The authors describe “megaproviders” as “giant health care systems” that operate multiple hospitals and outpatient centers, affiliate with doctors, and may even sell health insurance. In economics jargon, a megaprovider is a horizontally and vertically integrated firm in the health care industry. The three biggest U.S. megaproviders, ranked by revenue, are the University of Pittsburgh Medical Center, Partners Health, and Sutter Health. Observe Dranove and Burns, although “the hospital systems are nearly all nonprofit,” they manage “to post solid profits.”

Integration / The authors offer two reasons for blaming megaproviders for the high cost of health care. One is based on what megaproviders do: they acquire market power, which enables them to charge higher prices. The other is based on what they do not do: effectively manage doctors, whose decisions influence the bulk of expenditures on health care, in ways that will reduce costs.

Health care has been expensive for a long time. During the Great Depression, several government agencies and private foundations created the Committee on the Cost of Medical Care to study both the cost and quality of U.S. health care. Its 1932 report “condemned the high and often wasteful spending that made health care inaccessible for most Americans,” note Dranove and Burns.

They write at length on the history of the health care industry in America. A watershed moment was the emergence of the “managed competition movement,” sparked by the work of economists Alain Enthoven of Stanford and Stephen Shortell of California, Berkeley. Their ideas formed the basis of the Clinton administration’s 1993 attempt to remake U.S. health care. Although the administration’s Health Security Act never passed, it motivated hospital executives to act. Their response was a strategy of “integration.”

Hospitals grew into “integrated delivery networks.” Hospital mergers and acquisitions are examples of horizontal integration. Hospitals employing doctors is an example of vertical integration. One rationale for this integration was to achieve economies of scale and scope. Another rationale was to gain “control of referrals” by doctors whose decisions influence spending.

Hospital executives initially attempted integration in the early 1990s. Neither economies of scale nor scope materialized. One reason for this is that, “because every hospital was making the same investments, no one could ramp up their volumes.” Various difficulties plagued vertical integration of doctors. Hospitals paid too much to employ doctors or acquire their practices. The doctors who were more likely to accept employment with hospitals were less motivated to work. Hospital executives neglected to incorporate “productivity incentives” in the agreements they signed with doctors. The initial attempt to integrate wound down by the end of the 1990s as hospital revenues fell short of expenses.

After the start of this century, hospital executives made another attempt to integrate, egged on by health policy experts. New rationales were based on government policies. Two stand out: the Centers for Medicare and Medicaid Services (CMS) implemented “pay for performance,” while the Affordable Care Act promoted the creation of accountable care organizations (ACOs). Both take advantage of CMS financial incentives to hospitals to lower the cost of care and increase the quality.

Megaproviders now earn profits based on integration. Their gain appears to be at the expense of consumers. “Prices are up,” Dranove and Burns inform us, “quality is unchanged at best, and the quest for efficiency continues.” The authors cite numerous journal articles to support their charges. Their reading of the literature on the horizontal integration of hospitals leads them to conclude that “mergers between competing hospitals do not appear to generate cost savings.” Worse, their review of the literature on the vertical integration of hospitals and doctors convinces them that prices are higher as a result. And quality does not improve from these changes, though it also does not decrease.

ACOs achieve mixed results. An abundance of studies concludes that “roughly half of the ACOs reduced spending.” Part of the problem is that doctors do not directly benefit when they cut costs. And they are unhappy with integration in general: hospital executives call on them to exercise business skills, but they would rather get to know their patients and solve their health problems.

Competition / Given the profits megaproviders earn, the high prices they charge, and the unhappy lot of doctors they employ, Dranove and Burns ask of these entities, “If they are so successful, how can they be so bad?” Their answer: “Too many megaproviders face too little competition, and too many of their executives seemingly do not know how to manage the complex process of organizing and delivering health care.” The former is a steppingstone to the authors’ discussion of antitrust policy in the health care industry.

Hospital mergers have drawn the attention of the Federal Trade Commission, the Department of Justice, and state attorneys general. Merging firms testify that their market is vast, with many competitors. Antitrust agencies argue the opposite. To resolve this, the DOJ adopted a standard created by economists Kenneth Elzinga of the University of Virginia and Tom Hogarty of Virginia Tech (and later the American Petroleum Institute) to define a geographic market. If my understanding is correct, the “E‑H test” deems a market area to be appropriately sized when it is large enough that the percentage of patients traveling outside the area for care, and the percentage of outside‐​the‐​area patients receiving care in the area, both fall below a certain benchmark, typically 10%. In a landmark case employing this test, when Rockford Memorial and Swedish American hospitals of Rockford, IL attempted to merge in the 1980s, the DOJ opposed it. In 1989, the trial judge decided that the combination would result in too much market power and ruled against it. The ruling was upheld on appeal.

Ironically, merging hospitals learned that the E‑H test enabled them to define markets so geographically broad that they would defeat challenges from the antitrust agencies for several years. Economists — including Elzinga — eventually showed that the test was an unreliable means to determine the relevant boundaries of markets for hospital facilities. Their analysis shifted to documenting that past mergers resulted in higher prices and the recognition that insurers play a larger role in setting prices with hospitals than consumers. “If a merger increases the bargaining leverage of providers,” the authors explain, “they will command higher prices.” The FTC used that reasoning along with testimony from insurers to argue that Evanston Northwestern Healthcare possessed unacceptable pricing power in and around Chicago. The FTC won its case; however, it decided to regulate Evanston Northwestern rather than break it up.

Dranove and Burns mention another technique to demonstrate market power that Dranove helped to devise in previous work: willingness to pay (WTP). The gist is that “WTP captures a hospital’s ability to negotiate higher prices, and the extent to which two hospitals can command higher prices than they can when they are separate.” By employing WTP in the courtroom, the FTC has thwarted several attempted mergers around the country.

Equipped with this new theory of how hospitals and insurers bargain with each other and empirical evidence of how integration increases prices, antitrust agencies prevent some but not all new mergers in more narrow, geographically smaller markets. Among the problems that persist, hospitals that had merged in the 1990s and early 2000s still wield market power and search for additional mergers and acquisitions in geographically larger markets. And they engage in “questionable conduct” to maintain market power.

Now that the FTC has persuaded judges that the appropriate market for hospital merger and acquisition activity is about the size of a city, either the agency will prevent hospital executives from merging or acquiring another health system within a city or the executives will not even bother trying. Instead, executives planning to integrate will look for partners or targets in other cities. A few researchers claim that these “cross‐​market mergers” empower hospitals to increase prices. One theory of how this happens begins with patients’ expectations to choose among a variety of hospitals. Employers in turn aim to fulfill those expectations when negotiating with insurers on behalf of their employees. “Some megaproviders are so [geographically] large that insurers cannot easily meet these standards without them,” write Dranove and Burns. A cross‐​market merger thus gives a hospital an advantage over insurers when negotiating prices.

Another theory is that a cross‐​market merger is a way to raise prices without drawing scrutiny from regulators. The authors put it this way: “Rather than charge extremely high prices where the systems truly have power, they only charge very high prices across the board.”

Value chain / The “questionable conduct” that hospital executives engage in refers to techniques that inhibit consumers from finding lower prices or higher quality. A “must‐​have provider” is a hospital known for high‐​quality care, medical research, or expertise in a given area such as cancer treatment. In an “all‐​or‐​nothing contract,” “insurers must include every system provider in their networks, or none.” Hospital executives with must‐​have providers negotiate all‐​or‐​nothing contracts with insurers. Insurers evidently want to guarantee care for their customers so much that they are willing to accept bad returns for their money: paying for services at hospitals that charge higher prices or provide lower quality. By stipulating “gag rules,” hospitals prevent insurers from sharing the prices they pay, which hinders consumers searching for better deals. This foreshadows the authors’ suggestions for antitrust policy: “These tactics seem blatantly anticompetitive.”

The idea of a “value chain” forms the basis of Dranove and Burns’ suggestions for antitrust policy. “In health care,” they explain, “the value chain represents the formal and informal linkages among payers and providers that govern the entire medical care process.” The authors want to promote competition among value chains because they believe the payoff in terms of reduced health care expenditures is significant.

They propose to evaluate mergers and acquisitions by asking and answering the following:

• Can the market support three value chains?
• Are there three organizations that could serve as foci for organizing the chains?

If the answer to both questions is yes, then the agencies should scrutinize any deal that threatens to reduce the numbers to two. If the answer to either is no, then the market is already concentrated and all deals involving focal organizations should be scrutinized. Based on the cases they describe, Dranove and Burns reason that a combination of providers with different value chains will mean the elimination of one, and therefore such a merger should be blocked.

The authors do not think big hospitals are necessarily bad or all bad. “As long as markets support competition among three or more value chains,” they specify, “we would leave the megaproviders alone.” Otherwise, they endorse breaking up large hospital systems that possess market power or regulating their prices. They would prohibit all‐​or‐​nothing contracts and gag rules. Readers who think that publicly available prices are a feature of markets that work well will be interested in their reasons against “mandatory price disclosure.” The authors have a lot to suggest. “The point,” they emphasize, “is that we need a new bible for health‐​care antitrust enforcement.”

Big Med is a valuable survey of the health care industry. Dranove and Burns arguably succeed in causing the reader to think about what causes the high cost of health care in America, as well as government policies and business strategies that might halt that trend. Readers will contend with the economics of industrial organization, business practices such as anti‐​steering and bundling, and an abundance of acronyms. That may make the book too demanding for the wide readership the authors hope to attract.