Making the case for consolidation

The recent ruling in the case of ProMedica Health System vs. the Federal Trade Commission offers two key lessons for CFOs about how hospitals and health systems should proceed with mergers or acquisitions: Make sure any deal serves to keep costs low and competition high.

On April 22, a three-judge panel for the U.S. Court of Appeals for the Sixth Circuit ruled that the Federal Trade Commission was correct in challenging the merger of Toledo, Ohio-based ProMedica with St. Luke's Hospital of Toledo. In 2010, the two entities merged, giving ProMedica a share above 50 percent in the market for primary and secondary services and above 80 percent for obstetrical services, the court ruled.

The FTC had challenged the merger under the Clayton Act. After finding the merger would adversely affect competition, the FTC ordered ProMedica to divest St. Luke's. ProMedica appealed, saying the FTC was wrong on the law and on the facts in its analysis of the competitive effects of the merger.

The court found otherwise. "We think the commission was right on both counts, and deny the petition," the three-judge panel said.

In a statement, FTC Chairwoman Edith Ramirez called the ProMedica decision a victory for the residents of Lucas County, Ohio. ProMedica told the Toledo Blade that it would appeal the ruling.

Costs of market power

"This case shows that for hospitals, there is a real tension between the benefits of consolidation—better integration of care—and the costs related to market power," said Robert G. Hansen, senior associate dean and professor of business administration at the Tuck School of Business at Dartmouth College. In his classes this spring, Hansen has used the ProMedica case as an example of the thorny problems hospitals face when seeking better performance through a merger or acquisition. 

He sees lessons for CFOs in this case, as well as strong similarities between ProMedica's case in Toledo and the acquisition by St. Luke's Health System in Boise, Idaho, of the Saltzer Medical Group in nearby Nampa, Idaho. The FTC stepped into the St. Luke's-Saltzer case last year and argued successfully that St. Luke's in Boise would gain too much market power by acquiring the 40-physician Saltzer Medical Group. As in the Toledo case, a court ruled against the Boise merger and ordered a divestiture. St. Luke's in Boise is appealing the ruling of the U.S. District Court.

One of the similarities in the cases is how the merged entities would affect the market. Then FTC uses the Herfindahl–Hirschman Index (HHI) as a measure of market concentration.

"Among the similarities, the increase in the HHI and the level of the HHI post-merger are in the same ballpark," Hansen said. "Of the Toledo merger, the appeals court said, 'the merger here blew through those barriers in spectacular fashion.' The court in the Boise case could say the same about the St. Luke's/Saltzer merger."

In any merger under review, the heart of the issue is the bargaining power of the merged entities. "In the ProMedica case, the two entities were good substitutes for one another, and removing one would leave payers or managed care companies with few alternatives. The same holds with St. Luke's/Saltzer. Those two were the best alternatives to one another," Hansen explained.

"In Idaho, there is a history of St. Luke's having higher prices than other hospitals, and the appeals court in the Toledo case pointed to evidence showing that higher market shares in Ohio led to higher prices," he added.

Proving benefit

The lesson then, said Hansen, is merged entities should demonstrate a benefit to the public. 

"Most important, the appeals court says ProMedica did not even try to justify the merger on the basis of consumer welfare -- meaning how the merger might reduce cost or improve quality. This kind of 'efficiency defense' is critical to mounting a credible argument," he said.

Hansen was unsure if the ProMedica decision means the case in Idaho would ultimately be decided in a similar fashion.

"In St. Luke's/Saltzer, there is a pretty strong set of arguments in favor of better quality and lower cost after the merger. The court did not dispute this fact, but found instead that the synergies would be achievable without the merger, through less problematic means," Hansen explained. "The other obvious difference is that the appeal in Idaho will be in a different court."

Nonetheless, Hansen doesn't see the St. Luke's appeal in Idaho as a "slam dunk" either way.

"The 'efficiency defense' of St. Luke's/Saltzer will be the pivotal issue, and the appeals court will be hard pressed to overturn the first judge's finding that the efficiencies are not merger-specific," he said.