally, the report recommends using market forces to promote the nationwide quality improvement agenda it describes.(35)

Misconception # 3: Antitrust enforcement has been stifling beneficial hospital combinations.

Let me offer some perspective on the number of challenges to hospital mergers actually brought by the federal antitrust enforcement agencies. Since the Commission brought its first hospital merger case in 1981, it has taken enforcement action against 21 hospital merger transactions. From fiscal years 1981 though 1997, the Federal Trade Commission and Department of Justice received 956 premerger filing involving general acute care hospitals, but the two agencies combined challenged only about 2% of those transactions. The fact is, that most hospital mergers do not warrant government action; we investigate only a few, and challenge even fewer. We recognize that there is excess capacity in many sectors of the hospital industry, and we have not challenged activities designed to consolidate and thereby achieve efficiencies, so long as they do not significantly impair market-wide competition that otherwise could exist. We have intervened only where necessary to preserve for consumers the benefits that flow from competition.

In light of both the continuing flurry of hospital mergers and other types of collaborative activities, and the relative scarcity of litigated cases involving such conduct, it is doubtful that the threat of antitrust enforcement, much less its actuality, has had a negative effect on the level of such activities. The fact that we have challenged so few mergers, paradoxically, has given rise to the complaint in some quarters that our decisions to challenge some mergers are arbitrary, and fail to give sufficient guidance to hospitals that are considering merging. To some extent, I suppose, this is the inevitable result of the fact that our enforcement decisions are based on in-depth review of the market in question, and do not depend on any simple formula. Thus, simply looking at the basic facts of the number and size of the hospitals in a market is not enough to predict whether a merger would pose a significant danger to competition. Moreover -- in order to protect the persons from whom we obtain information, including both the parties to a merger under investigation and the third parties from whom we seek information -- we are prohibited from disclosing to the public much of the information upon which our decisions are based. Consequently, we typically cannot explain in detail why we challenged one merger, and let another proceed unopposed. On the other hand, I believe that informed antitrust counsel can predict with a great deal of accuracy the types of transactions that are likely to cause the most concern. Finally, it needs to be understood that the antitrust laws do not stand in the way of joint ventures short of merger that permit hospitals to achieve efficiencies without unnecessarily sacrificing competition among themselves. For example, our Health Care Policy Enforcement Guidelines explicitly sanction joint ventures among hospitals to provide a specialized clinical service or to purchase and operate expensive equipment that neither profitably could support individually.(36) Thus, in many cases it is possible for hospitals to cooperate in bringing new services into the community, while preserving competition for services that can profitably be provided competitively. Other types of collaboration -- for example, joint ventures to provide maintenance and support services, or to purchase supplies jointly -- rarely endanger competition, and thus do not raise antitrust issues, in most instances.

Misconception # 4: There is no need for merger enforcement involving nonprofit hospitals.

Some commentators have argued that antitrust principles developed in the context of for-profit firms are not appropriately applied to nonprofit hospitals,(37) and some district court judges appear to have adopted this view, explicitly or implicitly.(38) Indeed, the hospitals' nonprofit status was a major factor in Judge McKeague's decision not to enjoin the merger in this community. Certainly, nonprofit status may affect firm behavior in some respects. For example, a vision of institutional mission, rather than profit maximization as such, may strongly influence the behavior of many nonprofits. At the same time, there is a great deal of variety among nonprofit hospitals,(39) and in some markets significant price increases have occurred in the wake of hospital mergers, even when they are nonprofit. Empirical research on the pricing behavior of nonprofit hospitals, and the effect of market concentration on that behavior, is underway. One study, relied on by Judge McKeague, was based on an analysis of 1989 data regarding California hospitals and did not find a systematic price-increasing effect for private non-profit hospitals related to higher market share or market concentration; instead, it found an association between higher market shares and lower prices.(40) But more recent studies that have sought to test the validity of these findings have reached different results.(41) A full discussion of the literature is beyond the scope of my address today. But whatever that research shows with respect to the particular questions examined, I do not believe it will suggest that competition among nonprofit hospitals generally is not beneficial. On the contrary, there is abundant evidence that nonprofit hospitals respond to competition in ways that benefit consumers, benefits that would be lost if competition is eliminated. Nonprofit hospitals, like for-profit hospitals, must be responsive to the demands of patients and those who purchase from them (e.g., employers and other health plans), who have the option to turn to alternative hospital providers if a hospital's prices are perceived to be too high or its services are wanting in some respect. The incentive for both nonprofit and for-profit hospitals is to do what is necessary in terms of price, quality, service, or other measures valued by customers, in order to attract or retain their business. The ability of customers

to go elsewhere helps assure that nonprofit hospitals provide what their customers actually demand, as that demand is expressed through their purchasing decisions. The absence of vigorous competition eliminates the most direct and powerful incentive for hospitals to serve consumers as efficiently and as well as they can. Community involvement in governance, no matter how dedicated, cannot duplicate these market forces.(42) The board may not be representative of all segments of the community, and community board members' views on what is best for the community may well differ from what those actually purchasing the services would prefer. Because it is not elected by the community at large, a non-profit Board also lacks the accountability that is present in government institutions. It is also very difficult for community board members to exercise detailed and on-going supervision of management actions; and in any event, board members owe a fiduciary duty to the hospital to put its interests first. This, of course, in no way is a reflection on the integrity or commitment to the public of leaders of nonprofit hospitals. The changes sweeping the health care market are the result of payers' demands for new ways of producing and coordinating services; new mechanisms for aligning the incentives of providers, payers, and patients; new methodologies for determining appropriate care and measuring its quality; and a lot of effort by hospitals, doctors and other health care providers -- all in the interest of providing high quality care more efficiently. These goals are difficult to realize, and require hard work. It is the fundamental premise of the antitrust laws that the presence of vigorous competitors in the market -- and not a "benevolent" hospital monopoly -- is the best way of ensuring that hospitals have the direct incentives to keep up with these market changes, innovate, and ultimately provide the best mix of price, quality and services for consumers.

Misconception # 5: A "community commitment" by the hospitals makes merger enforcement unnecessary.

Hospitals' commitments to limit price increases or otherwise constrain the post-merger exercise of market power do not adequately substitute for the benefits of continued competition, whether the commitments are voluntary or are embodied in a binding consent order negotiated with a state attorney general. In general, I believe that if a merger is anticompetitive, only a prohibition or undoing of the merger will give consumers the benefits of a competitive marketplace. Decrees or undertakings that attempt to regulate post-merger conduct inherently are subject to a number of limitations. First, they are essentially a form of price regulation, and effective regulation of prices is very difficult in any circumstance, which is the reason why hospital price regulation has been abandoned by virtually all states. The necessary information is entirely under the control of the "regulated" party, and analyzing such information requires substantial expertise and resources. Determining whether to regulate prices, operating margin, or other factors poses thorny issues. Moreover, even aggressive regulation cannot duplicate the operation of a competitive market. In the absence of competition it is impossible to know what is the "competitive" price that the regulation is supposed to approximate. For example, many of these undertakings limit price increases, whereas a competitive market might have resulted in price reductions, as is occurring in some areas. The Prospective Payment Assessment Commission reported last year that real expenses per adjusted inpatient admission fell each year from 1994 through 1996.(43) In the face of such trends, a promise by a hospital to increase revenue at a rate no greater than increases in the consumer price index, for example, would not be worth much. Second, pricing commitments can make it more difficult for hospitals to adopt forms of contractual arrangements that can control costs more effectively. For example, in many areas of the country, hospitals have been offering innovative contractual arrangements, such as per diem or per case rates, that incorporate incentives for hospitals to provide services more efficiently. Price commitments usually do not address (or lend themselves to application to) these types of pricing arrangements, and in fact can be used as excuses to avoid entering into such arrangements. Third, price and other commitments are easy to circumvent, or they may create inappropriate incentives. For example, restrictions on hospital profits may reduce incentives to reduce costs and operate efficiently. On the other hand, restrictions on hospital prices could create incentives to reduce quality of care.

Fourth, the commitments or orders usually are temporary. And drafting commitments to extend over longer periods is impractical because it is impossible to accurately foresee changes in the future that a commitment may need to address. Thus, in the absence of new entry, consumers eventually will be left in the unfettered power of the merged entity. Finally, some of the commitments contain provisions that are affirmatively anticompetitive, such as commitments to terminate individual price negotiations and charge all health plans the same price. For all of these reasons, I do not believe that "community commitments" are an adequate substitution for vigorous hospital competition.

Misconception #6: Mergers are essential to creating efficiencies and dealing with excess capacity.
In analyzing hospital mergers, we carefully consider the potential of efficiencies to benefit competition and thus consumers. The hospital industry is experiencing rapid and significant change, and there is excess capacity in many areas. In many cases, there is a significant potential for efficiencies that are likely to benefit consumers, and that is one of the reasons we decide not to challenge many mergers. At the same time, there are ample reasons for skepticism about many hospital efficiency claims. Over the last two decades, the hospital industry has succeeded in reaping extraordinary efficiency gains,(44) principally without mergers, and many of the efficiencies claimed in connection with planned consolidations could be achieved even in the absence of a merger. And while hospital mergers always involve consolidation of ownership, they often do not result in the kinds of consolidation of facilities that can be expected to produce significant efficiencies.(45) Furthermore, the economic literature suggests that, at best, the achievement of efficiencies from hospital consolidation is more difficult, and more costly, than anticipated, and is lagging well behind the consolidation of ownership, and market power, that flows immediately from mergers among direct competitors. For these reasons, some observers are concerned that a primary motivation for many mergers is to increase market power, rather than to increase efficiency,(46) and feel that antitrust scrutiny of mergers in highly concentrated markets is imperative.(47) Moreover, at some point, the danger of anticompetitive effects simply outweighs the benefits that can be expected to flow, even from mergers that can create substantiated real efficiencies. There can be no competition in any market without some duplication of facilities, and all mergers, even highly anticompetitive ones, can be expected to create some efficiencies. Efficiencies are of most direct benefit to consumers when they permit the merging parties to be more effective competitors or otherwise increase competition in the market. A related concern is that antitrust is preventing struggling firms from exiting the market gracefully. This concern also is misplaced. The law provides a defense to a merger enforcement action in the case of a firm that is failing financially. The requirements of this defense are quite strict, and it does not apply in most cases. But even if a firm is not failing according to the legal standard, the prospects (or lack thereof) that it will remain a vigorous competitor in the future is taken into account in our analysis of competitive effects. Thus, if a hospital is not likely to be a significant constraint on the behavior of other hospitals in the market, its acquisition by another hospital is not likely to have a significant anticompetitive effect. However, the mere fact that inpatient admissions may be declining, or that there is some excess bed capacity, does not mean that a hospital cannot survive, or that the public would not benefit from its remaining independent. Neither does the inability of current management to operate a hospital profitably necessarily indicate that the only viable alternative is a merger with a hospital operating in the same market. Where such claims are made, we carefully evaluate the actual competitive attractiveness of the hospital -- that is, the extent to which other potential purchasers have expressed interest in purchasing the facility and maintaining it as an independent institution. If an outside firm is willing to put its money into purchase and operation of a hospital as a independent entity, this is powerful evidence

that it is not, in fact, in danger of failure and market exit. In such cases, the public is likely to be better served by sale of the facility to another owner, than by elimination of competition in the market.

Misconception # 7: Mergers are driving nonprofits into the arms of for-profits.

We sometimes hear it said that mergers are necessary to protect nonprofit hospitals from the threat of acquisition by for-profit chains, and that antitrust enforcement is driving nonprofits into the arms of the for-profit hospitals. The record does not bear this out. The fact is that the rapid growth of the for-profit chains appears to have stopped, at least for the moment. It is the non-profit hospitals that are now poised to acquire their rivals. Observers expect to see continued significant hospital merger activity, particularly among nonprofit and religious systems.(48) There is no evidence, moreover, that hospital merger enforcement has resulted in the acquisition of formerly nonprofit hospitals by for-profit hospital chains. On the contrary, of the 33 nonprofit hospitals known to us that have been involved in proposed mergers that were blocked or abandoned during (but not necessarily as a result of) an antitrust investigation, all are still open and are still nonprofit. Interestingly, in three FTC cases where for-profit firms agreed to divest hospitals in order to settle antitrust charges, the hospitals were sold, with FTC approval, to nonprofit firms.(49)

WHERE DO WE GO FROM HERE?

The Commission remains committed to preserving competition in hospital markets. In fact, just this past April, the Commission issued a complaint challenging the merger of the only two general acute care hospitals in Poplar Bluff, Missouri. While the hospitals in that matter are both for-profit, rather than nonprofit, the case involves consideration of some of the other issues I have discussed. Trial of the preliminary injunction action is scheduled to begin on June 22. The bottom line is that hospital mergers in some markets can lead to higher prices, preclude future price reductions, reduce quality, and diminish the incentives for hospitals to operate more efficiently and to participate in innovative financial arrangements. They can preclude future entry or growth of managed care organizations. Moreover, such mergers can reduce competitive pressure on hospitals to innovate -- for example, by developing methods of clinical, physician/hospital, and other integration that could produce additional efficiencies in the delivery of the entire spectrum of health care services. Accordingly, protection of hospital competition is vital. But as I have tried to emphasize today, all merger cases are highly dependent on the specific facts of each matter. It is very important that local providers, employers, and consumers be informed, look at proposed mergers early on, ask the hard questions, and let us know their opinions on proposed mergers in their communities. Such individuals are the closest to the situation, will be the most directly affected, and are in the best position to convey to the enforcement agencies the information they need to make the right decision on whether to intervene. I should make it clear, however, that in the course of a merger investigation we do not simply tally up the "votes" of supporters and opponents of a merger. What we need is informed views on the likely effects of the merger from persons who have knowledge and experience relating to the important issues in the matter. For that reason, I applaud your efforts -spanning fifty years -- in taking such an active role in developments in your local health care market.

CONCLUSION
For the reasons I have described, assessment of the likely impact of hospital mergers can be particularly challenging. Market conditions are changing rapidly, and we will adapt our analysis and enforcement strategies as necessary to keep abreast of market realities. Our commitment is to maintain competitive markets where it is feasible to do so, so that consumers can have reasonable choice among providers, and enjoy the quality, services, and price benefits that flow from competition.

Endnotes

1. Federal Trade Commission v. Butterworth Health Corp., 946 F.Supp.1285 (W.D. Mich. 1996), aff'd without published opinion, 1997-2 Trade Cas. 71,863 (6th Cir. 1997). 2. As always, I am speaking only for myself, and my views do not necessarily reflect those of the Commission, any Commissioner, or the Bureau of Competition. 3. For discussions of recent changes in health care and hospital markets, see Managed Health Care Improvement Task Force, "Health Industry Profile," in Improving Managed Health Care in California, Vol. 3, 155-201 (1998); Congressional Budget Office, "Trends in Health Care Spending by the Private Sector" (April 1997); Prospective Payment Assessment Commission, "Hospital Payments, Costs, and Financial Condition," in Medicare and the American Health Care System: Report to the Congress 63-95 (June 1997); Frech, Competition and Monopoly in Medical Care 17-50 (1996); Zelman, The Changing Health Care Marketplace (1996); Etheredge et al., "What is Driving Health System Change," 15:4 Health Affairs 93 (1996). 4. Aggregate expenses in 1996 totaled $1.035 trillion. Levit et al., "National Health Expenditures, 1996," 19:1 Health Care Financing Review 161-62, 166 (1997). 5. While the employers and health plans that structure the health benefit plans and negotiate with providers are not the ultimate consumers of health services, it is often appropriate, in analyzing marketplace dynamics, to consider these parties as surrogates for consumers when they negotiate with providers and evaluate the alternatives available in the market. As the Supreme Court has stated:

Insurers deciding what level of care to pay for are not themselves the recipients of those services, but it is by no means clear that they lack incentives to consider the welfare of the patient as well as the minimization of costs. They are themselves in competition for the patronage of the patients -- or, in most cases, the unions or businesses that contract on their behalf for group insurance coverage -- and must satisfy their potential customers not only that they will provide coverage at a reasonable cost, but also that coverage will be adequate to meet their customers' [medical] needs.

FTC v. Indiana Fed'n of Dentists, 476 U.S. 447, 463 (1986). 6. Levit et al., "National Health Expenditures, 1996," 19:1 Health Care Financing Review 161, 162 (1997). 7. See, e.g., "Health-Care Inflation Kept in Check Last Year," Wall Street Journal, Jan. 20, 1998, at B1. However, there are some signs of an impending resurgence of significant health care cost increases. See "Health Care Inflation Revives in Minneapolis Despite Cost-Cutting," Wall Street Journal May 19, 1998, at A1; "Large Firms Paying More for Health Care," Washington Post Jan. 7, 1998, at D11. 8. See Congressional Budget Office, "Trends in Health Care Spending by the Private Sector," (1997); Prospective Payment Assessment Commission, Medicare and the American Healthcare System: Report to the Congress 19, 2526 (June 1997). 9. See, e.g., Dranove et al., "Determinants of Managed Care Penetration," forthcoming in Journal of Health Economics; Connor et al., "Which Types of Hospital Mergers Save Consumers Money," 16:6 Health Affairs 62 (1997); Manheim et al., "Local Hospital Competition in Large Metropolitan Areas," 3 J. of Econ. and Man. Str. 143 (1994); Dranove & White, "Recent Theory and Evidence on Competition in Hospital Markets," 3 J. Econ. and Man. Str. 169 (1994); Arnould et al., "The Role of Managed Care in Competitive Policy Reforms," in Competitive Approaches to Health Care Reform, Arnould, Rich, & White, eds, 83-109 (1993); Dranove, "The Case for Competitive Reform in Health Care" in Competitive Approaches to Health Care Reform, Arnould, Rich, & White, eds, 67-82 (1993); Zwanziger et al., "California Providers Adjust to Increasing Price Competition," in Health Policy Reform:

Competition and Controls, Helms, ed., 241, 254 (1993); Dranove et al., "Price and Concentration in Hospital Markets: The Switch from Patient-Driven to Payer-Driven Competition," 36 J. L. & Econ. 179 (1993); Melnick et al., "The Effects of Market Structure and Bargaining Position on Hospital Prices," 11 J. Health Econ. 217, 229 (1992). 10. "A fat year for hospitals," Modern Healthcare 2 (Jan. 12, 1998). See also "Nation's Hospitals the Picture of Health," Washington Post, Feb. 7, 1998, at H1 (noting that even teaching hospitals have flourished, with a median profit margin of 4.5% in 1996). 11. Prospective Payment Assessment Commission, Medicare and the American Health Care System: Report to the Congress 63, 82 (June 1997). 12. 15 U.S.C 18. 13. U.S. Department of Justice and the Federal Trade Commission, Horizontal Merger Guidelines (1992). This document, along with other materials concerning the Commission's enforcement mission and health care competition issues specifically, can be found on the Commission's website at http://www.ftc.gov. 14. Id. at 0.1-0.2. 15. The analysis covers not only firms currently producing goods or services in the market, but those firms that could quickly and easily begin to compete in the market in the event of a price increase resulting from the merger. Id. at 1.3. 16. See id. at 1.51. The Guidelines threshold for a highly concentrated market is one in which there are approximately 6 equally-sized firms. The hospital mergers that we have challenged involved markets with much higher levels of concentration. 17. Id. at 1.52. 18. Id. at 0.2, 2.0. 19. Id. at 0.2, 3. 20. Id. at 4. 21. Id. at 5. 22. 946 F. Supp. at 1294. 23. "One of the main reasons for creating the Federal Trade Commission and giving it concurrent jurisdiction to enforce the Clayton Act was that Congress distrusted judicial determination of antitrust questions. It thought the assistance of an administrative body would be helpful in resolving such questions and indeed expected the FTC to take the leading role in enforcing the Clayton Act, which was passed at the same time as the statute creating the Commission." Hospital Corp. of America v. FTC, 807 F.2d 1381, 1386 (7th Cir. 1986, cert. denied, 481 U.S. 1038 (1987). 24. Section 3.26(d) of the Commission's Rules of Practice, 16 C.F.R. 3.26(d). 25. Butterworth Health Corporation, Docket No. 9283 (order granting motion to dismiss complaint issued Sept. 25, 1997). 26. Levit et al., "National Health Expenditures, 1996," 19:1 Health Care Financing Review 161, 193 (1997).

27. Health Care Financing Administration, "Managed Care in Medicare and Medicaid," Fact Sheet, August 19, 1997. 28. "For PSOs, it's . . . ready, set, go!" Modern Healthcare 34, 36 (Nov. 24, 1997). 29. Prospective Payment Assessment Commission, Medicare and the American Health Care System: Report to the Congress 41 (June 1997). In the long run, competitive bidding arrangements across hospitals may also offer the opportunity for significant savings to the Medicare program. For example, a demonstration project involving a negotiated global price for all inpatient care for heart bypass patients saved the government and beneficiaries more than $17 million over 27 months at only 4 cites. Cromwell et al., "Cost Savings and Physician Responses to Global Bundled Payments for Medicare Heart Bypass Surgery," 19:1 Health Care Financing Review 41 (1997). 30. 48 states offer some type of Medicaid managed care plan. Health Care Financing Administration, "Managed Care in Medicare and Medicaid," Fact Sheet, August 19, 1997. See Prospective Payment Assessment Commission, Medicare and the American Health Care System: Report to the Congress 26-27 (June 1997). 31. See, e.g., Mont. Code Ann. 50-4-601, 50-4-605 (1995). 32. 946 F.Supp. at 1299. 33. Nor can I agree with Judge McKeague's conclusion that "hospitals are in the business of saving lives, and managed care organizations are in the business of saving dollars." Id. at 1302. Like all other businesses, including hospitals, managed care companies are in the business of providing that which their customers demand, and are in competition with one another to make high-quality, affordable health care available to consumers. 34. President's Advisory Commission on Consumer Protection and Quality in the Health Care Industry, Quality First: Better Health Care for all Americans 75 (1998). 35. Id. at 92. 36. U.S. Department of Justice and the Federal Trade Commission, Statements of Enforcement Policy in Health Care 12, 31 (1996). 37. See, e.g., Sims, "A New Approach to the Analysis of Hospital Mergers," 64 Antitrust L. J. 633 (1996); Kopit and Vanderbilt, "Unique Issues in the Analysis of Non-Profit Hospital Mergers," 35 Washburn L.J. 254 (1996); Bazzoli et al., "Federal Antitrust Merger Enforcement Standards: A Good Fit for the Hospital Industry?" 20 J. Health Politics, Policy & Law 137 (1995). 38. See Federal Trade Commission v. Butterworth Health Corp., 946 F.Supp.1285 (W.D. Mich. 1996), aff'd without published opinion, 1997-2 Trade Cas. 71,863 (6th Cir. 1997); FTC v. University Health, Inc., 1991-1 Trade Cases 69,400 (S.D. Ga.) and 1991-1 Trade Cases 69,444 (S.D. Ga.), rev'd, 938 F.2d 1206 (11th Cir. 1991); U.S. v. Long Island Jewish Med. Center, 983 F. Supp. 121 (E.D.N.Y. 1997); Federal Trade Commission v. Freeman Hospital, 1995-1 Trade Cas. 71,037 (W.D. Mo.), aff'd, 69 F.3d 260 (8th Cir. 1995); U.S. v. Carilion Health System, 707 F.Supp. 840 (W.D. Va.), aff'd without published opinion, 1989-2 Trade Cas. (CCH) 68,859 (4th Cir. 1989). 39. For example, some nonprofit hospitals may have governing boards with significant representation of local employers, while other hospitals may be part of religious or other nonprofit chains that are controlled outside the local community. These differences also may be reflected in pricing behavior. 40. Lynk, "Nonprofit Hospital Mergers and the Exercise of Market Power," 38 J. of Law & Econ. 437 (1995).

41. Simpson, J. and R. Shin, "Do Nonprofit Hospitals Exercise Market Power?" Federal Trade Commission Working Paper No. 214, December 1996, accepted for publication by International Journal of Economics and Business; Keeler, E. B., G. Melnick, and J. Zwanziger, "The Changing Effects of Competition on Non-Profit and For-Profit Hospital Pricing Behavior," June 1997, mimeo, accepted for publication by Journal of Health Economics; Dranove, D. and R. Ludwick, "Competition and Pricing by Nonprofit Hospitals: a Reassessment," November 1997, mimeo, accepted for publication by Journal of Health Economics. 42. In making these general observations, I am not commenting, of course, on any of the activities of the new Spectrum Health Board, with which I am generally unfamiliar. 43. Prospective Payment Assessment Commission, Medicare and the American Health Care System: Report to the Congress 87 (June 1997). 44. See Prospective Payment Assessment Commission, Medicare and the American Health Care System: Report to the Congress 7-8, 22-25 (June 1997). 45. See Fubini and Limb, "The Ties that Bind," Health Systems Review 44 (Sept./Oct. 1997); Wicks et al., "Assessing the Early Impact of Hospital Mergers" (1998). 46. See, e.g., Ballit, "Ominous Signs and Portents: A Purchaser's View of Health Care Market Trends," 16:6 Health Affairs 65 (1997). 47. Id.; Wicks et al., "Assessing the Early Impact of Hospital Mergers" (1998). 48. See, e.g., "Cash rich and ready to deal; not-for-profit systems poised to gobble up market competitors," Modern Healthcare 27-28 (Jan. 5, 1998). 49. Columbia Hospital Corporation/Galen Health Care, Inc., C-3472, 116 F.T.C. 1362 (1993) (consent order); Columbia/HCA Healthcare Corporation/Healthtrust, Inc. - The Hospital Company, C-3619, 61 Fed. Reg. 33,509 (June 27, 1996) (consent order); Tenet Healthcare Corporation/OrNda Healthcorp., C-3743, 63 Fed. Reg. 3748 (January 26, 1998) (consent order).