American Journal of Law & Medicine

Night landings on an aircraft carrier - hospital mergers and antitrust law.(Managed Care Phase Two - Structural Changes and Equity Issues)


Justice Stewart's 1966 dictum about the inevitability of government success in challenging mergers under Section 7 of the Clayton Act held true for another fifteen years or so. In the early 1980s, however, federal enforcement agencies, the Department of Justice (DOJ) and the Federal Trade Commission (FTC), began to find the federal courts less hospitable to antitrust merger cases as more sophisticated economic inquiries and changing proof burdens complicated the task of identifying anticompetitive mergers. Indeed, since the early 1980s, the government has lost more litigated merger cases than it has won and has come under criticism from some quarters for becoming gun shy and not adequately policing the wave of consolidations that have occurred over the past decade.(2)

Hospital mergers, however, are a different story. Until two years ago, the government rode a streak of important victories in federal courts and FTC administrative proceedings,(3) and had obtained consent decrees from scores of hospitals that had announced plans to merge.(4) Antitrust enforcers under both Republican and Democratic administrations placed scrutiny of the structure of health care industry markets at the top of their agendas.(5) Critics argued that, if anything, it was too easy for the government to prevail in these cases because almost any hospital merger in small- or medium-sized communities would run afoul of concentration benchmarks used to assess the competitive effects of mergers.(6) That all changed abruptly when three federal district courts (one affirmed by a circuit court of appeals) refused to grant preliminary injunctions in challenges to hospital mergers.(7) Because all three cases involved relatively isolated markets in which the merging parties faced few (if any) competing hospitals in their immediate area, these cases seemed like sure winners for the government, especially given the favorable precedent that had developed from its successful litigation over the years.(8)

The somewhat surprising outcomes of the recent hospital merger cases reflect the convergence of several cross currents in antitrust law and the health care industry. The title of this Article expresses the author's thesis that courts deciding hospital merger cases are asked to make exceedingly fine-tuned appraisals of complex economic relationships. Further, these decisions require factual judgments regarding what the future may hold in an industry undergoing revolutionary change. Like pilots landing at night aboard an aircraft carrier, courts are aiming for a target that is small, shifting and poorly illuminated.


A. Merger Analysis Under The Clayton Act

Section 7 of the Clayton Act, enacted in 1914 and amended in 1950, outlaws mergers whose effect "in any, line of commerce or ... in any section of the country ... may be substantially to lessen competition, or to tend to create a monopoly."(9) Congress complicated the judiciary's task by adopting a standard, supported by clear expressions of legislative intent, that (1) contemplates a prospective examination of competitive effects; (2) focused on probabilities, not certainties; and (3) aimed at arresting anticompetitive concentration "in its incipiency."(10) These aspects of merger cases, coupled with the complexity of economic issues under investigation, necessarily render the inquiry more speculative and uncertain than those involved in most other areas of the law. Indeed, because of this focus, legal scholars have stressed the need for sensible presumptions, proof burdens and precedential guidance to cabin the inquiry and avoid speculative, standardless judicial decision making.(11) Unfortunately, the recent trend in the case law has been in the opposite direction.(12)

1. Presumptive Illegality

The basic paradigm set forth by the Supreme Court in its 1963 United States v. Philadelphia National Bank decision guides the antitrust law regarding horizontal mergers and acquisitions -- i.e., those involving two firms operating in the same product and geographic markets.(13) The first steps consist of defining the relevant product and geographic markets in which the merging parties compete,(14) making market definition a necessary predicate for finding a violation of section 7 of the Clayton Act.(15) The Court found that Congress had mandated an inquiry into the substantiality of the potential anticompetitive effects which in turn necessitates a determination of the market affected.(16) Next, the Court established a rule of presumptive illegality for mergers creating a "significant increase in the concentration of firms" within the market and producing a merged entity with an "undue percentage share" of the market.(17) The Court found the presumption of illegality based on market share and concentration data sufficient to warrant enjoining the merger "in the absence of evidence clearly showing that the merger is not likely to have such anticompetitive effects."(18)

The presumption-shifting approach of Philadelphia National Bank notably left little room for asserting justifications for the merger -- only salutary, procompetitive effects in the relevant market may be considered -- and placed a difficult burden on defendants to overcome the presumptive force of the government's statistical case.(19) However, in its most recent word on the subject, United States v. General Dynamics Corp., the Supreme Court held that concentration/market-share data could be rebutted by post-acquisition evidence showing that the market data on which the government relied did not adequately reflect defendant's competitive position.(20) Some lower courts have broadly interpreted General Dynamics as revising the Philadelphia National Bank approach by moderating the strength of the presumption and allowing for rebuttal based on nonstructural factors.(21)

The approach of the federal enforcement agencies(22) has been somewhat inconsistent. On the one hand, in litigation the agencies sometimes stress the strong presumptive rule that the Supreme Court has never overruled.(23) On the other hand, as part of their litigation strategy, agencies usually introduce detailed economic and testimonial proof in their case-in-chief, essentially refuting the defendants' rebuttal evidence on the feasibility of collusion or unilateral exercise of market power.(24) As a practical matter, the force of the presumption is watered down considerably. Moreover, the federal Horizontal Merger Guidelines (Merger Guidelines or Guidelines),(25) which articulate the framework the agencies apply in analyzing mergers and making prosecutorial case selection decisions, all but abandon(26) the burden-shifting presumptions that result from market-share and concentration data.(27) Instead, the Guidelines discuss in considerable detail the various economic factors that support or refute the likelihood that the merged entity will "create or enhance market power or facilitate its exercise."(28) The Guidelines enumerate a long list of circumstances that facilitate tacit or express collusion, such as product homogeneity, buyer characteristics, the number and size of sales, the presence of coordination-facilitating devices and historical pricing performance.(29) The Guidelines also list factors that facilitate single firm anticompetitive behavior, such as the closeness of the products of the merging firms(30) and capacity constraints(31) and factors that generally affect the likelihood that the merged parties would be able to exercise market power, such as entry conditions(32) and changing technological conditions.(33)

The changes described above have caused a subtle but profound shift in the inquiries undertaken by courts in examining antitrust merger challenges. Prior case law had presumed that tacit or express collusion was a significant threat when market share and concentration data was high.(34) By contrast, trial courts now routinely undertake detailed inquiries into the likelihood and effectiveness of post-merger collusion.(35) Parties tend to present essentially a narrative to explain how collusion may or may not occur and how impediments to reaching agreements and policing agreements may affect the likelihood and success of cartelization schemes or oligopolistic pricing.(36) Although an undeniably sound economic basis for considering the variety of factors discussed above exists, the results of these inquiries has not been altogether satisfactory. As the leading treatise on antitrust law points out, courts are "ill equipped to assess the relevance of each of these factors, assign weights to them, and then balance them against one another."(37) Moreover, given the continuing vitality of the underlying economic assumptions supporting the presumptive approach, there is good reason to attach a strong presumption that collusive activity will occur when high market-share and concentration statistics exist.(38)

Perhaps motivated by their inability to present convincing stories of collusive anticompetitive effects in markets involving differentiated products, antitrust enforcement agencies have recently shifted enforcement emphasis by stressing the adverse unilateral effects of such mergers.(39) Under this analysis, proof that a merger will enable the merged entity to increase prices after the merger without cooperating with rivals will obviate the need to tell a speculative story about the likelihood of oligopolistic coordination or perhaps even to define a market. Although apparently used extensively by the agencies in merger investigations,(40) the economic techniques and doctrinal implications have yet to be tested in litigation. It thus remains to be seen whether courts will dispense with the traditional requirement that the government define markets and prove market power as part of its prima facie case or accept sophisticated econometric evidence quantifying unilateral effects as sufficient proof to establish the government's case.

2. Market Definition

The analytic approach contained in the Merger Guidelines has also significantly affected market definition. Fact finders need to identify sellers that provide alternative sources for the merging parties' products.(41) This entails delineating the relevant product and geographic markets affected by the merger.(42) To do so the case law mandates an inquiry into the substitution responses of consumers: in product markets, the substitution of one product for another,(43) and in geographic markets, the substitution of one seller for another.(44) Under the methodology of the Merger Guidelines, adopted by most federal courts in recent years, the agency determines the substitutability of products or sellers by assessing the post-merger reaction of customers to a "small but significant and nontransitory increase in price."(45) Those products and services sold by the merging parties, together with any other products and services to which customers would turn in response to the hypothesized price increase, comprise the relevant product market.(46) Likewise, the relevant geographic market consists of those sellers to whom customers would turn in response to the price increase.(47)

Several important caveats must be noted about the Guidelines methodology for market definition. First, it is (or should be) regarded as more of an expression of fundamental economic principles than as a test that courts can readily apply in litigation.(48) Although parties often offer responses to hypothetical questions as evidence on these issues, the speculative and contingent nature of such inquiries makes them of questionable probative value.(49) Thus the Guidelines themselves appear to recognize that inferences drawn from concrete evidence or historical behavior patterns may provide more reliable indicia of the contours of the relevant market.(50) Second, it is widely recognized that to delineate a market properly, the Guidelines test must observe whether customers would switch purchasing patterns if the sellers moved from a competitive price to a supracompetitive price.(51) If prices in the alleged market are already significantly above competitive levels, the Guidelines standard does not identify an economically meaningful market because such markets will necessarily have a propensity for substitution if prices are raised further. Under the so-called "Cellophane fallacy," an overly broad market is identified when the starting point of the alleged market is an already monopolized price.(52) The Guidelines appear to recognize this difficulty, as they note that the agencies will base their analysis on "a price more reflective of the competitive price" where the evidence suggests that supracompetitive pricing is already occurring.(53) Nevertheless, these considerations confront the trier of fact with enormous difficulties. Before evaluating proof of price responsiveness, she must first determine whether current market prices are competitive.(54) If not, she must determine whether proffered evidence is probative of the likelihood that consumers would switch in the event of an increase from a hypothetical, current, competitive price to a hypothetical, noncompetitive price.(55)

B. Applying the Clayton act to Hospital Mergers

The case law and pronouncements by the federal enforcement agencies make it clear that, with a few minor exceptions, conventional antitrust law principles apply to hospital mergers. The joint Statements of Antitrust Enforcement Policy in Health Care(56) state that hospital acquisitions will be analyzed under the principles contained in the Merger Guidelines, except for a safe harbor allowing acquisitions of small hospitals with significant excess capacity.(57) By contrast, several states have undertaken a decidedly more regulatory approach to hospital mergers. Some states have adopted antitrust immunity statutes that establish mechanisms for administrative approvals based on a variety of competitive and public policy factors.(58) In addition, a number of state attorneys general have entered into consent decrees under the Clayton Act that allow hospital mergers to proceed on the condition that the merged entity contribute some portion of all prospective cost savings attributable to the merger to charities, public health programs or other funds selected by the state.(59)

Although these developments may indicate a degree of unease about restricting the ability of hospitals to consolidate in the rapidly changing health care environment, there is no indication that federal enforcement authorities are considering officially altering the legal benchmarks they apply in reviewing mergers.(60) In practice, however, the federal authorities may not be treating hospital mergers like any other industry. According to some commentators, the agencies routinely exercise their prosecutorial discretion not to challenge many acquisitions that appear to violate the Merger Guidelines.(61) Although the government has challenged relatively few hospital mergers,(62) the extent to which the agencies sidestep potential merger cases involving the hospital industry more readily than they do in other industries has not been empirically demonstrated. It is at least possible that the failure to challenge certain mergers is attributable to the uncertainties associated with resolving many fact-intensive issues in hospital markets.

Although, as discussed below in Part III, significant controversies still surround the application of antitrust law to hospital mergers, a rough consensus has emerged on several important issues. First, the cases identify the relevant product market as the cluster of services consisting of "general acute care hospital services," i.e., those services offered by hospitals for which there are no outpatient substitutes.(63) Courts emphasize that the existence of outpatient alternatives for some hospital procedures does not place any check on pricing those procedures that cannot be performed on an outpatient basis.(64) Although that core may be shrinking as more and more services once provided only on an inpatient basis are performed in doctors' offices or in other facilities on an outpatient basis, there has been almost universal acceptance of the inpatient market as a distinct relevant market in applying the Clayton Act.(65) Second, the geographic market has been treated as primarily local, owing to the emergency nature of some care, the preference of people to be hospitalized near their families and homes, physician staff privileges and other factors.(66) Notably, this analysis tends to narrow somewhat the core product market, as courts tend to focus only on the acute care inpatient services that do not entail extremely sophisticated tertiary care.(67) Third, courts have applied the rule of presumptive illegality and then proceeded to consider a broad range of factors that may support or undermine inferences to be drawn from market concentration and market-share evidence.(68) These factors have included the not-for-profit status of hospitals in the market, the presence of sophisticated buyers, excess capacity, entry restrictions and the heterogeneity of service offerings. …

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