Federal Trade Commission v. Advocate Health Care Network ( 2016 )

In the
United States Court of Appeals
For the Seventh Circuit
____________________
No. 16-2492
FEDERAL TRADE COMMISSION and STATE OF ILLINOIS,
Plaintiffs-Appellants,
v.
ADVOCATE HEALTH CARE NETWORK, et al.,
Defendants-Appellees.
____________________
Appeal from the United States District Court for the
Northern District of Illinois, Eastern Division.
No. 15 C 11473 — Jorge L. Alonso, Judge.
____________________
ARGUED AUGUST 19, 2016 — DECIDED OCTOBER 31, 2016
____________________
Before WOOD, Chief Judge, and BAUER and HAMILTON, Cir-
cuit Judges.
HAMILTON, Circuit Judge. This horizontal merger case un-
der the Clayton Act depends on proper definition of geo-
graphic markets for hospitals. Defendants Advocate Health
Care Network and NorthShore University HealthSystem both
operate hospital networks in Chicago’s northern suburbs.
They propose to merge. Section 7 of the Clayton Act forbids
asset acquisitions that may lessen competition in any “section
2 No. 16-2492
of the country.” 15 U.S.C. § 18. The Federal Trade Commission
and the State of Illinois sued in district court to enjoin the pro-
posed Advocate-NorthShore merger while the Commission
considers the issue through its ordinary but slower adminis-
trative process. See 15 U.S.C. § 53(b); 15 U.S.C. § 26; Hawaii v.
Standard Oil Co. of California, 405 U.S. 251, 260–61 (1972).
To obtain an injunction, plaintiffs had to demonstrate a
likelihood of success on the merits. 15 U.S.C. § 53(b); 15 U.S.C.
§ 26; West Allis Memorial Hospital, Inc. v. Bowen, 852 F.2d 251,
253 (7th Cir. 1988). To show that the merger may lessen com-
petition, the Commission and Illinois had to identify a rele-
vant geographic market where anticompetitive effects of the
merger would be felt. See United States v. Philadelphia National
Bank, 374 U.S. 321, 357 (1963); Brown Shoe Co. v. United States,
370 U.S. 294, 323 (1962). Plaintiffs relied on a method called
the hypothetical monopolist test. That test asks what would
happen if a single firm became the sole seller in a proposed
region. If such a firm could profitably raise prices above com-
petitive levels, that region is a relevant geographic market. In
re Southeastern Milk Antitrust Litig., 739 F.3d 262, 277–78 (6th
Cir. 2014). The Commission’s expert economist, Dr. Steven
Tenn, chose an eleven-hospital candidate region and deter-
mined that it passed the hypothetical monopolist test.
The district court denied the motion for preliminary in-
junction. Federal Trade Comm’n v. Advocate Health Care, No. 15
C 11473, 2016 WL 3387163 (N.D. Ill. June 20, 2016). It found
that the plaintiffs had not demonstrated a likelihood of suc-
cess because they had not shown a relevant geographic mar-
ket. Id. at *5. The plaintiffs appealed, and the district court
stayed the merger pending appeal. That stay remains in place.
No. 16-2492 3
Even with the deference we give a district court’s findings
of fact, the district court’s geographic market finding here was
clearly erroneous. The court treated Dr. Tenn’s analysis as if
its logic were circular, but the hypothetical monopolist test in-
stead uses an iterative process, first proposing a region and
then using available data to test the likely results of a price
increase in that region. Also, the evidence was not equivocal
on two points central to the commercial reality of hospital
competition in this market: most patients prefer to receive
hospital care close to home, and insurers cannot market
healthcare plans to employers with employees in Chicago’s
northern suburbs without including at least some of the merg-
ing hospitals in their networks. The district court rejected that
evidence because of some patients’ willingness to travel for
hospital care. The court’s analysis erred by overlooking the
market power created by the remaining patients’ preferences,
something economists have called the “silent majority” fal-
lacy.
Part I lays out the facts of the proposed merger, the rele-
vant economics, and the district court proceedings. Part II-A
discusses briefly the relevant product market, which is not
disputed. Part II-B addresses the disputed issue of the rele-
vant geographic market, looking at the issue first generally
and then with respect to hospitals. Part III explains what we
see as the errors in the district court’s analysis of the geo-
graphic market: in Part III-A, mistaking the nature of the hy-
pothetical monopolist test; in Part III-B, the role that academic
medical centers play in markets for general acute care; in Part
III-C, patients’ preferences for convenient local hospitals; and
in Part III-D, the “silent majority” fallacy.
4 No. 16-2492
I. The Proposed Merger and the District Court Proceedings
In the United States today, most hospital care is bought in
two stages. In the first, which is highly price-sensitive, insur-
ers and hospitals negotiate to determine whether the hospi-
tals will be in the insurers’ networks and how much the insur-
ers will pay them. Gregory Vistnes, Hospitals, Mergers, and
Two-Stage Competition, 67 Antitrust L.J. 671, 674–75 (2000). In
the second stage, hospitals compete to attract patients, based
primarily on non-price factors like convenience and reputa-
tion for quality. Id. at 677, 682. Concerns about potential mis-
use of market power resulting from a merger must take into
account this two-stage process.
Chicago area providers of hospital care include defendant
NorthShore University HealthSystem, which has four hospi-
tals in Chicago’s north suburbs. The area surrounding
NorthShore’s hospitals has roughly eight other hospitals. Two
of those hospitals belong to defendant Advocate Health Care
Network, which has a total of nine hospitals in the Chicago
area. A map of Chicago area hospitals included in the record
is an appendix to this opinion.
In September 2014, Advocate and NorthShore announced
that they intended to merge. The Federal Trade Commission
and the State of Illinois took action in December 2015 by filing
a complaint in the Northern District of Illinois seeking a pre-
liminary injunction against the merger. The court heard six
days of evidence on that motion. Executives from several ma-
jor insurers testified. Some of the details of their testimony are
under seal, but they testified unequivocally that it would be
difficult or impossible to market a network to employers in
metropolitan Chicago that excludes both NorthShore and Ad-
vocate. Additional evidence shows that no health insurance
No. 16-2492 5
product has been successfully marketed to employers in Chi-
cago without offering access to either NorthShore hospitals or
Advocate hospitals.
The court also heard testimony from several economic ex-
perts, including Dr. Tenn. He used the “hypothetical monop-
olist test” to identify the geographic market relevant to the
case. That test asks whether a single firm controlling all out-
put of a product within a given region would be able to raise
prices profitably a bit above competitive levels. Economists
and antitrust cognoscenti refer to such a price increase as a
“SSNIP,” a “small but significant [usually five percent] and
non-transitory increase in price.” U.S. Dep’t of Justice & Fed-
eral Trade Comm’n, Horizontal Merger Guidelines 9 (2010). Dr.
Tenn simulated the market’s response to a price increase im-
posed by a monopolist controlling NorthShore’s hospitals and
the two nearby Advocate hospitals. He found that the monop-
olist could profitably impose the increase. He therefore con-
cluded that the contiguous area including just those six party
hospitals is a relevant geographic market.
Dr. Tenn also chose a larger candidate market to test, using
three criteria. First, he distinguished between local hospitals
and academic medical centers, which he rather inauspiciously
called “destination hospitals.” 1 Academic medical centers
draw patients from across the Chicago area, including the
northern suburbs, even though they are not in the northern
suburbs. Dr. Tenn excluded those hospitals from his candi-
1 Dr. Tenn’s “destination hospital” category included four academic
medical centers and two specialty hospitals. The parties focused on the
academic medical centers, and so do we.
6 No. 16-2492
date market, reasoning that patients require insurers to pro-
vide them more local and convenient hospital options. Sec-
ond, Dr. Tenn identified hospitals that had at least a two per-
cent share of the admissions from the same areas the parties’
hospitals drew from. Finally, he included only hospitals that
drew from both Advocate’s and NorthShore’s service areas.
Those criteria produced an eleven-hospital candidate mar-
ket: the six party hospitals and five other nearby hospitals,
without any academic medical centers. Dr. Tenn simulated
the response to a price increase by a hypothetical firm control-
ling those eleven hospitals. He again found that the price in-
crease would be profitable. He therefore concluded that the
area around the eleven hospitals is a relevant geographic mar-
ket. The plaintiffs focused their arguments on the larger,
eleven-hospital market both in the district court and on ap-
peal; they and we refer to it as the North Shore Area.
To test how robust his results were, Dr. Tenn also tested
another, larger market, selected using less restrictive criteria.
He added hospitals that drew only one percent of admissions
from either NorthShore or Advocate’s service areas, indicating
a fifteen-hospital market. That area included Presence St.
Francis, a hospital close to NorthShore’s Evanston hospital.
Dr. Tenn concluded that the larger area also passed the hypo-
thetical monopolist test.
As part of his simulations, Dr. Tenn calculated the percent-
age of patients at each of the North Shore Area hospitals who
would turn to each of the other available hospitals if their first
choice hospital were closed. For example, he determined that
if Advocate’s Lutheran General Hospital closed, 9.3 percent of
its patients would likely go to NorthShore’s Evanston Hospi-
tal instead. These measures are called diversion ratios. Dr.
No. 16-2492 7
Tenn calculated that for 48 percent of patients in the North
Shore Area, both their first and second choice hospitals were
inside the Commission’s proposed market.
Once he identified the relevant geographic market, Dr.
Tenn used the Herfindahl-Hirschman Index, a common
method for assessing a transaction’s competitive effects, to
evaluate the merger’s effects on the market’s concentration.
He found that for both the eleven-hospital proposed market
and the fifteen-hospital market, the proposed Advocate-
NorthShore merger would result in a presumptively unlawful
increase in market concentration.
The defendants called their own experts, including econo-
mist Dr. Thomas McCarthy, who criticized the criteria Dr.
Tenn used to select his candidate market. Dr. McCarthy ar-
gued that academic medical centers are substitutes for local
hospitals because patients seek the same treatments at both
hospital types. He also contended that the candidate market
should include competitors to either Advocate or NorthShore,
not just competitors to both. A competitor to either system, he
reasoned, would also compete with and constrain the merged
system.
The district court rejected Dr. Tenn’s analysis, found that
plaintiffs had not shown a likelihood of success on the merits,
and denied an injunction. Advocate Health Care, 2016 WL
3387163, at *5. Its analysis focused on Dr. Tenn’s candidate-
market criteria and echoed Dr. McCarthy’s criticisms of those
criteria. Id. at *4–5. There was, the court said, no economic ba-
sis for distinguishing between academic medical centers and
local hospitals and no reason to think a competitor had to con-
strain both Advocate and NorthShore to be in the geographic
market. Id. The court also criticized Dr. Tenn’s assumption
8 No. 16-2492
that patients generally insist on access to local hospitals, call-
ing the evidence on that point “equivocal” and pointing to the
52 percent of patients whose second-choice hospitals were
outside the proposed market. Id. at *4 n.4. At several points in
the opinion, the court implied that Dr. Tenn’s analysis was cir-
cular, saying that he “assume[d] the answer” to the geo-
graphic market question. Id. at *4–5.
We review the district court’s legal determinations de novo,
its factual findings for clear error, and its ultimate decision for
abuse of discretion. Federal Trade Comm’n v. Penn State Hershey
Medical Center, — F.3d —, No. 16-2365, 2016 WL 5389289, at
*1–2 (3d Cir. Sept. 27, 2016) (reversing denial of injunction to
stop hospital merger); Abbott Laboratories v. Mead Johnson &
Co., 971 F.2d 6, 12–13 (7th Cir. 1992) (describing standard of
review for preliminary injunction decisions generally); Federal
Trade Comm’n v. Elders Grain, Inc., 868 F.2d 901, 903–04 (7th Cir.
1989) (affirming Section 7 injunction).
II. Relevant Antitrust Markets
Section 7 of the Clayton Act makes it unlawful to “acquire
… the assets of another person … where in any line of com-
merce … in any section of the country, the effect of such ac-
quisition may be substantially to lessen competition… .” 15
U.S.C. § 18. The Act “deal[s] with probabilities,” not “absolute
certainties.” Ekco Products Co. v. Federal Trade Comm’n, 347 F.2d
745, 752 (7th Cir. 1965); accord, Brown Shoe, 370 U.S. at 323
(“Congress used the words ‘may be substantially to lessen
competition’ … to indicate that its concern was with probabil-
ities, not certainties.”). “All that is necessary is that the merger
create an appreciable danger of such consequences in the fu-
ture.” Hospital Corp. of America v. Federal Trade Comm’n, 807
No. 16-2492 9
F.2d 1381, 1389 (7th Cir. 1986). “[D]oubts are to be resolved
against the transaction.” Elders Grain, Inc., 868 F.2d at 906.
To show a Section 7 violation, the Commission must iden-
tify the relevant “line of commerce” and “section of the coun-
try.” See United States v. E.I. du Pont de Nemours & Co., 353 U.S.
586, 593 (1957) (“Determination of the relevant market is a
necessary predicate to a finding of a violation of the Clayton
Act.”). In other words, it must identify the relevant product
and geographic markets. Brown Shoe, 370 U.S. at 324 (“The
‘area of effective competition’ must be determined by refer-
ence to a product market (the ‘line of commerce’) and a geo-
graphic market (the ‘section of the country’).”).
A. The Product Market
Product markets usually include the product at issue and
its substitutes, the other products that are reasonably inter-
changeable with it. Brown Shoe, 370 U.S. at 325. But products
can also be “clustered” together if the “‘cluster’ is itself an ob-
ject of consumer demand.” Green Country Food Market, Inc. v.
Bottling Group, LLC, 371 F.3d 1275, 1284–85 (10th Cir. 2004)
(emphasis omitted) (affirming finding that branded bever-
ages are not a cluster market); accord, Philadelphia National
Bank, 374 U.S. at 356 (approving a “cluster of products … de-
noted by the term ‘commercial banking’”); Federal Trade
Comm’n v. Staples, Inc., — F. Supp. 3d —, 2016 WL 2899222, at
*8 (D.D.C. May 17, 2016) (“it is possible to cluster consumable
office supplies into one market for analytical convenience”);
United States v. Hughes Tool Co., 415 F. Supp. 637, 640–41 (C.D.
Cal. 1976).
10 No. 16-2492
As in many other hospital merger cases, the parties here
agree that the product market here is just such a cluster: inpa-
tient general acute care services—specifically, those services
sold to commercial health plans and their members. See Penn
State Hershey, — F.3d at —, 2016 WL 5389289, at *5 (parties
stipulated); Federal Trade Comm’n v. Tenet Health Care Corp., 186
F.3d 1045, 1051–52 (8th Cir. 1999) (same); Federal Trade Comm’n
v. Freeman Hospital, 69 F.3d 260, 268 (8th Cir. 1995) (same). That
market is a cluster of medical services and procedures that re-
quire admission to a hospital, such as abdominal surgeries,
childbirth, treatment of serious infections, and some emer-
gency care.
B. The Geographic Market
The dispute here is about the relevant geographic market.
The relevant geographic market is “where … the effect of the
merger on competition will be direct and immediate.” Phila-
delphia National Bank, 374 U.S. at 357. It must include the
“sellers or producers who have the … ‘ability to deprive each
other of significant levels of business.’” Rebel Oil Co. v. Atlantic
Richfield Co., 51 F.3d 1421, 1434 (9th Cir. 1995), quoting Thur-
man Industries, Inc. v. Pay ’N Pak Stores, Inc., 875 F.2d 1369, 1374
(9th Cir. 1989). “Congress prescribed a pragmatic, factual ap-
proach to the definition of the relevant market and not a for-
mal, legalistic one.” Brown Shoe, 370 U.S. at 336. The market
must “‘correspond to the commercial realities’ of the indus-
try.” Id., quoting American Crystal Sugar Co. v. Cuban-American
Sugar Co., 152 F. Supp. 387, 398 (S.D.N.Y. 1957); see also 42nd
Parallel North v. E Street Denim Co., 286 F.3d 401, 406 (7th Cir.
2002) (evaluating geographic market with “sensible aware-
ness of commercial reality”).
No. 16-2492 11
1. Geographic Markets in General
Since at least 1982, the Commission has used the “hypo-
thetical monopolist test” to identify relevant geographic mar-
kets. Gregory J. Werden, The 1982 Merger Guidelines and the
Ascent of the Hypothetical Monopolist Paradigm, 71 Antitrust L.J.
253, 253 (2003). That test asks what would happen if a single
firm became the only seller in a candidate geographic region.
Federal Trade Comm’n v. Whole Foods Market, Inc., 548 F.3d 1028,
1038 (D.C. Cir. 2008). If that hypothetical monopolist could
profitably raise prices above competitive levels, the region is
a relevant geographic market. Kenneth G. Elzinga & An-
thony W. Swisher, Limits of the Elzinga-Hogarty Test in Hospital
Mergers: The Evanston Case, 18 Int’l J. of Economics of Business
133, 136 (2011). But if customers would defeat the attempted
price increase by buying from outside the region, it is not a
relevant market; the test should be rerun using a larger candi-
date region. Saint Alphonsus Medical Center-Nampa Inc. v. Saint
Luke’s Health System, Ltd., 778 F.3d 775, 784 (9th Cir. 2015); In
re Southeastern Milk Antitrust Litig., 739 F.3d 262, 277–78 (6th
Cir. 2014). This process is iterative, meaning it should be re-
peated with ever-larger candidates until it identifies a rele-
vant geographic market. Southeastern Milk, 739 F.3d at 278.
That market can be as large as the globe, if for example the
buyers and sellers are sophisticated merchants and transpor-
tation costs and other barriers are low. See United States v.
Eastman Kodak Co., 63 F.3d 95, 98, 104 (2d Cir. 1995) (using
worldwide market for photographic film); United States v.
H&R Block, Inc., 833 F. Supp. 2d 36, 50 n.7 (D.D.C. 2011) (de-
scribing stipulated worldwide geographic market in tax prep-
aration software provided on the Internet); see also Brown
Shoe, 370 U.S. at 337 (“[A]lthough the geographic market in
12 No. 16-2492
some instances may encompass the entire Nation, under other
circumstances it may be as small as a single metropolitan
area.”).
Retail markets, on the other hand, are often small, espe-
cially when customers are motivated by convenience. Phila-
delphia National Bank, 374 U.S. at 358 (“In banking, as in most
service industries, convenience of location is essential to effec-
tive competition. Individuals and corporations … find it im-
practical to conduct their banking business at a distance. The
factor of inconvenience localizes banking competition… .”)
(footnote and citation omitted). (Still, there are limits. See 42nd
Parallel North, 286 F.3d at 406 (rejecting as “absurdly small” a
proposed market for retail designer jeans and t-shirts com-
prising only the “central business district” of Highland Park,
Illinois).)
The hypothetical monopolist test focuses on “the area of
effective competition” between firms. See E. I. du Pont, 353 U.S.
at 593 (emphasis added), quoting Standard Oil Co. of California
v. United States, 337 U.S. 293, 299 n.5 (1949). A geographic mar-
ket does not need to include all of the firm’s competitors; it
needs to include the competitors that would “substantially
constrain [the firm’s] price-increasing ability.” AD/SAT, a Di-
vision of Skylight, Inc. v. Associated Press, 181 F.3d 216, 228 (2d
Cir. 1999) (citation omitted); Rebel Oil, 51 F.3d at 1434 (“[A]
‘market’ is the group of sellers or producers who have the ‘ac-
tual or potential ability to deprive each other of significant
levels of business.’”) (citation omitted).
An alternative approach to relevant geographic markets is
the Elzinga-Hogarty test. See Elzinga & Swisher, supra, 18 Int’l
J. of Economics of Business at 136 (comparing Elzinga-Ho-
garty test and the hypothetical monopolist test). Devised in
No. 16-2492 13
the 1970s from studies of coal and beer markets, the test uses
product or customer movement to define geographic mar-
kets. Cory S. Capps, From Rockford to Joplin and Back Again: The
Impact of Economics on Hospital Merger Enforcement, 59 Anti-
trust Bull. 443, 450 (2014); Kenneth G. Elzinga & Thomas F.
Hogarty, The Problem of Geographic Market Delineation in An-
timerger Suits, 18 Antitrust Bull. 45, 73–74 (1973); Cory S.
Capps et al., The Silent Majority Fallacy of the Elzinga-Hogarty
Criteria: A Critique and New Approach to Analyzing Hospital Mer-
gers 1 (Nat’l Bureau of Econ. Research, Working Paper No.
8216, 2001). A geographic market passes the Elzinga-Hogarty
test if few customers enter or leave the area. Elzinga & Ho-
garty, supra, 18 Antitrust Bull. at 73–74.
Put more formally, a market passes the Elzinga-Hogarty
test if both: (1) a high level of sales (usually 75 or 90 percent)
is to buyers located in the market; and (2) a similarly high per-
centage of buyers located in the market buys within it. Id.;
Kenneth G. Elzinga & Thomas F. Hogarty, The Problem of Geo-
graphic Market Delineation Revisited: The Case of Coal, 23 Anti-
trust Bull. 1, 2 (1978); Federal Trade Comm’n v. Butterworth
Health Corp., 946 F. Supp. 1285, 1292 (W.D. Mich. 1996), aff’d
mem., 121 F.3d 708 (6th Cir. 1997). The test treats pre-merger
customer movement as a proxy for likely post-merger
changes in customer movement. Elzinga & Swisher, supra, 18
Int’l J. of Economics of Business at 136. It assumes that if some
customers currently buy from firms outside the area, others
would also switch to avoid a price increase within the area. Id.
at 136–37. That assumption holds, however, only if the cus-
tomers who currently buy from firms outside the area are
similar to those who do not. Capps et al., supra, at 1.
14 No. 16-2492
2. Geographic Markets for Hospitals
Markets for hospital services have three notable features.
First, because most patients prefer to go to nearby hospitals,
there are often only a few hospitals in a geographic market.
See United States v. Rockford Memorial Corp., 898 F.2d 1278,
1284–85 (7th Cir. 1990) (approving six-hospital market in part
because “for the most part hospital services are local”); Evans-
ton Northwestern Healthcare Corp., F.T.C. No. 9315, 2007 WL
2286195, at *2, *66 (Aug. 6, 2007) (finding that three merged
hospitals used market power to increase prices); Steven Tenn,
The Price Effects of Hospital Mergers: A Case Study of the Sutter-
Summit Transaction, 18 Int’l J. of Economics of Business 65, 66,
79 (2011) (plaintiffs’ expert showing a possibly anticompeti-
tive price increase following a two-hospital merger); Saint Al-
phonsus, 778 F.3d at 781, 784 (geographic market included pri-
mary care physician services in Nampa, Idaho, without ex-
tending to Boise, 20 miles away); Capps et al., supra, at 11 (ex-
plaining that its analysis “implies that the average patient is
highly averse to travel”); cf. Philadelphia National Bank, 374
U.S. at 358 (“The factor of inconvenience localizes [retail]
banking competition as effectively as high transportation
costs in other industries.”). This case’s record reflects that
preference: in the Commission’s proposed market, 80 percent
of patients drove to the hospital of their choice in 20 minutes
or less.
Second, patients vary in their hospital preferences. Getting
an appendectomy is not like buying a beer; one Pabst Blue
Ribbon or Hoegaarden may be as good as another, no matter
where they are bought. For surgery patients, who their sur-
geon will be matters, the hospital’s reputation matters, and
the hospital’s location matters. Different patients value these
No. 16-2492 15
(and other) factors differently. Capps et al., supra, at 12 (“The
high degree of heterogeneity in the taste for hospital attrib-
utes and in willingness to travel highlights the key point that
hospitals offer a differentiated product to a segmented mar-
ket.”). For example, some patients will be willing to travel to
see a particular specialist. See Elzinga & Swisher, supra, 18
Int’l J. of Economics of Business at 137–38 (giving a similar
example). Others will not. That means that, as Dr. Elzinga
himself has explained, the Elzinga-Hogarty test will often
overestimate the size of hospital markets. Id. at 137. 2 The test
assumes that if some patients presently travel for care, more
would do so to avoid a price increase, making an increase un-
profitable. Id. But in fact, often a “silent majority” of patients
will not travel, enabling anticompetitive price increases. Id.
The economic literature began describing this problem—
termed the “silent majority fallacy”—as early as 2001. Capps
et al., supra, at 1.
Finally, consumers do not directly pay the full cost of hos-
pital care. Instead, insurance companies cover most hospital
costs. Elzinga & Swisher, supra, at 138. Insurance thus splits
hospital competition into two stages: one in which hospitals
compete to be included in insurers’ networks, and a second in
which hospitals compete to attract patients. Saint Alphonsus,
778 F.3d at 784 & n.10; Vistnes, supra, 67 Antitrust L. J. at 672.
Insured patients are usually not sensitive to retail hospital
prices, while insurers respond to both prices and patient pref-
erences. Id. at 677, 680 (explaining that the credibility of an
insurer’s threat to drop a hospital from its network depends
on the importance of the hospital to the plan’s enrollees);
2 Dr. Elzinga is part of a group of economists who submitted a helpful
amicus brief in this case.
16 No. 16-2492
Capps, supra, 59 Antitrust Bull. at 454–55 (observing that un-
der most health insurance designs, the patient’s and the phy-
sician’s incentive to consider price is “either very small or
nil”); Penn State Hershey, — F.3d at —, 2016 WL 5389289, at *8
(explaining that insurers “feel the impact of price increases”
and that patient behavior “affects the relative bargaining po-
sitions of insurers and hospitals as they negotiate rates”).
The geographic market question is therefore most directly
about “the ‘likely response of insurers,’” not patients, to a
price increase. Saint Alphonsus, 778 F.3d at 784, quoting Saint
Alphonsus Medical Center-Nampa, Inc. v. Saint Luke’s Health Sys-
tem, Ltd., 2014 WL 407446, at *7 (D. Idaho Jan. 24, 2014). This
complication is sometimes termed the “payer problem.” El-
zinga & Swisher, supra, 18 Int’l J. of Economics of Business at
138.
The Commission and the judiciary have responded to the
academy’s evolving understanding of hospital markets. In the
1990s, they relied heavily on the Elzinga-Hogarty test. See,
e.g., United States v. Mercy Health Services, 902 F. Supp. 968, 977
(N.D. Iowa 1995) (noting government’s reliance on Elzinga-
Hogarty), vacated, 107 F.3d 632 (8th Cir. 1997); Rockford Memo-
rial, 898 F.2d at 1284–85 (approving a hospital geographic
market defined by where the defendants’ patients came
from); see also Capps, supra, 59 Antitrust Bull. at 455 (“courts
in the 1990s relied heavily on analyses of patient inflows and
outflows”). The Eighth Circuit briefly resisted that trend. In
Freeman Hospital, the court rejected the Commission’s pro-
posed geographic market, which relied on the Elzinga-Ho-
garty test. 69 F.3d at 264–65, 268. The Commission’s evidence,
it reasoned, did not address the “crucial question,” which was
not where customers currently go but where they “could
No. 16-2492 17
practicably go” in response to a price increase. Id. at 270–71.
Four years later, the Eighth Circuit embraced the test, reject-
ing another Commission-proposed market in part because
“over twenty-two percent of people … already use hospitals
outside the … proposed market.” Tenet Health Care, 186 F.3d
at 1053.
That reliance produced relatively large geographic mar-
kets in hospital merger cases. The Commission’s proposed
market in Freeman Hospital, for example, covered a 27-mile ra-
dius around Joplin, Missouri. 69 F.3d at 268. In Butterworth
Health, 946 F. Supp. at 1291, the Commission proposed a mar-
ket covering Grand Rapids, Michigan and the 30 miles sur-
rounding that city. Tenet Health rejected as too narrow a mar-
ket 100 miles across in Missouri. 186 F.3d at 1052–53. And
Mercy Health relied on patient movement to argue that hospi-
tals 70 to 100 miles away from the defendant hospitals were
viable competitors. 902 F. Supp. at 971–72, 979–80. By way of
comparison, in this case, 80 percent of patients in
NorthShore’s service area drive 20 minutes or less (and 15
miles or less) to reach their hospital of choice.
As economists have identified the limits of the Elzinga-
Hogarty test, courts and the Commission have begun to ad-
just their approaches to the problem. In Evanston Northwest-
ern, the Commission heard testimony from Dr. Elzinga about
those limits and concluded that patient movement was at best
“one potentially very rough benchmark,” to be used “in the
context of evaluating other types of evidence.” 2007 WL
2286195, at *66; see also Penn State Hershey, — F.3d at —, 2016
WL 5389289, at *6–7, *18 (reversing denial of preliminary in-
junction, in part because district court relied on elements of
Elzinga-Hogarty test).
18 No. 16-2492
That adjustment is necessary. If the analysis uses geo-
graphic markets that are too large, consumers will be harmed
because the likely anticompetitive effects of hospital mergers
will be understated. Penn State Hershey, — F.3d at —, 2016 WL
5389289, at *6 (“empirical research demonstrated that utiliz-
ing patient flow data to determine the relevant geographic
market resulted in overbroad markets with respect to hospi-
tals”); Evanston Northwestern, 2007 WL 2286195, at *65–66
(finding persuasive Dr. Elzinga’s testimony that “application
of the [Elzinga-Hogarty] test to patient flow data would iden-
tify overly broad geographic markets”); see also Cory Capps
& David Dranove, Hospital Consolidation and Negotiated PPO
Prices, 23 Health Affairs 175, 179 (2004) (“most consolidating
hospitals raise prices by more than the median price increase
in their markets”); Leemore S. Dafny, Estimation and Identifica-
tion of Merger Effects: An Application to Hospital Mergers 26
(Nat’l Bureau of Econ. Research, Working Paper No. 11673,
2005) (“there is conclusive evidence that mergers of inde-
pendent hospitals can lead to large increases in area prices”);
Martin Gaynor & Robert Town, The Impact of Hospital Consoli-
dation – Update, Technical Report (Robert Wood Johnson
Foundation/The Synthesis Project, Princeton, N.J.), June 2012,
at 2 (“Hospital mergers in concentrated markets generally
lead to significant price increases.”).
For example, in 2001 the Northern District of California
refused to enjoin a hospital merger, relying in part on patient
movement data. California v. Sutter Health System, 130 F. Supp.
2d 1109, 1131–32, 1137 (N.D. Cal. 2001). In 2011, a follow-up
study found that the cheaper of the two hospitals raised its
prices by 29 to 72 percent, much more than a control group
had. Tenn, supra, 18 Int’l J. of Economics of Business at 75–76.
Other merger case studies produced similar results. See
No. 16-2492 19
Aileen Thompson, The Effect of Hospital Mergers on Inpatient
Prices: A Case Study of the New Hanover-Cape Fear Transaction,
18 Int’l J. of Economics of Business 91, 99 (2001) (finding that,
following a hospital merger, two insurers experienced sub-
stantial price increases, one a large decrease, and one a normal
price change); Michael G. Vita & Seth Sacher, The Competitive
Effects of Not-For-Profit Hospital Mergers: A Case Study, 49 J. of
Industrial Economics 63, 65, 82 (2001) (finding that after a
merger, both the merged entity and its remaining competitor
raised prices).
NorthShore’s own history makes the point. NorthShore
was created in 2000 by a smaller merger between Evanston
Northwestern Healthcare Corporation and Highland Park
Hospital, involving just three hospitals. Evanston Northwest-
ern, 2007 WL 2286195, at *2; see also Messner v. Northshore Uni-
versity HealthSystem, 669 F.3d 802, 809 (7th Cir. 2012). Four
years later, the Federal Trade Commission challenged the
merger alleging a violation of Section 7. NorthShore “substan-
tially and immediately raised its prices after the merger.” Ev-
anston Northwestern, 2007 WL 2286195, at *53. NorthShore’s
own expert found price increases of nine to ten percent above
price increases of a control group of hospitals. Id. at *21, *54.
After a hearing before an administrative law judge and an ap-
peal to the Commission, the Commission found that the mer-
ger violated the Clayton Act. Id. at *4, *76. 3
3The Commission found, however, that by then the merged parties
were too entwined to order divestiture. Id. at *78. The Commission instead
ordered the merged entity to use two independent teams to negotiate with
insurers, one for each of the pre-merger hospital systems. Id. at *79.
20 No. 16-2492
III. Analysis
We review the district court’s decision in this case in light
of this history. As noted, we review the court’s legal determi-
nations de novo, its factual findings for clear error, and its ulti-
mate decision for abuse of discretion. Penn State Hershey, —
F.3d at —, 2016 WL 5389289, at *2; Abbott Laboratories, 971 F.2d
at 12–13. We find that the district court made clear factual er-
rors. Its central error was its misunderstanding of the hypo-
thetical monopolist test: it overlooked the test’s results and
mistook the test’s iterations for logical circularity. Even if the
court’s focus on the candidate market had been correct, its
criticisms were mistaken in three ways. It incorrectly found
that Dr. Tenn lacked a basis for distinguishing local hospitals
from academic medical centers. It erroneously determined
that the evidence about patient preferences for local hospitals
was “equivocal.” Finally, its analysis fell prey to a version of
the silent majority fallacy.
A. The Hypothetical Monopolist Test
As explained above, the hypothetical monopolist test is an
iterative analysis. The analyst proposes a candidate market,
simulates a monopolization of that market, then adjusts the
candidate market and reruns the simulation as necessary. The
district court criticized Dr. Tenn’s candidate market but did
not mention his results. The court did not explain why it
thought that a narrow candidate market would produce in-
correct results. Nor do the hospitals. We have not found sup-
port for that assumption. The economic literature explains
that if a candidate market is too narrow, the test will show as
much, and further iterations will broaden the market until it
is big enough. See Elzinga & Swisher, supra, 18 Int’l J. of Eco-
nomics of Business at 136.
No. 16-2492 21
The district court seems to have mistaken those iterations
for circularity. It criticized Dr. Tenn’s candidate market for
“assum[ing] the answer” to the market definition question.
Advocate Health Care, 2016 WL 3387163, at *4–5. But in fact, the
candidate market offers a hypothetical answer to that ques-
tion; the hypothetical monopolist analysis then tests the hy-
pothesis and adjusts the market definition if the results re-
quire it. That is not circular reasoning.
B. Academic Medical Centers
When Dr. Tenn proposed a candidate market, he excluded
what he called “destination hospitals,” which are hospitals—
primarily academic medical centers—that attract patients at
long distances from throughout the Chicago metropolitan
area. The district court criticized that classification, saying it
had no “economic basis.” Advocate Health Care, 2016 WL
3387163, at *4. The record belies that assessment: the wit-
nesses consistently used the term “academic medical center”
and recognized that demand for those few hospitals differs
from demand for general acute care hospitals like these par-
ties’ hospitals, which draw patients from much smaller geo-
graphic areas.
For example, one insurance executive explained that some
insured patients will “travel … for a higher level of care po-
tentially at an Academic Medical Center.” NorthShore’s CEO
also distinguished between academic medical centers and
community hospitals, explaining that the former provide both
“basic” and “complex” services. Other witnesses agreed. An-
other insurance executive explained that individual consum-
ers want their insurance network to include “[their] physi-
cian, [their] community hospital, and maybe potential access
to an academic medical center.” An executive of one academic
22 No. 16-2492
medical center differentiated between “community hospitals”
and “an Academic Medical Center” in terms of the complex-
ity of the services provided. Another insurance executive ex-
plained that NorthShore and Advocate hospitals were not ac-
ademic medical centers. That testimony provides an obvious
and sound basis for distinguishing between academic medi-
cal centers and other hospitals like those operated by Advo-
cate and NorthShore.
C. Patient Preference for Local Hospitals
Before Dr. Tenn chose a candidate market, he determined
that patients generally choose hospitals close to their homes.
The district court called the evidence on that point “equivo-
cal,” citing testimony that workplace locations and outpatient
relationships also influence patient choices. Advocate Health
Care, 2016 WL 3387163, at *4. But most of the cited testimony
addressed medical care broadly, not inpatient acute care spe-
cifically. For instance, one insurance executive testified that
Chicago area consumers use “services” close to both their
homes and their workplaces. Similarly, another witness ex-
plained that employees choose providers based on where
they live, work, and have relationships with doctors, but that
witness was speaking about “people Y consuming benefits”
generally, not about hospital choice in particular.
When it came to hospital care, the evidence was not equiv-
ocal on Dr. Tenn’s central point. As one insurance executive
put it: “Typically [patients] seek [hospital] care in their own
communities.” The evidence on that point is strong, not
equivocal. For example, 73 percent of patients living in plain-
tiffs’ proposed market receive hospital care there. Eighty per-
cent of those patients drive less than 20 minutes or 15 miles to
their chosen hospital. Ninety-five percent of those patients
No. 16-2492 23
drive 30 miles or less—the north-to-south length of plaintiffs’
proposed market—to reach a hospital. That evidence that
many patients care about convenience is consistent with what
we said in Rockford Memorial: “for the most part hospital ser-
vices are local.” 898 F.2d at 1285. That is consistent with retail
markets generally, at least where the seller (hospital) and
buyer (patient) must come face to face. See Philadelphia Na-
tional Bank, 374 U.S. at 358.
D. The Silent Majority Fallacy
The insurance executives were unanimous on a second
point: in the North Shore Area, an insurer’s network must in-
clude either Advocate or NorthShore to offer a product mar-
ketable to employers. The record as a whole supports that tes-
timony. There is no evidence that a network has succeeded
with employers without one or the other of the merging par-
ties in its network. (One company offers a network in the Chi-
cago area without either of the merging parties, but that net-
work’s membership is overwhelmingly individuals rather
than employers. And fewer than two percent of those individ-
ual members live near NorthShore’s hospitals.) Cf. Penn State
Hershey, — F.3d at —, 2016 WL 5389289, at *9 (noting that an-
titrust defendant in theory “may be able to demonstrate that
enough patients would buy a health plan Y with no in-net-
work hospital in the proposed geographic market,” but not
when an insurer that tried it “lost half of its membership”).
The district court discounted that testimony, citing Dr.
Tenn’s diversion ratios, although it did not explain what it in-
ferred from the ratios. Advocate Health Care, 2016 WL 3387163,
at *4 n.4. We assume the court was referring to two of their
features: the proportion (52 percent) of patients who, if their
24 No. 16-2492
first choice hospital were unavailable, would seek care out-
side the proposed market, and the proportion (7.2–29.2 per-
cent) of patients who, if their first choice hospital were una-
vailable, would divert to Northwestern Memorial Hospital,
an academic medical center outside Dr. Tenn’s proposed mar-
ket. 4
If patients were the relevant buyers in this market, those
numbers would be more compelling since diversion ratios in-
dicate which hospitals patients consider substitutes. But as we
have explained, insurers are the most relevant buyers. Insur-
ers must consider both whether employers would offer their
plans and whether employees would sign up for them.
“[E]mployers generally try to provide all of their employees
4 The hospitals understand the district court’s use of diversion ratios
differently. They argue that the court disregarded the insurer testimony
because one insurance executive incorrectly identified customers’ pre-
ferred hospitals. That executive viewed Advocate’s Lutheran General
Hospital as the main alternative to NorthShore’s Evanston hospital, and
saw Advocate Condell Medical Center as the primary alternative to
NorthShore’s Highland Park Hospital. The diversion ratios, the hospitals
point out, indicate that Northwestern Memorial is the most common sec-
ond choice for NorthShore’s Evanston, and that Northwestern Lake Forest
is the main alternative to NorthShore’s Highland Park.
We do not believe that was the district court’s reasoning. The court
did not cite that testimony and was not addressing insurers’ testimony
about patient hospital choices—it was addressing insurers’ testimony
about plan marketability. Advocate Health Care, 2016 WL 3387163, at *4 n.4.
The reasoning is unpersuasive in any case. One insurance witness’s minor
mistake about patient preferences for two hospitals is not a sufficient rea-
son to disregard the overwhelming weight of the evidence showing: (1)
the large proportion of patients who prefer hospitals close to their homes
and (2) the resulting need for insurers to offer networks that include com-
munity hospitals close to their customers’ homes.
No. 16-2492 25
at least one attractive option,” and may not offer even a
broadly appealing plan if it lacks services in a particular re-
gion. Vistnes, supra, 67 Antitrust L.J. at 678. As a result,
measures of patient substitution like diversion ratios do not
translate neatly into options for insurers. The district court
erred in assuming they did. 5
The hospitals correctly point out that, strictly speaking,
that reasoning is not the same as the silent majority fallacy.
The silent majority fallacy treats present travel as a proxy for
post-merger travel, while diversion ratios predict likely post-
merger travel more directly. But the district court’s reasoning
and the silent majority fallacy share a critical flaw: they focus
on the patients who leave a proposed market instead of on
hospitals’ market power over the patients who remain, which
means that the hospitals have market power over the insurers
5 The hospitals raise a related point on appeal, arguing that the diver-
sion ratios indicate that Northwestern Memorial Hospital is the closest
substitute for some NorthShore hospitals. They then point to the Merger
Guidelines, which say that in general relevant markets should include a
product’s closest substitutes even if the market passes the hypothetical
monopolist test without them. See U.S. Dep’t of Justice & Federal Trade
Comm’n, supra, Horizontal Merger Guidelines at 9. The hospitals’ reliance
on the diversion ratios, like the district court’s, overlooks insurers’ role in
the marketplace. Even if we take the diversion ratios to mean that a sizable
minority of patients consider Northwestern Memorial a close substitute,
it does not follow that insurers could offer it as a sufficient substitute for a
commercially viable insurance network. And in any event, the hospitals
concede that even with Northwestern Memorial included in the market,
the Herfindahl-Hirschman Index calculation still indicates that the merger
is presumptively unlawful. The hospitals argue that if Northwestern
should be included, so should the other academic medical centers. But
there is no comparable evidence about those centers as close substitutes
for the hospitals of the merging parties.
26 No. 16-2492
who need them to offer commercially viable products to cus-
tomers who are reluctant to travel farther for general acute
hospital care.
That flaw runs through the district court’s decision. The
court focused on identifying hospitals that compete with
those in the Commission’s proposed market. But the relevant
geographic market does not include every competitor. It is the
“area of effective competition,” E. I. du Pont, 353 U.S. at 593
(emphasis added) (citation omitted), the place where the “ef-
fect of the merger on competition will be direct and immedi-
ate,” Philadelphia National Bank, 374 U.S. at 357. It includes the
competitors that discipline the merging hospitals’ prices.
AD/SAT, 181 F.3d at 228; Rebel Oil, 51 F.3d at 1434. The geo-
graphic market question asks in essence, how many hospitals
can insurers convince most customers to drive past to save a
few percent on their health insurance premiums? We should
not be surprised if that number is very small. Plaintiffs have
made a strong case that it is.
We REVERSE the district court’s denial of a preliminary
injunction and REMAND for further proceedings consistent
with this opinion. The merger shall remain enjoined pending
the district court’s reconsideration of the preliminary injunc-
tion motion.