For the second time in a decade, the Federal Trade Commission is investigating hospital competition in Chicago’s northern suburbs. Next Wednesday, a federal judge in Chicago will convene a hearing on the government’s request for an injunction to temporarily halt the merger of Advocate Health and Hospitals Corporation and NorthShore University Health System. The combined Advocate/NorthShore would have 13 Chicago-area hospitals that, based on 2014 numbers, would receive nearly 200,000 annual patient admissions and generate over $7 billion in annual revenues. Having analyzed hospital market power in numerous merger reviews and antitrust litigation, I offer some observations on what to expect at the hearing.
Determining whether a merger violates the antitrust law presents a case unlike any other type of lawsuit because a violation is shown through a prediction about future effects of the merger. In weighing the arguments, it is critically important for the court to make the right decision. Letting an anticompetitive merger proceed could lead to higher prices and lower quality care, while blocking a competitive merger could deprive consumers of efficiencies and better care. So the judge will decide who has the better crystal ball in a proceeding where the wrong decision could lead not just to serious economic consequences will affect people’s health.
And because the Federal Trade Commission brought the case, there’s a procedural wrinkle. The court won’t be making the ultimate decision whether the merger violates the law. The FTC’s Commissioners will decide the merits of case through an administrative proceeding that will be many months down the road, expensive, and time consuming. The stakes at this week’s hearing are, therefore, enormous because, if the FTC succeeds in obtaining the preliminary injunction, it will have effectively doomed the merger.
The FTC’s Dire Prediction
The FTC claims that the merger may substantially lessen competition in an area it call the North Shore Area in violation of the FTC Act and the Clayton Act. It specifically alleges that the merger will allow Advocate and NorthShore to raise prices paid by commercial payers (and ultimately insureds) and eliminate incentives to compete for patients on the basis of quality.
What the FTC Needs to Prove
To prove this, the FTC must show that the merger will give Advocate and NorthShore added clout in defined product and geographic markets. In a hospital merger case, a geographic market for antitrust purposes is generally defined as a geographic area in which the merged hospitals compete. The relevant product market is the class of services that effectively compete with the products offered by the hospitals. These market are viewed in light of commercial realities—not lawyers’ or economists’ fantasies— and should include sellers and products to which consumers could reasonably turn in the face of a price increase by the merging hospitals.
Here, the FTC alleges a product market of general acute-care inpatient hospital services that typically require hospitalization (the “GAC” market). This is the type of product market generally alleged in hospital merger cases. Advocate and NorthShore say this market is too narrow because it excludes outpatient care medical services. Although interesting, the argument is not likely to get much traction: the GAC market is defined as a bundle of hospital services that typically require a hospital stay. Certainly, consumers in need of services that require a hospital stay would not view an outpatient procedure as a reasonable substitute.
The FTC’s Alleged Geographic Market: Inherently Flawed?
The alleged geographic market, which the FTC calls the “North Shore Area,” presents more controversial issues. This alleged market is bounded by six hospitals: NorthShore Evanston Hospital, Swedish Covenant Hospital, Presence Resurrection Medical Center, Northwest Community Hospital, Advocate Condell Medical Center and Vista Medical Center.
Five other hospitals are located within the FTC’s alleged geographic market: Advocate Lutheran General Hospital, Northwestern Medicine Lake Forest Hospital, NorthShore Highland Park Hospital, NorthShore Glenbrook Hospital, and NorthShore Skokie Hospital. Thus, Advocate and NorthShore have more than half, six out of eleven, of the hospitals in the so-called North Shore Area.
The FTC says that the combined entity will have a 55% share of inpatient admissions is the alleged market: a share large enough to sustain a charge of attempted monopolization. And under an analysis from federal merger guidelines, the Herfindahl-Hirshmann Index, which evaluates changes in market concentration, if the market is properly defined the merger is presumed likely to create or enhance market power in the merged entity; that is, a lessening of competition.
This would be very bad news for Advocate and NorthShore. But there are substantial questions whether the market alleged is really a proper relevant geographic market for antitrust purposes. As shown on the map, Presence Saint Francis Hospital is very close to NorthShore Evanston Hospital—closer to NorthShore Evanston than Advocate Lutheran General—but it is inexplicably excluded from the market. Moreover, there are numerous hospitals to the south of the alleged market:
In addition, the FTC expressly alleges that only 73% of patients in the alleged market remain there for GAC services. That means a 27% of patients in the area seek GAC services from outside the area. In the past, this market fact could doom the FTC’s case. Indeed, Advocate and NorthShore define the market much more broadly and claim to have a mere 28% of defined market. Look for Advocate and NorthShore to hammer these and other market facts at the hearing.
Nevertheless, the FTC has significant experience with NorthShore. In 2007, it sued to break up NorthShore and showed the NorthShore had significant market power despite facing similar problems with its geographic market. It will be very interesting to see how the FTC addresses these (and other) problems with its market definition.
Flaws in the FTC’s Anticompetitive Effects Theory
To support its claim that the merger will harm competition by eliminating price and non-price competition between Advocate and NorthShore, the FTC alleges that Advocate and NorthShore are “close—if not each other’s closest—competitors in the North Shore Area.” It says that they currently compete with each other for managed care contracts, enabling payers to negotiate better price terms. The FTC’s theory is that without that competitive threat, the merged entity will be able to demand, and will receive, higher prices.
Advocate and NorthShore claim there is a fatal problem with this theory. In a prior action against NorthShore, the FTC found that Advocate Lutheran General, in fact, did little to constrain NorthShore’s pricing. This raises interesting questions about whether the FTC can take different positions with respect to the same market. This is a purely legal argument is unlikely to determine the outcome. Foolish consistency is the hobgoblin of small minds. In an antitrust case, the goal should be to achieve the best result for competition and consumers, and not to penalize the government.
So What? Isn’t the Merger Pro Competitive Anyway?
Advocate and NorthShore urge that the merger will allow them to create a new managed care entity that will reduce prices by at least 10%. The product is conceptually similar to capitated (per member/per month) managed care arrangements where the hospital is paid a set fee in exchange for providing all the care the patient may need. Whether this arrangement is actually beneficial to consumers is beyond the scope of this article (did anybody like their capitated plan?). What’s important is whether the parties actually need to merge to create this product. This should be hotly contested. The court could find that even if the merger raised some anticompetitive issues, that harm could be outweighed by the benefits of the merger.
In a 1995 merger case, FTC v. Freeman Hosp., Judge Whipple told the FTC “I don't think you've got any business being in here…. It looks to me like Washington D.C. once again thinks they know better what's going on in southwest Missouri. I think they ought to stay in D.C.” The competitive conditions in Chicago are nowhere close to those in southwest Missouri. In Chicago, there are dozens of other hospitals, most of which are part of a larger system, out-patient and specialty clinics of all kinds, and large sophisticated payers. But the government must have reason to think it can prevail. And, in its previous case against NorthShore, it demonstrated its ability to overcome some of the same arguments that are sure to be made here. So, while at first blush the case has many warts it would be a mistake to assume the merger will be allowed to proceed.