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Hospital Mergers That Don’t Happen

Article · October 24, 2016

U.S. hospitals are increasingly motivated to merge or to affiliate with other hospitals or hospital systems. Most of these arrangements are competitively benign, so they attract little or no attention from the antitrust authorities. In 2014, for example, 27 proposed hospital mergers were large enough to be reportable to the Federal Trade Commission (FTC) and the Department of Justice (DOJ) under the Hart–Scott–Rodino Act. Of these 27, only one (about 4%) went beyond a preliminary investigation. In 2013, only about 10% of proposed mergers made it that far.

However, since 2008, the FTC has deemed six mergers problematic enough to justify legal action to block them. In three instances, the FTC successfully challenged the mergers in court. For example, in 2012, the FTC challenged and succeeded in blocking a merger between OSF HealthCare and Rockford Health System in Illinois. In three other instances, hospitals have abandoned their proposed mergers in the face of the FTC’s announced intention to bring an enforcement action. For example, in 2008, the Inova Health System abandoned its acquisition of Prince William Hospital in northern Virginia.

What the FTC Looks For

To help explain which mergers attract the FTC’s attention, let me briefly describe the basics of how the FTC analyzes hospital mergers.

Firms that propose to merge generally believe that the merger will increase their profits. These higher profits can come from eliminating competition (allowing the hospitals to raise prices or reduce the amount of resources devoted to quality); from achieving efficiencies (allowing the hospitals to achieve the same quality at lower cost); or both.

Mergers tend to raise prices or reduce quality when the merging firms are close competitors of each other and when non-merging firms are not close competitors of the merging firms. In the case of hospitals, mergers are most likely to have these negative effects when the merging institutions offer similar services, are located near each other, and do not have many nearby competitors.

However, many mergers also create efficiencies, meaning that the merging firms can do things better or more cheaply together than they could separately. These efficiencies may lower prices or raise quality. The FTC’s merger analysis is fundamentally about balancing the anticompetitive harm against the efficiency benefits. The antitrust authorities’ basic approach to analyzing mergers is laid out in the highly readable Horizontal Merger Guidelines from the FTC and the DOJ.

What Happens When a Merger Is Blocked?

Consider these facts: In recent years, six mergers involving hospitals have been blocked or reversed by a court following an FTC enforcement action — or have been abandoned in anticipation of such an action. In four of these cases, the would-be acquired firms subsequently found an alternative partner. For example, after Prince William Hospital was prevented from joining Inova Health System, it instead joined Novant Health. (In the other two cases, courts have ordered divestitures that have not yet been completed, so we don’t yet know whether new affiliations will be formed.)

Stepping back, we can see that in all four cases whose final disposition is known, alternative affiliations were ultimately made. It stands to reason, then, that the hospitals are deriving at least some of the anticipated efficiencies of the initially contemplated merger in the merger that they finally complete.

Consider a hypothetical example of a merger between two closely competing hospitals. Let’s say the FTC concludes that the negative effects are likely to be large but that the efficiencies, mostly related to technical and resource advantages from belonging to a larger hospital system, are likely to be large as well. The FTC must now weigh the harms against the benefits.

At this point, I must pause to introduce a bit of antitrust jargon — merger specificity. This term represents the commonsense idea that efficiencies count as an offsetting benefit for an otherwise problematic merger only to the extent that those efficiencies are specific to that merger, meaning that the efficiencies would not be reasonably achieved in any other way. If the efficiencies would likely happen some other way (possibly through an alternative merger), consumers are better off if the merger is blocked and the harm from lost competition is avoided.

Suppose our hypothetical merger involves 100 dollars’ worth of harm to consumers for every 120 dollars’ worth of expected efficiencies. It might appear that this merger has a net benefit, but that is not necessarily so. Perhaps only half of those efficiencies are merger-specific, so that each $100 of harm would be offset by only $60 of efficiencies, yielding a net harm instead. This simple example highlights the importance of accurately evaluating merger specificity.

This is where those mergers that the FTC recently blocked become relevant. Remember: In all four cases whose final disposition is known, the would-be acquired facility ended up entering into other mergers or affiliations that the FTC did not challenge. If those mergers were profitable (which they presumably were or they probably would not have happened), it is likely because they involved some meaningful efficiencies. This fact is relevant for the evaluation of future mergers — because it suggests (but does not prove) that a substantial portion of hospitals’ anticipated merger-related efficiencies may not actually be merger-specific.

Bottom line: Determining what portion of anticipated merger-related efficiencies are merger-specific can be an important question in evaluating mergers. Any information relevant to this question is valuable, and the recent experience of firms whose mergers were blocked by the FTC provides a good clue.

Good News for the Future

The fact that these hospitals chose alternative affiliations after the FTC blocked their initially preferred mergers is welcome news for the hospitals and for consumers. Again, these affiliations are presumably profitable because they yielded meaningful efficiencies — and the bigger the efficiencies from the alternative affiliations, the smaller the merger-specific efficiencies that were forgone when those mergers were blocked. This means that the anticompetitive harm from the original mergers was avoided at a smaller cost to society.

And there’s more good news: Hospitals and other health care providers that wish to affiliate can choose among many options. These options range from small hospital systems to enormous ones, and from arms-length contractual arrangements to full integration with physicians, ancillary services, and even insurance companies. Hospitals can form affiliations with any willing partner to find the best, most efficient ways to organize themselves, except in the very few cases that raise antitrust concerns.

There is no single right answer, given how greatly hospitals’ circumstances vary. But there are surely some wrong answers, and the freedom to affiliate with almost any willing partner offers hospitals the flexibility to identify those wrong answers and avoid them.

The FTC continues to vigorously pursue its hospital-merger enforcement mission. But for any given hospital, only a small number of potential merger partners are of concern. This means that the FTC’s work will not encumber hospitals’ efforts to find partners with which they can grow and excel, as so many have already done.

 

The views expressed in this article are those of the author and do not necessarily reflect those of the Federal Trade Commission.

This article originally appeared in NEJM Catalyst on March 30, 2016.

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