CASE : A Strategic Imperative to Merge in an Oligopolistic Market?

In June 1995, George L., CEO of Mack Hospital, was surprised and angered. That morning, his major competitors, Cassid Hospital System and St. Mark’s Hospital, had announced plans to merge. Until now, their market area had been an oligopoly, divided into four major quadrants, each area mostly controlled by one of the four major hospitals located in that respective location. Mack Hospital was by far the largest hospital in the metropolitan area, and the nation, with over 900 beds in service. It was located just off the intersection of two of the busiest freeways just outside of the western portion of the community and dominated the western market. Although centrally located, the hospital had 17 outpatient and ambulatory surgical centers in the suburbs. It also owned and ran a physician-hospital organization (PHO), a network of five community health centers, and an IPA-style HMO, called M-Plan. St. Mark’s Hospital was a religiously affiliated hospital. It had a main hospital with over 700 set-up beds and a satellite smaller hospital, located in the affluent northern part of the community. St. Mark’s also owned a network of primary care physician practices and a PHO, and was part owner of a HMO and PPO. The hospital has also joint ventured with its large cardiology groups to provide catheterization laboratories for each group. These two cardiology groups accounted for about 50 percent of St Mark’s revenues. Cassid Hospital System was located in the eastern area and had just over 500 set-up beds. It also owned physician practices, a PPO, and a PHO. They have the only CEO in the area that graduated with an MBA and was seen as highly aggressive. The last major hospital was St. Francis, another religiously affiliated system that was not affiliated with St. Mark’s. They were located in the far south of the community. St. Francis was located in a poorer section of the community and provided just over 400 set-up beds. It also was a part owner in the PPO and HMO that St. Mark’s owned and owns primary care physician practices and a PHO. Other, less dominant hospitals existed, including a 300-bed public hospital in the center of town that had rundown facilities and was the safety net hospital, the only children’s hospital in the state also located in the center of the community, a university hospital next to the medical school and children’s hospital, and a for-profit women’s hospital located in the northern part of the city. Physician referrals within the community had become increasingly influenced by physician affiliations with PHOs and health systems and their respective financial incentives. Their market also had about 13 percent more hospital beds per 1,000 population than the U.S. average, and its inpatient utilization was about 22 percent higher. Most of the bed capacity was located in the urban core. The community also had about 6 percent more primary care physicians and 17 percent more specialty physicians per 1,000 population than the national average. (Source: Center for Studying Health System Change, 1997) George L. approached his CFO, Clyde B., and asked, “What in the world are those guys at St. Mark’s and Cassid thinking? How can they think they can get away with coming together like that? When they combine their hospitals they will effectively control more than half the metropolitan area. We cannot stand for that!” Until now, this division of the market had served the hospitals well. Charges were high compared to national averages (one report indicated their average charges were about 30 percent above their neighboring state’s charges). They had also been able to keep most major HMOs from deeply penetrating the marketplace. However, in the past three years, managed care had been making progress in influencing the market. About 15 to 20 percent of the commercial insurance market is enrolled in HMOs, but until now, most of these had been owned by one of the top area hospitals. Recently, however, a former BlueCross plan had begun to garner greater market share and threatened the existing, hospital-owned HMOs. Almost all of the area hospitals have been reasonably profitable and had relatively strong financial positions, but had been deteriorating.

2000 to 2003 Net Operating Income/Margin for Area Hospitals (Million) Beds 2000 2001 2002 2003 Mack 900 $11.6/1.9% $12.5/2.0% $9.7/1.5% $9.1/1.4% University 450 $27.8/7.6% $4.2/1.2% $1.1/0.3% $0.1/0.0% Cassid System 500 $8.5/5.1% $–1.1/–1.5% $2.3/1.9% $1.2/1.3% St. Francis 400 $1.8/0.4% $2.4/1.1% $–3.4/–2.4% $–1.8/–0.8% St. Mark’s 700 $16.1/2.9% $22.1/3.5% $28.2/4.2% $12.1/2.1% Safety Net 300 $–88.5/–33.3% $–38.4/–21.8% $–44.3/–27.2% $–55.2/–29.6% Children 220 $5.5/2.2% $4.8/1.9% $–1.3/–0.3% $1.3/0.8%

George continued the conversation with his CFO. “If they are going to come together, we will have to do something to protect ourselves. What about combining Mack with the children’s and university hospitals? This would still make us the biggest hospital system in the U.S. with the capacity to provide almost every type of medical service and allow us to leverage the new HMOs and keep Cassid’s and St. Mark’s HMO products from further penetrating our market. Don’t you think that we could also get some operational efficiencies this way?” Clyde was not too certain that this was a good idea. “But, the children’s and university hospital are almost downtown and just four miles from Mack! They are also academic facilities and, having worked in one before coming here, I can tell you that physicians and administrators there will have a totally different culture and practice style than we have here. Besides, both hospitals are making money, so why would the state (who owns them) allow them to merge with us? This sounds like a huge headache, but I guess we can’t merge with a loser like the safety net hospital or a weak system like St. Francis, though they would let us capture the southern part of our area.” George continued unabated, “Clyde, if they merge we just can’t remain by ourselves! Get to work on developing a merger option with these two hospitals.” Comment: As in this case, hospitals in oligopoly markets most often divide up their market and do not directly compete against each other. This case demonstrates what can occur when members of an oligopoly deviate from their traditional behaviors. Strategies sometimes become reactive.

Questions

1. Why is George concerned if the merger of St. Mark’s and Cassid occurs?

2. What are the advantages and disadvantages for considering merging with the children’s and university hospital?

3. What would happen if the merger of St. Mark’s and Cassid did not occur, yet Mack announced their merger? Would Mack be stronger or weaker?