Federal Trade Commission Protecting America's Consumers

DKT/CASE NO.:P951201

TITLE: HEARINGS ON GLOBAL AND INNOVATION-BASED COMPETITION

PLACE: Washington, D.C.

DATE: November 7, 1995

PAGES: 1527 through 1750

C O R R E C T E D C O P Y

Meeting Before the Commission

Date: November 7, 1995

Docket No.:P951201

FEDERAL TRADE COMMISSION

I N D E X

WITNESS: EXAMINATION

None.

E X H I B I T S

FOR IDENTIFICATION

Commission's:

None.

FEDERAL TRADE COMMISSION

In the Matter of: )

)

) Docket No.: P951201

HEARINGS ON GLOBAL AND )

INNOVATION-BASED COMPETITION )

Tuesday,

November 7, 1995

Federal Trade Commission

Sixth and Pennsylvania Avenues

Room 432

Washington, D.C. 20580

The above-entitled matter came on for hearing,

pursuant to notice, at 9:40 a.m.

SPEAKERS:

ROBERT PITOFSKY

Chairman, Federal Trade Commission

ROSCOE B. STAREK, III

Commissioner, Federal Trade Commission

JANET D. STEIGER

Commissioner, Federal Trade Commission

SUSAN S. DE SANTI

Director, Policy Planning

DEBRA VALENTINE

Deputy Director, Policy Planning

LAURA A. WILKINSON

Deputy Assistant Director, Merger I Division

Bureau of Competition

SPEAKERS (Continued):

RICHARD SCOTT

President, HCA Healthcare Corp.

JAMES CUBBIN

Executive Director,

General Motors Health Care Inititiatives

WILLIAM C. MacLEOD

Collier, Shannon, Rill & Scott

Grocery Manufacturers Association

PHILLIP PROGER

Jones, Day, Reavis & Pogue

Alliance for Managed Care

JOSEPH BRODLEY

Professor, Boston University

TERRY CALVANI

Pillsbury, Madison & Sutro

TIMOTHY MURIS

Professor, George Mason University

KEVIN O'OCCONOR

Assistant Attorney General, Wisconsin

Chair, NAAG Multi-state Task Force

P R O C E E D I N G S

CHAIRMAN PITOFSKY: Good morning, everyone.

We continue our hearings. We're up to Day 10 of hearings, and our emphasis last week and today will be on the question of how to deal with efficiencies in the context of competition policy.

This morning our emphasis will be, to some extent, on efficiencies as they emerge, are relevant in the fast-changing health care industry.

Our first speaker this morning is James Cubbin, Executive Director of General Motors Health Care Initiatives, a position he has held since March 1994. As Executive Director, he is responsible for all activities relating to GM's health care initiatives, legislative analysis, and cost and quality improvements.

Mr. Cubbin joined GM in August 1963 and held a series of engineering positions at the former Ternstedt Division and Fisher Body Division. He joined the GM legal staff in 1972 and practiced law in a variety of areas, including environmental, product liability, marketing, and trade regulation. He has also served as general counsel for Saturn Corporation and the Buick-Olds-Cadillac Group.

Mr. Cubbin, welcome to these proceedings.

MR. CUBBIN: Thank you.

I would like to thank the Federal Trade Commission for affording me the opportunity today to share with you some of the General Motors' views regarding the role that judicious antitrust enforcement can play in achieving greater efficiencies in the delivery of health care services.

General Motors has a profound interest in health care and its reform. As well as being the nation's largest industrial corporation, we are the largest single private payer for health care services in the world.

We currently provide health care coverage to over 1.6 million employees, retirees, and to families throughout the United States. In 1994, our U.S. health care bill was $5.4 billion. On a per vehicle basis that amounts to approximately $1200 for every car or truck we built, more than we spent for steel.

We are also vitally concerned with improving the health status of our work force. Our employee population is older than is typical for the United States manufacturers as a whole, and maintaining their health is a crucial element in our drive to improve productivity.

When we look at the nation's health care system today, we see many similarities to our own business just a few years ago. In the early '80s, GM was not sufficiently innovative or flexible in driving improvements to our systems in order to bring costs down while better meeting our customers' needs. As a result, we lost market share and our profits suffered.

Our experience has taught us that meeting customer needs must come first and foremost, and the same principle holds true for health care. Better meeting health care customer needs while holding costs will require innovation and different ways of doing business.

Wise application of the antitrust laws has been and can continue to be a force that promotes the sort of innovation that can improve customer access to necessary health care services while containing costs.

We are concerned, however, that antitrust issues, whether real or imagined, could stifle valuable experimentation in how health care services are planned for and provided at the community level.

We believe that health care reform is moving to the local level and that we can best contribute to improving efficiency and quality by becoming an active player in planning the evolution of community health delivery systems.

In doing so, however, we need the freedom under the antitrust laws to work jointly with providers, insurers, other payers, and citizens' representatives to explore more efficient means of delivering care and better meeting the community needs.

We also need to have a system that emerges from these community-wide discussions evaluated under a rule of reason analysis that takes into account some of the key problems in applying conventional economic analysis to health care markets.

As I noted, increasing efficiency in the health care sector, while at the same time meeting customer needs, will require innovation and experimentation. To date, antitrust enforcement has largely been a force to promote such innovation.

For example, the antitrust enforcement agencies, by placing a check on the power of incumbent entities to control access to key services, have proved a powerful weapon in speeding the acceptance of managed care plans as an alternative to additional fee-for-service medicine. But too rigid an application of the antitrust laws could stifle further innovation.

The fundamental problem in analyzing health care markets under the antitrust laws, we believe, lies in the definition of "output." I understand from our economists and antitrust lawyers that typically the first question in determining whether a particular practice or form of organization enhances consumer welfare is whether or not it enhances output.

The problem with properly applying this criterion in health care markets is that the output that consumers want out of the health care system is better health.

While the statistics that are generally used measure numbers of procedures, hospital stays, doctor visits and the like, these statistics measure inputs, not output, a distinction missing from the conventional antitrust analysis I've read concerning health care markets.

This mode of analysis can ignore efficiency gains because it makes no distinction between medically beneficial services -- which improve health outcomes and, hence, are output enhancing -- and medically questionable services which represent inefficiencies and have a neutral or, more often, negative effect on outcomes.

As an example of how this distinction applies in the real world, I would like to call your attention to a study published last October in the New England Journal of Medicine looking at hospital readmission rates in Boston and New Haven, two cities with similar demographics but which differ significantly in the number of resident-occupied hospital beds per capita.

The researchers looked at matched cohorts of Medicare patients initially admitted for one of five potentially life-threatening conditions and then compared how often the patients were readmitted in the following 35 months.

Patients in Boston were 1.64 times as likely to be readmitted to the hospital as were patients in New Haven, roughly proportional to the added per capita availability of beds.

Yet mortality rates across the two cities and across particular hospitals did not vary systematically with readmission rates. If outcomes in Boston were no better than in New Haven, despite 64 percent more readmissions, can these readmissions really be classified as enhanced output? In our view, they are better characterized as examples of inefficiencies in the system.

Our experience as a payer causes us to believe that the health care system can achieve greater efficiencies while simultaneously enhancing the provision of medically beneficial services.

One of the clearest examples to us is the remarkable success that community-based health care planning has achieved in Rochester, New York.

There are many features of the system in Rochester which are analyzed and discussed in the 1993 General Accounting Office report. We feel the most important relate to community involvement in overall capacity planning and the rationalization of the provision of specialized hospital-based medical services.

Our experience in Rochester has been highly satisfactory for both GM and for those who obtain their health care coverage through us. Our health care costs in Rochester are substantially lower than they are in any of our top nine GM cities.

For example, on an age-adjusted basis, our cost per member last year for one of our highest cost communities, which is Anderson, Indiana, was 50 percent higher than in Rochester.

If we could achieve the type of cost savings achieved in Rochester in all our major employment areas, that is the nine top cities, GM alone could reduce its annual health care bill by almost $500 million.

Such cost savings need not come at the cost of lower quality care. In fact, they should not come at the cost of lower quality care. By one important measure we regularly track, the rate of inpatient complications per non-Medicare claim, Rochester outperforms any of our top nine communities.

Our experience is typical for companies operating in Rochester. The GAO report, for example, shows that Eastman Kodak's health care cost in Rochester averages more than $900 less per employee than elsewhere in the United States.

With lower health care costs come lower insurance premiums, making health insurance more accessible to individuals and small employers; and Rochester has a far lower rate of uninsured residents than does the rest of the U.S.

With lower costs and better access, Rochester's residents express a higher level of satisfaction with their health care system than U.S. residents on average.

We believe that some of the elements that have helped to reduce costs and improve access in Rochester can be replicated elsewhere.

Perhaps the largest gains are possible through achieving greater efficiencies in the provision of the costly specialized or tertiary care services.

In Rochester, there is virtually no duplication across hospitals in the provision of such services where costly high-tech equipment or highly specialized human skills are required, duplicative provision of services at less than efficient scale can result in unnecessarily high costs. It can also result in poor patient outcomes.

Our experience with heart surgery in some of our communities, for example, shows that programs operating on an adequate scale have significantly lower complications and lower mortality rates than do small marginal programs.

These considerations, of course, are already recognized in the FTC/Department of Justice Policy Statements on joint ventures for high technology equipment and for specialized procedures.

More generally, there are potential efficiencies to be gained from capacity planning.

The economic forces shaping decisions in the absence of planning are often not subject to much market discipline. Indeed, the health care market is very different in our view from other consumer goods and services markets. Health care consumers have little, if any, quality or cost information readily available to them.

Competition among facilities to provide expanded services often takes place in an environment in which generous insurance reimbursement policies on capital costs largely insulate hospitals from downside risks.

In addition, while for-profit firms may be reluctant to enter into or remain in unprofitable lines of business, non-profit institutions may choose to do so indefinitely provided that revenues elsewhere in the institution are sufficient to offset the ongoing losses.

Without planning, communities often end up with capacity for some medical services in excess of reasonable community needs. If that capacity goes unused, it constitutes a clear example of inefficiency. If it is used, but in ways that do not improve patient outcomes, it creates even greater inefficiencies.

While these inefficiencies are especially acute when the excess capacity occurs in tertiary care facilities, they can also be found in other parts of the health care system as well.

We believe the most effective path to real health care system reform is through consumers and payers becoming more knowledgeable about the quality and cost of services provided in their communities and then using that knowledge to participate actively in re-engineering their local delivery systems.

GM and our UAW partners have begun a large scale test of this approach by undertaking initiatives to explore the gains that might be achieved from community-based planning in two of our highest cost GM communities.

We are now in the midst of gathering necessary background data for Flint, Michigan, and Anderson, Indiana. We have recently been joined in this endeavor by HCFA, the Health Care Financing Administration.

The consultants working with us in Flint -- Lou and VHI -- and in Anderson are preparing detailed community assessments. Their work plan requires them to produce three separate types of evaluations. The first is a health assessment. It is designed to provide both a general gauge for judging whether the health care delivery and public health systems are meeting community needs in a context for more in-depth analysis for the delivery system's effectiveness.

From public sources and GM enrollment data, the consultants plan to answer these questions pertaining to the demographic and overall health profile of the target communities.

Special attention will be paid to the health status of mothers and children, to the special needs of vulnerable populations, and to the prevalence in the community of high-risk behaviors on the one hand and to the prevalence of health promotion and disease prevention behavior on the other.

The health assessment will compare the health status of the target communities for the national and state norms as well as to Healthy People 2000 Goals developed by a broad consensus processed under the sponsorship of the Department of Health and Human Services.

The second stage of the evaluation is the resource assessment. It serves to identify available resources in the community and to estimate service capacity levels, assess health service needs, and from these, identify areas of resource imbalance.

The resource assessment is designed to address the full continuum of health care services from an examination of public health resources through an exploration of long-term care services. Although, the most detailed analysis will be for in-patient services.

The resource portion of the assessment will rely on a wide variety of sources including AMA and AHA statistics while the community needs portion will be developed using actual utilization data and best practice benchmarks based on expert opinions and existing research.

The final stage of the community assessment is the value assessment. Working from the base of information developed in the other two stages, the value assessment is designed to assess the effectiveness of the delivery system in achieving positive health outcomes and determine if the delivery system is operating in an economically efficient manner.

While the resource assessment will focus on the availability of services, the value assessment will focus on the desirability of those services.

The value assessment will rely on patient level transaction data and aggregate quality and cost data.

Benchmarks will be drawn from existing research, published literature, expert opinion, and the best performance systems and institutions.

It is just this sort of assessment that we believe is necessary to evaluate fully the economic performance of a community's health care system. Its emphasis on how well the system helps achieve positive health outcomes rather than how well it provides particular services reflects the distinction I attempted to draw earlier between measuring output rather than measuring inputs.

When added services do not contribute to improving health outcomes, the assessment will properly label those services as inefficiencies to be reduced rather than as output to be encouraged.

The community assessment, when completed, will serve as the basis for a fact book that can be used by providers, insurers, other payers, and community leaders to facilitate future discussions on improving the efficiency of the health care delivery system in the target communities.

We hope to be able to engage all of these parties in these discussions with the goal of rationalizing the delivery of services in these communities.

If we are successful, we expect to cut costs, improve outcomes, and enhance access by eliminating inefficiency.

We believe that allowing such discussions to take place among providers, consumers, and payers is in the public interest and that they should not be the subject of antitrust enforcement action.

How can judicious antitrust enforcement aid experiments with community-based planning?

Let me first emphasize that we do not believe that blanket exemptions for horizontal combinations in the provision of health care services are warranted or necessary.

However, in light of the difficulties that conventional analysis has in measuring output and in capturing all the efficiencies that might be achievable from community-based planning, we think that the antitrust authorities would be wise to allow some experimentation in this area.

Provided that all the relevant stake holders -- that is providers, payers, and representatives of the consuming public -- take an active part in the discussions, we believe that the usual market power concerns about horizontal agreements among providers or payers alone are not relevant.

The antitrust authorities have apparently allowed community-based planning to evolve naturally in Rochester, New York. And we believe that other communities ought to have the freedom to adopt similar arrangements if they prove mutually satisfactory to all the relevant stake holders.

If even a fraction of the cost savings and improved access that have taken place in Rochester can be replicated elsewhere, then permitting such experimentation will prove extremely beneficial.

Should it prove difficult to replicate the success of the Rochester system, then the risks of permitting experiments are small.

Since community-based planning does not require widespread mergers and consolidations and since the system depends on the cooperation of all stake holders, failed experiments will undoubtedly expire naturally.

The test such arrangements ultimately will have to satisfy to win antitrust approval needs to be established under the rule of reason. One important consideration should be whether the agreement represents input from all of the relevant stake holders. Another will be to verify that the plan contains credible measures to improve the efficiency of the health care system.

The sorts of questions that might be asked include:

Does the plan contain measures that might improve the delivery of services currently provided?

Does the plan expand the output of medically useful services previously under-supplied to the community by improving overall access or meeting specific unaddressed community needs?

And is there reasonable expectation that the plan will enhance outcomes?

In conclusion, while the antitrust laws have, to date, been an overwhelmingly positive force in opening the U.S. health care system to new and more efficient ways of doing business, there is a danger that too rigid an interpretation of these laws could stifle valuable further experiments.

The antitrust laws should not serve as a barrier to achieving greater efficiency in the provision of health care. We think that antitrust analysis that properly takes a broad view of the efficiencies that might be achieved through community-based planning can aid the continuous evolution of the U.S. health care system for a more efficient provision of needed services.

That concludes my prepared remarks. If you have any questions, I'll try to answer them.

CHAIRMAN PITOFSKY: Well, thank you. That's a remarkable view of these issues from what, I guess, must be America's leading purchasers of health care service, if not the leading purchaser.

MR. CUBBIN: Well, $5.4 billion, I think, probably outstrips most others.

CHAIRMAN PITOFSKY: It's a big chunk.

Let me follow up on your proposal about community involvement, community assessment.

You did go out of your way to say that, on balance, antitrust has been a useful force in keeping the opportunities for new forms of health service and cost containment in play.

Have you seen any situation -- I wouldn't think that antitrust would be concerned about community involvement designed to achieve efficiencies.

Have you seen situations where, either because -- where people backed away from the kind of community involvement that you're suggesting, either because they thought the law wouldn't permit it or they thought the law was so unclear that it was dangerous to engage in it?

MR. CUBBIN: We have situations where that conduct has occurred, at least the providers have indicated that they were concerned about antitrust issues or confused.

It may be just an excuse to avoid the discussions that are necessary; and we are trying to do everything we can to encourage discussions that will be productive, including, you know, offering to have antitrust lawyers that have health care backgrounds available at those discussions, inviting government to be involved. As I mentioned, we got the Health Care Financing Authority and HHS.

We would welcome the FTC involvement in our community assessment plans.

CHAIRMAN PITOFSKY: Commissioner?

COMMISSIONER STEIGER: May I ask, and you may not know, would the Joint Policy enforcement statements, which Justice and this agency have issued together, there has been an offer for advisories by either of the agencies within 90 days on questions that may involve the policy statements, area of concern and within 120 days on any health-related question that the community might have as they move forward in this rapidly changing world?

Do you know any instances where concern about antitrust has been expressed whether they have sought advisory opinions from either of the agencies?

I'm anxious to know whether this is being fully used.

MR. CUBBIN: Right. I don't think so. The two situations I'm thinking of, I don't think there was an advisory sought.

I think there's -- again, it depends on whether or not the concern is real or imagined or is just being used as an excuse.

I've heard expressed concern that even though the advisory is available that there's a potential for maybe too rigid an application; and, in fact, maybe we don't want to ask the question because we don't like the answer.

COMMISSIONER STAREK: If I heard you correctly, I think you said that in the community-based systems that you were describing, using Rochester as an example, that enforcers should not be concerned about market power, that the traditional concerns about market power in these situations are not relevant.

I wonder if you could -- first, if I heard you correctly? And, secondly, if I did or didn't, would you tell me what you think about that?

MR. CUBBIN: Well, I think that was a little broader than my statement. I think in community-based planning when all the stake holders are involved -- including representatives of consumers, local government, et cetera -- then concerns about market power may not be relevant.

But I wouldn't say, in a broad context, we'd never worry about concentration or market power.

COMMISSIONER STAREK: Why is that the case, then?

I mean, I don't understand how the fact that communities are involved in it, then the market shouldn't be something to be concerned about.

MR. CUBBIN: If, in fact, the community plan is based on the best interest of all of the stake holders, if it's consensus process that results in efficiencies and quality improvements for the consumers, then I'm not really too worried about one stake holder getting advantage. And that's what you're talking about with market power.

I don't think that the providers would have that much power in those kinds of circumstances, especially with big payers involved like General Motors and Kodak and others. We can always, I think, go outside the system and bring in new players if the existing players aren't playing the game.

CHAIRMAN PITOFSKY: I think that would be true when you have sophisticated companies like your own --

MR. CUBBIN: Oh, I agree --

CHAIRMAN PITOFSKY: -- who are in the process, but let me press you a little bit.

Suppose you have complete community involvement in a community in which there's a wide distribution of mid-sized businesses and suppose the proposal is that there are three hospitals in -- four hospitals in town and the group decides that we're better off with two, four to two.

Are you saying that antitrust authorities looking at that hospital merger should defer to the community's joint decision that two hospitals are better than four and not apply the antitrust laws?

MR. CUBBIN: Not necessarily. I think you've got to look at the facts; you've got to look at the expectations for efficiencies. Are they real or imagined? The depth of analysis.

I don't think that that kind of community-based reform, necessarily, is perfect in every community. I think what we've got to do here is allow for the opportunity of experimentation, some flexibility, and always be focusing on the consumers and whether or not the consumers' interest really are being served by the activity.

CHAIRMAN PITOFSKY: And perhaps give some weight to what the community tells us --

MR. CUBBIN: Right.

CHAIRMAN PITOFSKY: -- who are close to the situation about what they think of efficiencies on the one hand and anti-competitive effects on the other.

MR. CUBBIN: Exactly.

CHAIRMAN PITOFSKY: Susan?

Debra?

Well, thank you very much.

MR. CUBBIN: You're welcome.

As I mentioned, I will have copies of my statement available. We didn't have it yet this morning, but I'll submit that.

CHAIRMAN PITOFSKY: Good.

Our second participant this morning is Richard Scott, President and Chief Executive Officer of Columbia/HCA Healthcare Corporation, which I believe is now the largest hospital corporation in the United States.

Mr. Scott formed Columbia in 1987, in Fort Worth, Texas. Before founding that organization, he specialized in health care mergers and acquisitions in his Texas law practice.

Mr. Scott is a member of the Healthcare Leadership Council, the Business Roundtable, and the Business Council, and serves as a Director of Banc One Corporation. He was recently recognized as a Silver Award winner for CEO of the year by Financial World Magazine and cited as one of the top 25 performers in 1995 in U.S. News & World Report.

Mr. Scott, it's a great pleasure to welcome you to these proceedings.

MR. SCOTT: Well, thanks for the invitation.

First, I apologize for being late. I thought it started at 10:00, and we had great weather coming in from National. I especially like not being able to see and then the last turn so we don't go over the White House. We don't do that in many other cities.

Chairman Pitofsky, Commissioners, thank you for the opportunity to participate in these important hearings. It is my hope that the actions resulting from these deliberations will ultimately contribute to the health and well being of our nation's citizens who turn to those providing health care in often their greatest times of need.

Providing the best possible care to our patients is what drives Columbia; and although these hearings deal with complex and often esoteric economic theory, in the final analysis it is the impact on our ability to provide care to patients which formulates our perspective on these issues.

The issues at hand are, one, how competition really works in today's health care industry; two, when government intervention should be used to protect that competition; and, three, what impact government intervention has on the health care industry's ability to continue to provide excellent patient care at affordable prices.

The past decade has seen dramatic changes with our nation's health care delivery system. The fact is that these changes have been driven by the competitive forces at work in the marketplace. Competition has never been greater. Large employers and other purchasers of health care are contracting for health care services on a large scale, in some markets being able to relocate 50 percent or more of a hospital's patients to another provider in less than one week.

According to a Peat Marwick study cited in the October 25, 1995, edition of the Washington Post, the percentage of workers in managed care has risen from 29 percent in 1988 to 70 percent in 1995, with a dramatic reduction in the rate of increase in employers' spending on health care.

The nation's largest purchaser of health care, the federal government, is proposing massive reductions in Medicare and Medicaid. It is inevitable that, as part of these reductions, most Medicare/Medicaid beneficiaries will participate in a managed care program.

As a result of proposed Medicare and Medicaid changes, there will be increased cost pressure on a reimbursement system in which hospitals are already losing money on many procedures.

For example, there are heart and circulatory disorders for which hospitals lose almost $1400 per case. On the state level, Medicaid rates are being reduced dramatically. In West Virginia, some non-emergency visits by Medicaid beneficiaries to hospital emergency rooms are being reimbursed at the rate of $8 per visit. Other states are proposing substantial reductions.

Combine these significant reductions in health care costs with the highly capital-intensive nature of the business and you have an industry that is under intense pressure to increase efficiency and control costs while maintaining the highest quality.

These pressures are creating the need for rapid consolidation of the industry and the formation of innovative partnerships and alliances.

Today, more than 35 percent of the nation's hospital beds are empty. Of the more than 910,000 hospital beds in the U.S., nearly 330,000 are empty. Occupancy rates on average are at their lowest rates in decades.

In a number of states, 40 percent or more of the hospital beds are empty. The cost and overhead of maintaining this overcapacity are high and add to the health care cost to consumers.

A typical consolidation of two facilities can save 4 to $5 million dollars annually. Cost effectiveness is not the only benefit derived from appropriate consolidations. Eliminating redundant services results in an increase in the number of times a specified medical procedure or service is performed at a facility. This improves quality as the best practices are developed due to the increased performance of the procedure of service.

Of the approximate 5300 hospitals in the United States, about 4600, or 86 percent, are tax-exempt facilities. Tax-exempt hospitals generally have no obligation to pay federal, state, or local taxes; nor do they have an obligation to provide care to those who cannot pay.

All hospitals provide care on an emergency basis to those who cannot pay. The remaining approximately 700 hospitals are tax-paying, generally owned by publicly owned companies, like Columbia.

Of the 5300 hospitals in the United States, Columbia owns approximately 6 percent. Columbia was founded in 1987 after a series of mergers and acquisitions which included: Basic American Medical in 1992; Galen Health Care in 1993; Hospital Corporation of America and Medical Care America 1994; and Health Trust in 1995. We now operate more than 330 hospitals, more than 100 surgery centers and a number of other health care businesses in 36 states and two foreign countries.

Columbia pays more than $1 billion annually in taxes, provides $1 billion annually in uncompensated care, and contributes almost $2 billion to community foundations.

In many rural areas where Columbia is the only hospital provider, physicians affiliated with our hospital and Columbia provide all of the charity care.

Last week an article appeared in the Wall Street Journal about the $80 million foundation which was created in Dickson, Tennessee, a town of less than 9,000 people. The foundation was created when Columbia purchased Good Luck Hospital. All of the foundation funds will be used for charitable and community causes including: parks, educational opportunities, and social needs.

Similar foundations have been created when we purchased hospitals in Miami and Winter Park, Florida; Alexandria, Louisiana; Oklahoma City, Oklahoma; Wichita, Kansas; Denver, Colorado; Cleveland and Canton, Ohio; and Columbia, South Carolina.

Clinics for the poor, elderly, day-care centers, teaching programs, research grants for new medical devices and drugs, mammography centers for the poor are just a few of the uses of these foundation funds.

Columbia was founded with a strong commitment to the values of free markets in a competitive process. The company was formed with the belief that we could provide a full range of health care services. If we could provide a full range of health care services over a broad geographic area as needed by employers, insurance companies, and individuals and provide better outcomes and higher patient satisfaction, then we would be able to attract patients to our facilities.

We recognize that the ability to create comprehensive integrated networks of health care providers would be the key to offering high quality care in the most cost-effective way.

The vision of Columbia is to work with its employees and physicians to build a company that is focused on the well being of people, that is patient oriented, that offers the most advanced technology and information systems, that is financially sound, and that is synonymous with quality, cost-effective health care.

Within that vision, the foundation of our philosophy is offering an affordable price, producing a high level of patient satisfaction, and having the best outcomes in the country.

We have a strong track record of fulfilling this vision. Ongoing Gallop Polls conducted at our facilities indicate that 95 percent of the patients we serve were either satisfied or very satisfied with the care and the service they receive at Columbia facilities.

Each quarter, more than 40,000 patients are surveyed by Gallop concerning issues such as overall nursing care, concerns shown by staff, cleanliness, staff communication, and a number of other issues pertinent to patient satisfaction.

For most consumers, the purchase of specific health care procedures is a one-time or first-time event. They have little experience in terms of making intelligent choices concerning which provider offers the best services.

Columbia is leading the industry in the development of outcome measurements whereby consumers can rate and compare the results of specific procedures among hospitals.

Columbia uses industry-accepted outcome measures to assist the facilities in monitoring and improving the quality and effectiveness of care.

These measures address quality from a multiple of perspectives, including clinical, financial, customer satisfaction, and patient health status and well being.

Columbia compares its results to national benchmarks and peer facilities in an effort to promote and transfer best practices throughout the country.

To date, Columbia's Miami Heart Institute has the lowest mortality for open heart surgery in the entire nation.

And seven of Columbia's Florida hospitals were included in the list of the top 10 hospitals with the lowest mortality rates in open heart surgery.

Within the context of all of our efforts, let me say that Columbia holds a deep-seated belief in and respect for the intent of antitrust laws.

Columbia does not want to deal with monopolies or cartels in connection with any of its supply purchases or purchasers of health care services.

We recognize the importance of well-reasoned antitrust enforcement in protecting competition and consumers.

As we are all aware, Columbia is no stranger to this Commission. In the past two years, we believe we have filed more Hart-Scott-Rodino pre-merger notifications than any other single company.

The FTC has thoroughly scrutinized Columbia, requiring us to supply more than 2,000 boxes of documents in the last two years -- incurring the time and expense of numerous attorneys and economists -- in order to justify our competitive activities. We have been forced to divest 10 hospitals and one surgery center and undo one joint venture.

In other cases, your actions have inhibited others from entering into negotiations with us that would have benefitted the delivery of health care in certain markets.

Significant FTC resources and staffing levels have been allocated to scrutinized Columbia and the health care industry.

It will come as no surprise that from our perspective, FTC efforts related to Columbia have, in certain cases, resulted in actions that have entrenched the dominant provider and prevented the increase of competition.

The mandated divestitures and undoing of joint ventures have not only failed to improve competition in the health care industry but have also, in some markets, entrenched and strengthened larger competitors.

The rulings in some cases have caused a reduction in the quality of care in certain communities by inhibiting the development of cost-effective consolidations.

Let me give you some examples.

In the Augusta, Georgia, area there are eight hospitals. The 662-bed University Hospital is by far the most dominant in the market. Because of its size and resources, the tax-exempt University Center has built a network of out-patient centers, rural health centers, and ambulatory surgery centers, which has enabled it to capture close to 50 percent of the patients in the Augusta market.

Because University Hospital offers a full range of services, including heart, and because many of its competitors are not allowed to add services such as heart services due to state certificate of need laws, University can and does refuse to contract with certain insurance companies and makes exclusion of other providers a condition when it elects to contract with an insurance company.

Columbia operates Augusta Regional Medical Center, which, because of Georgia's certificate of need laws, cannot offer certain services such as heart services, angioplasty, and lithotripsy.

Aiken Regional Medical Center was part of Hospital Corporation of America, a company we acquired in February 1994. Aiken Medical Center is in South Carolina across the Savannah River and approximately 35 miles from Augusta Regional.

It was our intent that through the combined resources of the two facilities and the belief that Aiken would be allowed to add heart services, we would begin a heart program. Our ability to offer these programs would have increased the competition in the Augusta area for these services and lowered the cost of health care to the community.

We believed that Augusta Regional and Aiken Regional combined would have provided an opportunity to compete against University Hospital. Yet the FTC refused to let the transaction transpire.

The result is that the dominant player in the market, University Center Medical Center, remains secure in its position without the need to renegotiate prices. Thus, prices for heart services, incidentally, are almost three times higher than in nearby Atlanta.

Not one doctor on Augusta Regional's medical staff was on Aiken's medical staff, and not one doctor on Aiken's staff was on Augusta's.

The FTC's actions in Augusta have clearly entrenched University Hospital in this area.

Next, in Anchorage, Alaska, Alaska Surgery Center was part of our acquisition of Medical America. Our intent to utilize the facility to complement our operations at Alaska Regional Hospital was denied by the FTC on the basis that once the acquisition was complete we would have had 12 of the 27 surgery suites located in the City of Anchorage.

The purpose of the acquisition was to increase competition with Providence, the market's dominant player with 65 percent market share.

Part of that competition would have been lower prices. Part of that competition would have been to offer options to insurance companies like Aetna and Blue Cross that now have contracts with Providence on a basis that Providence has all of the services.

The FTC ruling in Anchorage ensures that Providence Hospital will continue its dominance, thus hindering competition. Providence has 15 operating rooms combined. Anchorage Regional and Alaska Surgery Center would have had only 12.

As in Augusta, the ruling has produced the very effect it was intended to prevent: entrenching a dominant player within the marketplace.

In our efforts to sell the Surgery Center, we negotiated a provision with a potential buyer of the Surgery Center preventing the buyer from, in the future, selling the Surgery Center to Providence, the dominant hospital in the market.

The FTC would not allow us to include that provision in the sale. Once sold -- and we were having a very difficult time selling the Surgery Center -- the Surgery Center will be allowed, then, to team up with Providence, again entrenching the dominant player in the market.

Another example of FTC intervention which produced negative impact on a community is in the Orlando area.

As a result of Columbia's merger with Galen and -- first off, there's the maps in the back of the presentation.

As a result of Columbia's merger with Galen, we would have owned two hospitals in Kissimmee, Florida, next to Disney World, and clearly part of the Orlando market. Practically every physician on the medical staffs of the Kissimmee hospitals was on the medical staff of the Orlando hospitals.

We would have been able either to consolidate services on one of the Kissimmee campuses or direct specific services to either campus, generating a conservatively estimated savings of $20 million.

In the last seven years, we, as a company, have consolidated 20 hospitals nationwide with other hospitals in our markets. In either case, this would have significantly reduced costs and improved care.

The FTC forced us to divest one of those facilities to Florida Hospital, a tax-exempt hospital system that already had six Orlando hospitals -- and you can see on the map, it's sort of the purple color -- controlling more than 35 percent of the Orlando market.

As a result of that divestiture, the Kissimmee community is serviced by two half empty hospitals. Duplicative services have been added in the market that were not needed.

A major flaw in the FTC decisionmaking process was its failure to analyze the Orlando market as a whole, rather, looking at adjacent community as stand alone areas with a majority of patients in the area directed to medical services through managed care contracts.

The market dynamics are such that patient populations across a multiple county area must be looked at as an integrated whole, not separate populations served in separate communities.

When looked at in the reality of managed care, it becomes apparent that Columbia would not have been a monopoly in Kissimmee at all.

As a result of the Columbia Health Trust merger, there is a similar scenario in the northern part of Orlando where one party in a 50/50 joint venture must divest.

Orlando Regional Hospital, ORHS, a second hospital system in the area, which, without this facility, already owns four hospitals and already controls nearly 35 percent of the Orlando market now controls this facility.

It's located where the question mark is. So what you can see is Florida Hospital covers the entire market area. Orlando Regional is sort of in the center. But if we're forced to divest -- which we're being forced to -- then they will again have a presence in the north.

Because ORHS knows there is no other buyer for our 50 percent ownership interest in the joint venture and we are forced to insure one party to divest, they have offered to purchase our 50 percent interest for $12 million dollars, even though they have turned down our offer to purchase their 50 percent interest for $30 million dollars.

Combined, Florida Hospital and ORHS, that operate hospitals, who were forced to -- or are being forced to divest -- now control more than 70 percent of the Orlando market and are seeking alignment strategies that establish joint marketing and service opportunities.

One of ORHS's stated goals for 1996 is to, quote: "Complete agreement to complete at least one shared or joint venture community project with the Florida Hospital system," unquote.

Once again, rather than opening up competition, the FTC decision squashed it. The FTC decisions have clearly entrenched the two largest hospital systems in Orlando.

This is a map of the state of Utah. As you can see on this map, there's a tax-exempt group called Inter-Mountain Health Care. They have 19 hospitals in the state.

We're -- and they're the orange. We're, I guess the diamond. It looks like green. And we're allowed to keep seven hospitals.

Probably the FTC decision I understand the least is the decision to cause the divestiture of three Utah hospitals after the merger of Columbia with Health Trust.

Currently, the former Health Trust Hospitals are being held in a separate company with which I cannot communicate related to strategy and operations.

And that was caused by the Federal Trade Commission's decision.

During this down time, Inter-Mountain Health Care, IHC, the dominant player in the market, is using this delay to its full advantage to further entrench its market position, utilizing media blitzes of unparalleled proportions.

Based on 1994 admission data, Inter-Mountain, a Utah hospital managed care system, attracted 54 percent of in-patient admissions and 57 percent of out-patient visits statewide.

If Columbia had been able to retain all the hospitals Health Trust owned, it would have attracted only 26 percent of the in-patient admissions and 21 percent of the out-patient visits statewide.

We are being left with 18 percent of the in-patient admissions and 21 percent of the out-patient visits, because the FTC has ordered us to divest three Utah hospitals.

Inter-Mountain will control 45 percent or greater of Salt Lake City area admissions compared to 19 percent for Columbia; 85 percent of Utah County admissions, compared to 15 percent for Columbia; 60 percent of Northern Utah admissions compared to 30 percent for Columbia; and 53 percent of statewide rural admissions compared to 18 percent for Columbia.

In a recent newsletter in the market, IHC stated, quote: "Sure, Inter-Mountain has had a dominance in the marketplace," unquote, quote: "IHC has come away with its reserves." "So what is the benefit to the patients and to the community of the Columbia HCA intrusion? Probably a little lower rates."

And, finally: "I don't think Columbia appreciates the depth of support for its opponent, the political and financial network of IHC and the support of the LDS church. IHC will be standing when all is done," unquote.

Once again, the actions of the FTC not only inhibited additional competitive forces to be interjected into the market in question but also further entrenched the position of the dominant player in the area.

Neither the health care industry nor the communities served have benefitted from these actions. The perception of the health care industry in each of these examples cited is that it was the case that the FTC demanded a pound of flesh in a large transaction where, one, the divestiture would not have occurred if the acquisition had been a single transaction; and, two, the FTC took actions irrespective of the impact on the communities and patients involved.

These actions have merely added to Columbia's cost of doing business and prevented savings efficiencies that could have benefitted consumers in these areas in these facilities.

The FTC continues to prescribe that individual markets must have certain numbers of hospital providers. The truth is, most markets can support three delivery systems at best, with many requiring and only being able to support two competitive systems. In some markets, one hospital is all that a community can support.

It makes no sense, either from the standpoint of efficiency, cost, or quality to have competing facilities standing across the street from each other each 40 percent full and both incurring the overhead necessary to remain open, offering redundant services and staffing.

Requiring hospitals to operate in such environments can only result in severe pressures on facility cash flows which are operating in a very capital-intensive business.

For example, at Columbia, 150 percent of our annual net income is spent on new equipment and renovations at our existing facility.

As in any business, when there are cash flow problems, there are usually reductions in variable costs and capital expenditures.

In health care when hospitals have significantly reduced reimbursements, are prevented from reducing costs through consolidation, there is no other choice than to eliminate the purchase of new technologies and limit or eliminate procedures on which the hospital loses money.

Often these cash flow constraints force staff lay-offs, many times the best paid and the best trained. These actions have a profound negative impact on patient care. Like you, I would not want to take a child, spouse, family member, or friend to a facility which could not offer the latest technology and the best employees. And yet that is what people are being forced to do in some cases where consolidations are prohibited.

The cost and potential harm of government interventions, including the unintended consequences, suggest that antitrust enforcement policies must be based on sound economic theory and supported by empirical evidence.

Moreover, the application of these policies or those policies in any particular case should reflect the true nature of competition in that industry.

Antitrust enforcement officials must attempt to identify the forces that actually determine competition in that industry and take them into account before and during any antitrust review.

In our view, the federal Horizontal Merger Guidelines utilize a model of competition that does not correlate to the real world of health care. We asked the distinguished economists of Economists Inc., many of whom have served on the Federal Trade Commission and the Antitrust Division, to review the concentration models employed by the FTC to help us better understand, one, the reasons for the specific concentration standards incorporated in the guidelines; and, two, the relevance of those standards to predicting the effective hospital mergers on competition.

The results of their analysis appear in Appendix B of my written testimony.

Very briefly, their findings indicate that: One, the models on which the guidelines analysis have differentiated products appear to be based not -- appears to be based not -- do not provide a clear relationship between concentration and market performance.

Next, there is no evidence of a critical concentration level above which coordination becomes likely. In fact, an FTC staff report could not find any relationship between concentration and price. Yet, the guidelines presume that a problem would exist.

And, three, the very nature of hospital operations makes coordination almost impossible.

Hospitals compete along hundreds of discrete services, and their customers are represented by powerful bargaining organizations. Illegal coordination under these conditions is virtually impossible.

Given the facts that studies have shown very little relationship between concentration and competition in the marketplace when it comes to health care and that consolidation and innovation are absolutely critical components for controlling health care costs and maintaining quality, we would suggest the following:

One, that the FTC more formally recognize the substantial efficiencies and benefits achieved through hospital integration within the current economic conditions in the marketplace and acknowledge the benefits to consumers in terms of cost and quality.

Two, eliminate the use of the concentration presumption in evaluating hospital mergers and in fact presume that three or even two hospital systems in a community will provide effective competition.

Three, that the potential for anti-competitive effects be examined on the basis of the specifics of the transaction at hand and the conditions that exist in that particular geographic market. Examples that I cited in Augusta, Anchorage, Orlando, and Utah are good illustrations of why this is needed.

Four, that the investigative process be reformed to make the discovery process less burdensome in light of knowledge gained through a long history of hospital merger investigations and that the review process for divestitures be streamlined.

And, five, that the FTC take into account that preventing consolidation could adversely impact the quality of patient care.

In health care, the ability to be innovative and react quickly to changing market conditions will be the keys to both hospital survival and consumer well being.

Hospitals must be allowed the freedom to innovate, consolidate, and form creative partnerships in order to meet the dual demands of controlling price and providing high quality care.

The Commission must recognize and communicate this recognition that the factors that drive competitive performance in the health care industry cannot be captured by the static models of competition currently employed.

Having offered these solutions, let me emphasize that they are really suggestions directed to the Commission itself. Your staffs have been notable in their willingness to work with us to minimize burdens within the limiting parameters of what they consider your directives.

My suggestions, therefore, should not in any way be considered as an adverse reflection on anyone on your staffs; but in the spirit of these hearings, I do not want to note -- I do want to note that some further changes need to be made to reduce the cost and burden of antitrust investigation.

In conclusion, we at Columbia believe that the enforcement of federal antitrust laws, which the Supreme Court has called the Magna Carta of our economic liberties, is vital. Columbia supports vigorous enforcements. We also applaud your efforts in these hearings to come to grips with the realities of competition in varied and highly different industry and service markets in order to determine which government intervention is really required to ensure competition.

We have done our best to describe the marketplace in which we work, what conditions should exist to best serve our patients, some real world examples of the effects of unnecessary intervention, and changes that are needed in the way government intervention is determined in hospital situations.

We hope this testimony and accompanying appendixes will add in your endeavors.

Thank you very much.

CHAIRMAN PITOFSKY: Well, thank you for extremely candid and informed testimony on this question.

It's a little difficult to discuss those cases that turn on relevant market definition. What I hear you saying is that in Augusta, the Commission drew the market too narrowly, in South Carolina too broadly. It's hard to get at that. So let me ask -- let's talk about the policy questions.

You say there's no evidence of a connection between concentration and price; and you say we should drop our presumptions based on concentration; and that three hospitals or two are okay.

Do you mean that for cities like New York and Washington and Chicago, that three hospitals are enough or two and that there should be a presumption that mergers leading to that kind of concentration is permissible?

MR. SCOTT: I think what you should expect in cities like -- take Miami, Atlanta, Chicago -- I can't talk about New York; we don't do business there -- Houston, Dallas, I think what -- all you're going to be able to support in those markets is a two- or three-hospital system, probably in a bigger city like that, a three-hospital delivery system. In some smaller cities, you'll end up having a two-hospital delivery system. And then in small towns, you can't afford to have more than one hospital.

If you look at the pressures you have in the industry -- just think about, first off, reimbursement for a second. We're close to the industry average. We have 50 -- about 53 percent of our revenues are Medicare and Medicaid. 42 percent Medicare, I think it is, and 13 percent Medicaid. All those prices are set by the government.

We have about 6 percent bad debt. That doesn't include uncompensated care. We have approximately, depending on the quarter, 12 to 14 percent of our revenues are sort of -- are charges, what we set the price at. The rest are negotiations with companies like General Motors or companies like United Health Care and things like that.

If you have three or two delivery systems, you have competition and you have the ability to do the things that we're doing: consolidate hospitals, which we have done. We have closed 20 hospitals close to our other hospitals. When you can do that, and instead of running 40 percent occupancy, run 80 percent occupancy, you can dramatically reduce your costs and improve your quality.

You can -- which we're doing -- a significant number of management consolidation in each of these markets to reduce the highest paid people and layers of management, basically, to reduce cost.

You can't do that if you keep, in a market, 42 separate hospitals open and operating all separately.

CHAIRMAN PITOFSKY: I guess, again, I'm referring back to the some of the illustrations that you mentioned.

The common theme is that there is an entrenched dominant hospital in a community. And let's assume it's a community that can't support 10 hospitals or even 6. And what you're saying is that antitrust makes a mistake in allowing 2 or 3 of the smaller hospitals to get together and combine in order to compete with the entrenched monop- -- dominant company, not a monopolist but a dominant company.

Now, we wouldn't listen to that argument if we were talking about tooth paste or if we were talking about oil or steel.

And I do hear one of the things that you're saying, which is that hospital services are so heterogeneous that even if there are two firms left, it's unlikely they're going to get together and work out a decent conspiracy.

Are there other reasons besides hetero- -- incidentally, you know, supermarkets and department stores have a wide range of heterogeneous products; but we wouldn't let all the supermarkets in town merge down to two in a medium-sized community.

What is it about health care that you think should make the difference?

MR. SCOTT: Well, I think -- well, I mean -- unfortunately, I'll talk about examples. But let's take Utah as an example.

You know, you sit there, somebody has over 50 percent market share. Okay? And you can use your best efforts all you want to try to say, golly I'd like to have even three competitors statewide. You're not going to get it. It will cost probably $500 to $700 million in new capital in an industry that doesn't need a lot of new capital or a lot of new buildings. That's what it would take to have each new player to have a statewide delivery system to compete against Inter-Mountain.

You know, you can't solve all of the problems. You go to places that have certificate of need laws. I mean, take Georgia, I mean, right or wrong, whether we should or shouldn't have certificate of need laws, there's somebody entrenched that has all the services. If you want competition, you should support a second player that gets the position that they really can compete.

But what -- your actions are preventing that from happening. You don't -- you've prevented a second player. I mean, we're -- you take Utah, we're a weak player, much weaker now. I mean, we have -- they have four hospitals in Salt Lake City. We were allowed to keep one. I mean, we're -- I mean, we can't go to people like United and get the contracts. They have to deal with Inter-Mountain.

So, I mean that's -- I mean you -- I mean -- I think if you can -- in a big enough market and there's enough reimbursement that you can have three players, I think that's great.

But if the markets -- you know, somebody already has 50, 75 percent, I mean, you're not going to be -- you can't force it to happen. And that's what you're trying to do in my opinion.

CHAIRMAN PITOFSKY: Okay. So it's better to have two powerful players because a third player is unlikely to enter the market because --

MR. SCOTT: Right.

CHAIRMAN PITOFSKY: -- of certificate of need?

MR. SCOTT: If I was not in Utah today, it would make no sense to go, you know, spend -- I guess it would cost, for a statewide -- it would cost me, you know, somewhere between $500 million and a billion dollars to go into that state of two million people. You know, I mean, nobody would do that.

CHAIRMAN PITOFSKY: One last question. I don't mean to dominate this. But all of the people in America -- this question has bothered me for a long time, and you're probably in a better position to answer this than anyone else I could possibly talk to.

Most of your acquisitions are really what we call conglomerate acquisitions. You're not buying two hospitals in Salt Lake City. You're coming into new territories where you weren't competing previously.

And I've been curious. What -- and you've done extremely well and the market appreciates what you've accomplished. What are the efficiencies that you achieve by having 300-some odd hospitals, including many in which you are the only hospital in town?

How do you get those efficiencies?

MR. SCOTT: Well, let me talk about -- we have some efficiencies from size, and then we have efficiencies by having a lot of facilities in a saturated marketplace having good geographic coverage.

So let me talk about -- let's take, a -- first, a market. In that market, I can -- if I have two hospitals that's across the street from each over that are, you know, each running 40 percent occupancy, I can either direct services between the two, but hopefully I can consolidate them into one.

Let me give you examples.

Just to open up the doors, okay? of a 300-bed hospital, it's a million to $2 million dollars just in utility costs. Just to keep it going every year, it's 500,000 to $2 million in capital costs, just for new equipment and technology. All right? And that's something that might only be used three hours a day. And if I can only attract, you know, get 40 percent occupancy, I mean, it's just not very well used.

So, one, I can have one emergency room, one radiology, one lab, if I just put two together. All right? And that's -- I mean, one we did in Miami where we merged Victoria which operated about 116 patients a day with Cedars which operated about 260. I think our first year we eliminated at least $12 million of daily operating costs.

Next, we can take, where we have -- take Miami, Fort Lauderdale, Palm Beach, we have 16 in-patient facilities down there and a variety of surgery centers. We can take and run a reference lab in one facility. We have a big reference lab in Cedars Medical Center. And we do that for the entire marketplace which helps us reduce our lab costs.

We can -- we've done -- just in 1995, we've taken and said we'll take one person and they'll be responsible for two or three hospitals. And that's the highest paid person there, the CEO of the hospital.

I mean, the reason I went on Banc One's board is the banking industry is basically doing the same thing; and I wanted to understand what they were doing.

We can share department heads. You take a hospital's -- and, again, the highest cost is the management positions; and so when we can share department heads among a variety of hospitals, we can dramatically reduce the costs.

Next, you look at the marketing. When you have, you know, 16 facilities -- you know, I think Miami to Palm Beach would probably be 3-1/2 to 4 million people, my marketing costs can be a lot less expensive if I market as a group.

I can afford to employ a lot of people that our individual hospital couldn't afford, such as we have a lady, Carolyn Lipp, that all she does is focus on outcomes just for that market. I couldn't afford somebody like that at any one facility, and so I would have to go hire consultants to do that. And they have to be there to have the biggest -- they have to be in that marketplace to have the biggest impact.

Now, some of the big -- probably the -- so -- and those things add up. You know, 4 to $5 million is what I said in the presentation. It's more than that. By putting things together, that's a conservative number.

Now, what can I do nationally?

I buy $2.4 billion a year in medical supplies. By committing more volume to companies like Marriott, where we purchase all of our food, by committing to do business with DuPont, Johnson & Johnson, Baxter, I've -- and when we've compared our supply costs as compared to our competition, which are bigger buying groups -- they are the tax-exempt buying groups -- we save 15 to 35 percent. That's, for you as a buyer of health care, 3 to 4 percent of what you're charged, because the supply costs depend on the tertiary services of the hospital's 12 to 20 percent.

I put in an information system that -- the cost for me to put in that system -- and it's the best information system in the country. It's got a real-time medical record; so if you're a physician and you're sitting at your house or at your office, as soon as the lab results are done, you're flagged; your computer beeps; or, eventually we're doing it with the pagers; and you get the information.

We can put that in for one-third of what it costs a stand-alone facility to put it in. Plus, for you as a patient, when you end up in an emergency room, would you rather that your medical record be there or be sitting at some other hospital or some physician's office?

In our system, your medical record is on-line at our facility at any one of our emergency rooms, any one of our urgent care centers; your medical record is immediately available as you walk in. So it dramatically reduces the cost.

Then you have all the -- you know, the issues that we have in our industry, you know, just the cost of tax, reimbursement, legal, all those things we can share costs. And -- but those -- the big dollars are -- is probably the information systems and the supplies and then individual market consolidating management teams and directing service.

I mean, I'll tell you, the dollars are unbelievable, the size. Just by -- just -- because, historically, this industry had nobody of size and they made no commitments to vendors and so you got no discounts.

We went and we got all of our orthopedic surgeons together, or a big group of them, and we said: What are the two top orthopedic companies for hip implants? And we said: We will try, okay, to commit more volume to them. You tell us who the best two are, because we believe that we can commit more volume to them we will get a better price.

Most hospitals lose money on hip replacements -- Medicare hip replacements. There had been no discounts, basically, in the industry. We got 45 percent reduction. Now, we still have to talk everybody into using it because you can't dictate these things. But it's -- so it's a lot of work. But I mean by committing volume, you really can get significant reductions; and you can pick the best products.

CHAIRMAN PITOFSKY: Thank you.

COMMISSIONER STEIGER: Very brief question, Mr. Scott. In your extensive management experience, have you found that some over-capacity in hospital beds is necessary to handle peak usage?

And, if so, is this only a regional phenomenon due to, say, population fluctuation?

MR. SCOTT: If you look at the numbers -- if you go to places like Fort Meyers and Fort Lauderdale, you can have a doubling in the number of patients between summer and winter. Okay?

Now, that's the -- that would be more true the more tertiary your services. So we have large -- where we have large open heart programs in Florida, we could double our services.

A lot of that is because we have a significant number of Canadians who come to the United States for open heart services.

If you look at the rest -- you know, where you don't have a significant number of snow birds, the difference would probably be in the 10 to 20 percent range between winter and summer. That is slowly going away as length of stays are coming down so dramatically and as patients are leaving the hospital faster and going into home health faster. But that would probably be a history, you know, it would be 10 to 20 percent for a normal market.

CHAIRMAN PITOFSKY: Susan?

MS. DeSANTI: Yeah, Mr. Scott, I wanted to address some of the policy questions. As the Chairman says, it's hard to discuss some of these issues that you have raised. There, obviously, may be factual disputes. You have one view of the facts and there are some --

MR. SCOTT: Mine are always right. They're logical.

MS. DeSANTI: -- views.

I have no doubt that you put together everything in a logical manner. I have full confidence in your ability to do so.

But what I'm hearing on the issue of competition and three versus two and two is fine to have a fully competitive market, I'm hearing more from you about efficiency gains and this is just a fact of life.

Can you tell us something more about other markets in which you currently operate where there are two competitors, yourself and some other, and how does competition operate in those markets, that would give us more confidence?

MR. SCOTT: You know, that's -- I can't think -- I guess the only place where you would only have -- that I can think of -- that you only have two competitors are in smaller towns, where you only have two.

Here's typically -- if you go to a typical larger market, the -- you end up having fewer -- you have more competitors than this. But here's what happens in the marketplace. We go in and we're building up a -- you know, a delivery system. Okay? And you do that primarily by buying because it doesn't make sense to build a lot of new hospitals in this country.

What happens is our competitors, which most of them are tax-exempt competitors, they don't have an interest generally of consolidating their balance sheets and their income statements. So what they do is they create alliances; and they say, we are all going to work, you know this group of 6, 10, 20 hospitals -- probably not that many -- 6 to 10 hospitals, we're all going to work together and go work with managed care players as a group. Okay?

And so what you'll end up having in a lot of markets, you'll have us; you'll have a tax-exempt affiliation; and then you'll have a group of independent facilities that become very dependent upon Medicare and Medicaid because that's the only thing that they can attract.

That's what happens more.

We even had an example where in -- down in New Orleans, where -- I can't remember the number of these, but it's something like 8 or 10 hospitals after we went into that market, tax-exempts -- they all agreed that they wouldn't sell to us for 18 months; and they created, you know, an environment that they're going to work together with managed care, you know, to combat us. Because, you know, when we go into a marketplace, a lot of times people are concerned about our position.

Because no one's ever done it before.

MS. DeSANTI: When you say for 18 months they wouldn't --

MR. SCOTT: They signed a document. They will not sell to us -- not negotiate to sell to us for 18 months, because they're all worried that they are going to be -- you know, they're all worried that they're going to be the last one out there; and they know that they -- they look at the numbers in California and the days per thousand in California, and they look in places like New Orleans or in other places and they say, you know, if that happens here, golly, we're in trouble because we don't need, you know, eight times the number of beds that they use in California.

And so they know that they're going to have to consolidate or they're going to slowly, basically, bleed to death. They're not going to spend any capital. They're not going to keep the employees.

So, I mean, there's a lot of concern right now in the industry about what's going to happen to them.

MS. DeSANTI: But at the moment, you don't really have a lot of markets in which there were one or two?

MR. SCOTT: I guess Tulane has a good delivery system in New Orleans; but you have, you know, a lot of tax-exempt. I can't think of -- other than smaller towns, where you have just -- where you have two.

Probably Orlando is -- Orlando is an unusual market. You generally don't have two or three, yet -- I mean, there's almost no independence left in that area. That's still pretty unusual. That's where it's going to go, but it's unusual.

MS. DeSANTI: Okay. And can you give me a rough sense -- there are a lot of statistics in your testimony -- but I don't think we have the number of hospitals that Columbia has acquired over, say, the past 5 or 10 years.

MR. SCOTT: I could get you the numbers. You know, we've done these big mergers. And I think HCA was 96 hospitals; Galen was 71 hospitals; Medical Care was, I think, 96 surgery centers; Basic American, I think, was 8 hospitals.

But in this -- you know, we're adding -- we'll add -- I couldn't give you an exact number. But we'll continue to add hospitals primarily in markets where we're already located. But we're going -- like last week, we went into Cleveland, Ohio; Canton, Ohio; and Columbia, South Carolina, where we had not been. And we're going into Massachusetts and Rhode Island where we had not been.

We've really not been, historically, in the North, many tax-paying, investor-owned hospitals, because of the companies that did the mergers which were started at a time when all the growth was in the South; and certificate of need laws prevented them from getting into the business in the North primarily.

MS. DeSANTI: I have just one last question, which is, there are a lot of very interesting statistics in your testimony. And I'm wondering if you could provide us with the citations for that so that we can follow up on this as well?

MR. SCOTT: All these are basically employees of our company that got all these numbers.

I mean, I can get you the data where they --

MS. DeSANTI: Well, just a few of the key sources would be of interest --

MR. SCOTT: Okay. I can do that.

MS. DeSANTI: -- because this is very interesting testimony, and we would like to see more of the basis.

MR. SCOTT: Okay.

COMMISSIONER STEIGER: And just to make sure the record reflects it, is it accurate to say that of the substantial number of mergers that you have accomplished in recent years Commission action has affected 10 hospitals?

Is that the correct number?

MR. SCOTT: I think it's 10 hospitals.

COMMISSIONER STEIGER: Thank you.

MR. SCOTT: But it's still 10.

MS. VALENTINE: Just one more quick question. I also find the efficiencies -- you've achieved them, what areas they are in, whether it's management reduction or marketing savings -- interesting; and I want to know a little bit also about where they're going, what you're doing with them.

At one point you said that your -- that if one is not able to make cost savings through consolidation, hospitals will not be able to invest in new technologies in the future.

What percentage of your cost savings are going to investments in new and improved technologies?

MR. SCOTT: Well, I mean, I don't think it's a -- you know, what your -- the way -- here's the way -- it doesn't really operate that way.

We -- well, in -- Medicare and Medicaid has not stayed up with inflation since 1983. And we're seeing significant reductions. We have states like Kentucky that passed provider taxes that's $18 million dollars a year. That's $18 million dollars out of our cash flow stream.

So, then you have -- you have -- whether it's companies like General Motors or you have insurance companies that are demanding reduced reimbursement constantly. And they're getting it, because it's a very competitive marketplace.

And so we're on that side figuring out how we can streamline the process and try to move the industry to be more value driven by providing better outcome information, patient satisfaction information, things of that sort.

Now, the capital expenditure decisions are: How can we -- where you have a certain percentage; and each year it's generally a third to a half of our capital expenditure is basically renovation of existing physical plants because they're old, adding and replacing existing technology because it's old or it needs to be updated, things of that sort.

And then you have other capital expenditures that are going for -- it would be a third to a half, depending on how you look at it.

Just looking at new services that we can provide -- because, you know, in this industry there's constantly new services that are being provided. But -- and, you know, the dollar -- as an example, we're spending $170 million a year on information systems. That's efficiency directed.

But I couldn't tell you a percen- -- you know -- that's not a good answer, I guess; but it's the best I can do.

CHAIRMAN PITOFSKY: Thank you very much for some really fascinating testimony.

MR. SCOTT: Thanks.

CHAIRMAN PITOFSKY: Our next participant is Phil Proger, a partner at the law firm of Jones, Day, Reavis & Pogue, where he has practiced since 1989.

Mr. Proger is coordinator of the firm's Government Regulation Group. And in his antitrust practice, he pays special attention to mergers and acquisitions as well as the application of antitrust law to the delivery of health care services.

He is, among other things, a member of the editorial boards of Managed Care Law Report and Healthcare Systems Strategy Report and publications officer of the ABA Antitrust Law Section.

I must say that when I was an academic, before I came over here, when I had a health care question, I called Phil Proger; and, therefore, it's a special pleasure to welcome you to these hearings.

MR. PROGER: Thank you, Mr. Chairman.

Is this on?

CHAIRMAN PITOFSKY: Yeah.

MR. PROGER: Can you hear it?

I'm here today on behalf of the Alliance for Managed Competition, which is Aetna, CIGNA, The Prudential, and United Health Care, which, together, purchase health care coverage for over 60 million Americans.

The Alliance for Managed Competition believes very strongly in the continued enforcement of the antitrust laws in the health care industry and believes, as I will testify, that the antitrust laws have done a great deal to enable the current health care system to develop.

And in answer to the question posed to this panel, whether the antitrust laws impede businesses, in this case, the health care industry's abilities or efforts to obtain efficiencies, the Alliance for Managed Competition believes that, in fact, the antitrust laws have facilitated the ability to obtain efficiencies, not impeded that ability.

When we talk about efficiencies, we're talking about not only the reduction of cost but the enhancement of quality and then the enhancement of services.

I must confess, I have done prepared testimony which I will leave, but you have given me a difficult assignment, to follow Mr. Scott and Mr. Cubbin. And I think -- I've made some notes, and I'm going to deviate a little bit and talk about, I think, some of the issues raised.

It strikes me, at the outset, that there are some things that everyone can agree on in this debate, as illustrated by both their testimonies.

And that is, one, there is an enormous amount of efficiencies to be obtained yet in the health care industry.

Prior government intervention in this industry resulted in the lack of market forces in the industry, which resulted in, frankly, a very inefficient over-built industry that, by the beginning of 1980, which is really when competition began to be seriously injected into the health care industry, left us in the current situation we have.

And as Mr. Scott correctly testifies, there's enormous excess capacity in, particularly the hospital fixed cost industry. Most of you -- you are well aware of the history with Hillburton and other federal statutes that encouraged, regardless of cost, the building of neighborhood hospitals that would be fully equipped, opened seven days a week, 24 hours a day, with emergency rooms, and a great deal of redundancy.

We, as a nation, really did not care about the cost of our health care system. We wanted it convenient, and we wanted it high quality.

Beginning in the '70s, we began to recognize that there were certain costs associated, as a society, to that type of health care delivery system. And seriously beginning in the '80s, we have used competition as hopefully a way of trying to enhance the delivery of services yet eliminating some of the over-capacity.

So I think, at the outset, we can agree that there's a great deal of efficiency in the industry. I think we can also agree that since 1980 competition has made significant strides in dealing with those issues.

Frankly, it is the antitrust laws that -- whose enforcement way back in 1940's in the District of Columbia has permitted the current state of managed care in a variety of innovative and new forms of competition, and I think opened up the markets to the remarkable things that Mr. Scott has done in putting together Columbia HCA and other organizations.

Since 1980, what we have seen is the growth of managed care, the horizontal consolidation of the hospital industry, the formation of integrated delivery networks, the formation of vertically integrated health care entities. Mr. Scott testified, for example, about the situation in Salt Lake City.

I would just add to that, just to point out, that one of things Inter-Mountain Health Care has done is created an integrated delivery network where the physicians own, as he points out, half the hospitals in Utah, offer its own insurance product and goes directly to the marketplace. Similarly, for example, Henry Ford in Detroit, Sentura in Norfolk have done the same thing.

If anything the transformation of the industry is accelerating not declining. So what we're seeing is an industry that is undergoing rapid transformation in a relatively short period of time. If you look at sort of the scheme of industries, 15 years is a relatively short period of time for competition to have done what it has done here. And it's produced enormous efficiencies.

So I think we can all agree that there are enormous efficiencies in this industry. I don't think that's the question. I think the question is, as you produce these efficiencies, how do you ensure that the efficiencies are going to be passed on to the consumer? And I think that's the key issue.

I think we all agree that there are two possible ways you can do that. One is through competition in which the competitive forces force the recipient of the efficiencies to pass them on to the consumer in the form of either lower costs or higher quality or better services.

Or we could try a regulatory model. I, myself, on behalf of the AMC, is highly skeptical to the regulatory model. I point out that it was that model that did get us into the situation we're in today.

If you look at the data as it now is beginning to come in -- some of it done by economists at the Commission and former economists at the Commission -- what you discover is in markets where we have now begun to see competition over a prolonged period of time, like Southern California, it is clearly out-performing regulated markets like my own native state, Maryland, where the costs initially look more favorable under the Health Service Cost Review Commission of Maryland.

And now as you're seeing the effect of competition in California, you're see it dramatically out-perform the regulated environment of Maryland. So places like California, Minnesota, and some of the markets where competition has now reached a more mature state are doing what we would expect it to do.

Absent competition or regulation, the efficiencies are not going to be passed on to the consumers.

So I think the real issue is, we have to answer two questions:

Does competition work in health care?

And, secondly, has antitrust enforcement or even, as pointed out, the perception of antitrust enforcement deterred conduct by providers to principally hospitals and physicians that was and is, one, lawful and, two, would have created efficiencies that would have been passed on?

I think the answer is:

One, competition does work in health care, not perfectly. As has been pointed out, there are information flow problems. There are quirks to the industry. But what we have discovered over the last 15 years is, like any other industry, in the United States, it is susceptible to competition. I think there are issues in rural markets. I think there are issues in some other markets. Clearly, competition raises issues of access and coverage.

Let me suggest to you that's the wrong question to put to competition. I don't think competition needs to be responsible for access and coverage. That's more a national policy issue and a financing issue than a competition issue. What competition gets to is how we ensure that consumers get the best quality, the best services, and the lowest prices.

Has antitrust enforcement deterred pro-competitive collaborative conduct that would produce efficiencies?

Well, certainly the presence of antitrust has been a deterrent to some people. I think the perception is a real issue. We have all talked about it at length. The Commission and the Department of Justice, on September 15 of '93 and September 27 of '94 issued policy statements to address this.

As Commissioner Steiger pointed out in her questioning, there is an ability to have advisory opinions. I haven't looked in the last few days, but there's well over 30 advisory opinions under this policy which, since 1994, is fairly a lot.

But, nevertheless, there are still some in the industry who say they would do things, but they are concerned about antitrust. I think that's just inherent in the situation. I commend the Commission and the Department of Justice for its constant efforts to issue advisory opinions and to give speeches.

I think Mark Horoschak said that at times you get tired of the whining in the industry because there was no industry that had received so much attention with such little gratitude; and I think there may be some fair comment there. But I think you've got to continue to do that so that people get the message.

But when we ultimately look at what is going on here, what we're really seeing is two basic things happening that are producing efficiencies. One is the elimination of the excess capacity in the hospital industry; and, two, the formation of horizontally and vertically integrated networks.

Now, in each of those situations, the analytical model of the antitrust -- of the policy statements and of the Merger Guidelines applies. On one hand, we weigh the anti-competitive effects of market power and collusion with the pro-competitive effects of efficiencies.

It strikes the Alliance for Managed Competition that there is very little benefit to the society or to the consumer for enormous efficiencies unless it can be assured that there isn't market power collusion so that those efficiencies are passed on to the consumer.

Competition is dynamic. It is constantly changing; and I think, as Mr. Scott points out, we have to be aware of the changes in the competitive marketplace to determine whether or not these transactions that produce these efficiencies still remain or leave enough competition behind to ensure that the efficiencies are passed on.

In that regard, I think it is important that we recognize the the formation of integrated delivery networks is moving the industry from an atamistic in-patient hospital competition where collusion I think was easier than it is on a vertically integrated differentiated product that is going ultimately to the purchaser like the Alliance for Managed Competition or, in some cases, directly to corporations like General Motors.

Although, as the Chairman points out, there are probably few industrial corporations or other entities -- buyers in the United States that have that degree of sophistication to go at it alone. Most of the purchasers today do purchase through Blue Cross or the companies in the Alliance for Managed Competition or other -- the numerous insurers. The actual financing market, as you're well aware, is a highly de-concentrated, highly competitive market.

So clearly the role of purchaser remains key here. But as you look at these issues, and as set forth in one of the examples to the policy statements, you need to look at the role of the purchaser in ensuring that efficiencies are passed on.

There may be markets, particularly in rural areas, where, as Mr. Scott points out, you're not going to have more than two networks competing against each other. I think the role of the process of the antitrust laws is to ensure that there's a maximum amount of competition so that the maximum amount of efficiencies are passed on.

I think there are things you can look at. If you look at the examples under the guidelines, particularly under the policy statements, particularly in the area of the physician networks and the multi-provider networks, there is a real distinction made for risk sharing for integration,

which, obviously, stems from the per se rule itself as opposed to the rule of reason.

Nevertheless -- and I think in a number of markets, because of culture, because of other reasons -- the markets may not be prepared totally for full integration and, yet, would be enhanced by the formation of networks that can act as a single actor but have to deal with the spillover issue but still could act as a single actor and yet doesn't have integration.

As the present policy statements are set up, as the present situation in the area is, it's very difficult for physician and hospital groups to get together and form any kind of meaningful competitive alternative unless they were prepared to integrate or take capitation, which isn't always possible.

The other thing that we would suggest that the Commission might consider is under what circumstances would efficiencies be considered and what level of proof must be satisfied by the parties.

You, the Commission, yourself, in different speeches and documents have indicated some thought on this. And, of course, Section 4 of the Merger Guidelines deals fairly extensively with efficiencies, as do the policy statements, which follow the Merger Guidelines in this area, at least in the analytical approach.

Today's efficiencies must be merger specific. And some even argue that it has to be that particular merger specific, meaning that if there is another less anti-competitive merger that the parties -- one of the parties could engage in, the efficiencies will be discounted.

I think that doesn't take into account realistically some of the practical realities of what goes on in marketplaces and the recognition that sometimes it takes a cataclysmic event like a merger to create the necessary culture to allow the efficiencies to occur.

And I grant that it is important to make sure that the efficiencies that are occurring are ones that are real and ones that will be achieved after the merger. But if there's sufficient competition after the transaction, say, for example, a hospital merger, then I think we are too harsh in forming sort of mechanical tests of where the lines of efficiencies are by discounting all efficiencies that could have been achieved otherwise or through a different transaction.

Secondly, the level of proof, exceedingly difficult to do in these transactions. Exceedingly difficult as the guidelines point out, particularly in non-manufacturing efficiencies, to be able to quantify and demonstrate them.

Further, to Mr. Scott's point, I have seen some transactions where, in hindsight, we're looking at $20 million a year savings, $200 million over 10 years, which is really real.

I don't think the issue is the magnitude of the efficiencies. I think the issue is whether there's enough competition to ensure that they get passed on.

So, in conclusion, the Alliance for Managed Competition clearly supports the continued enforcement of the antitrust laws in the health care industry; believes that, by and large, the Commission's policies in this area and enforcement have been well thought out and well done; believes that the antitrust laws do not impede business's efforts to obtain efficiencies.

We respectfully suggest that the paradigm is to encourage collaborations that produce efficiencies but only to the extent that, afterwards, there is enough competition to ensure that the efficiencies will be passed on.

It's a balancing act, but it's one that's done every day. It's the very core of antitrust analysis. And we think that it can be quite successfully done in the future as it has been done in the past.

I would be happy to answer any questions.

Thank you for the time.

CHAIRMAN PITOFSKY: Thank you. You've probably had as much experience with efficiency claims in hospital and health care deals as anybody. Hard to do, you say? I mean, hard to quantify? How hard is it?

We've had some testimony that it's a shell game, that people come in with these claims, they put together economic reports; but, in fact, they don't know if they're going to be efficiencies; and certainly the Commission doesn't know.

Is that you're sense, that it's so amorphous that it's an unreliable indeterminate factor?

MR. PROGER: Mr. Chairman, I confess I have been unpersuasive, as most, on this subject.

I don't think it's a shell game. I think, to some extent, the way we're doing it causes it to be that way.

Let me divide this into two different issues.

One: Are there real efficiencies to be achieved in the formation of these horizontal and vertical networks?

I think, my experience is, absolutely, yes.

Two: How do you go about proving them?

Let's talk about some of the practical problems. One is, in a Section 7 context -- we're talking about the future. It hasn't happened, and we've got to predict it.

Two: In many of the communities where this is now occurring, you have situations where what you're really talking about is the elimination of FTE's, the elimination of -- sometimes of an entire facility.

Very fragile thing to talk about in a community before it's happened, particularly -- to be exceedingly blunt -- if you don't know that the antitrust Hart-Scott-Rodino process will lead to a government challenge of the transaction so that when you're done, you may have wounded yourself and not had the transaction.

In order to really determine whether or not you're going to achieve efficiencies, what you really need to do is get into the bowels of that organization, sit down with the medical staff, really understand how they practice, really understand how they can consolidate.

The real savings are in clinical programs. And my experience is, that's a real balancing act. Because, on one hand, if it's a difficult transaction but there's significant efficiencies, you have to weigh how much risk you're going to put your organization to. Because once you expose it to the medical staff, you're going to have some physicians thinking there's winners and losers; they're going to shift; you're going to have people switching for jobs; and you may not be able to put, frankly, Humpty-Dumpty back together again.

So what often people do is hire one of the professional consulting firms, usually a big six accounting firm, to go through with people who are essentially industrial engineers.

And, depending on the degree that they go, go through department by department and look at what can be obtained.

Is it a shell game? I think it often is a realistic expectation of what you can do at the best case. Whether you will achieve it or not is going to depend on a changing market, the willingness of physicians to go along with it, your own willingness often as a non-profit board -- this is usually the case we're talking about -- to sort of survive the wrenching experience, particularly if it means closing one of your facilities.

But they're there. And I think what competition is doing is forcing people to come to grips with this issue and forcing people to deal with it.

So is it a shell game? I think it can be; but in most cases, I think it's real.

The shell game is proving it.

COMMISSIONER STEIGER: Just one brief question. I asked Mr. Scott about excess capacity. You, too, have had extraordinary experience, Phil; and we very much thank you for sharing it with us today.

I believe I heard him say that at the present time the excess capacity needed to handle peak load was between 10 and 20 percent and, indeed, that it would vary regionally depending upon population shifts. I think his original figure was that there is now 35 percent over-capacity.

It is possible to take a snapshot and suggest how much over-capacity is, indeed, required for successful management?

And is this going to change dramatically, as I believe Mr. Scott suggested, with shorter hospital stays?

And I may apologize in case I am misstating anything that Mr. Scott said.

MR. PROGER: Well, I certainly want to defer to Mr. Scott's expertise. I'm a practicing attorney and have never run a hospital, let alone a hospital corporation.

I do have the benefit of, not in my present capacity today, but actually in my real life of having been a hospital trustee of a system for a number of years. And I'm the immediate past President of the American Academy of Hospital Attorneys of the American Hospital Association, where I, vicariously, have picked up a fair amount of information on this.

My understanding is that, essentially, a hospital that's operating between 80 to 85 percent is pretty much at capacity. You have weekends. You have seasonable problems, such as the summer in Florida, winter in some of the northern states, where there are certain demand changes.

If you're at 85 percent, that means that during the week, you're at a higher percentage -- on the weekend most people try and be discharged if they could and you're at a lower percentage -- you're pretty close to capacity on your in-patient side.

I think some can argue it's 90 percent.

There's a real issue, by the way, as to what you call "capacity" in this area. Most states have licensed beds. With the decline today in demand on the in-patient side, we're seeing more and more hospitals that have, say, 400 licensed beds but 30 in-service beds and 250 staff beds for that particular day as hospitals are trying too wrench down their costs and respond to the marketplace. Some of this now gets moved to out-patient services, and you have to factor that in.

Quite outstanding, to me, having watched this since 1973, we're on the verge of 50 percent of hospital revenues or more will be out-patient as opposed to in-patient. So the business is really changing.

But I think on the in-patient side, say 80 to 90 percent is somewhere the range of what a fully -- a full hospital would be on an appropriate weighted capacity; you'd have to agree on the number, but I think you would look at staff beds with the understanding, in short order, they could move up to end-use beds and then de-mothball the beds up to their licensed capacity. Then in terms of the excess capacity, the number he gave of 40 percent is the one that I have universally heard.

I think you can't look at it universally. I think you have to look in the particular market you're in. But in a lot of markets today in the United States, there's 40, 50 of excess capacity, even on these rated numbers

COMMISSIONER STEIGER: Very useful. Thank you very much.

COMMISSIONER STAREK: Phil, do you think the current version of the Merger Guidelines and the two policy statements adequately provide guidance for the way the enforcement agencies view efficiencies and the kinds of efficiencies that the enforcement agencies will take into account?

MR. PROGER: Well --

COMMISSIONER STAREK: And how they will analyze them?

MR. PROGER: You know, I think you get into a philosophical question, Commissioner Starek, as to how far you go in guidelines. I've always been amazed that you put out the guidelines and you put out the policy statements, because I'll confess, as a practicing lawyer, to the extent I can use them to my advantage, I always will.

It seems to me that Section 4 of the Merger Guidelines is not a very detailed statement of how to look at efficiencies. And, accordingly, the policy statements which incorporate them, I think suffer that frailty.

And, particularly, if you look at what has become the practice now, particularly at the Commission and over at the Department of Justice, which always uses Dr. Taylor, the actual process of looking at efficiencies is very different. It's a very line-by-line, score-by-score analysis that is in great detail.

So, I guess my answer to your question is I don't think the current guidelines or policy statements do represent the actual analysis that's done in a particular situation.

Having said that, I'm not sure -- because I have thought about this; and I confess, I haven't thought of a better way to say it than it's presently there -- that it's so factually unique, which is the basis of the flexibility of the antitrust laws -- there's always this debate between predictability and flexibility. We can create bright lines that make it much more predictable, but we're going to fence outside of those bright lines a lot of lawful conduct, a lot of lawful efficiencies.

I guess, from my own standpoint, I still think the key issue is competition, not efficiencies. And weighing --

I will make two comments.

One is -- and I think this applies to the overall Merger Guidelines process and not just efficiencies -- I think we're in danger of becoming too mechanical with them. I think that they are a good analytical tool. They are a good way of thinking about things.

But whether entry could occur in 23 months or 25 months, to me, doesn't seem to be like a significant difference; and yet I hear people now saying, "Well, it's now 24 months; and you've got to be within that time period."

The same with efficiencies. The guidelines say they have to be efficiencies that you could only achieve through this transaction. I think actually they say "reasonably." And I think we really have to look at that because I'm not sure I know what that means. I think, as a practical matter, in many instances the only way you're going to achieve these efficiencies is if you do this merger.

Having said that, I confess to you that, in fact, you could have downsized and achieved the efficiencies; but your organization just didn't have the culture, didn't have the wherewithal to do it; it's too wrenching and too destructive to do it, unless you have this kind of major event to surround yourself in.

So, as I suggested in the testimony, I think that's one area I would look at. But only if you still have enough competition to ensure that those efficiencies are passed on.

CHAIRMAN PITOFSKY: Susan?

MS. DeSANTI: Yes. You focused us on the key issue of what's enough competition. And it seems to me to relate to the issue raised in Mr. Scott's testimony as well as in the hospital markets, what's enough competition.

And I'm wondering if you can give us some guidance from the Alliance's experience, as purchasers of health care, a representative of customers in the health care process, what's enough competition?

Purchasing from two hospital networks? Three hospital networks? Four networks of providers?

I assume there isn't any magic number. I have yet to find any magic number in life. But can you give us some sense of how the dynamics of competition work and what are the key aspects that we should be looking for?

MR. PROGER: Yes. That's actually very, very thoughtful but almost an impossible question to answer for a number of reasons.

One is, we're in an evolving state where the markets are changing and it depends market by market.

I think from the Alliance's standpoint, purchasing health care for 60 million Americans, we want to be able to purchase in the most efficient way, the most efficient health care services; we want the highest quality, the highest service at the lowest possible cost.

Obviously, depending on the circumstances of that market, it will vary. I think there are some common denominators.

One is clearly we are moving to a medical management on an integrated delivery basis. And, therefore, the move to horizontal and vertical integration is helpful, particularly as we talk about what is, in the industry, referred to as a continuum of care. That is, to position the patient, you and I, in the highest quality in service, lowest cost situation.

And by the way they're not necessarily, incompatible. For example, Mr. Scott talked about open heart procedures and the success they have had at the Miami Heart Institute. We know there is a high correlation between volume and morbidity, mortality; the higher the volume, generally, the lower morbidity, mortality.

And it, interestingly enough, doesn't occur in the general surgeon who does -- the cardiac surgeon who's making the incision. They're usually reasonably high-skilled people. You get your efficiencies and your higher quality in the redundancy of the back-up people, respiratory therapist, the physical therapists, the rad techs, you know, all those people who are supporting the procedure and need to be there when something goes wrong. And the higher the volume, the better you are.

So we want integrated networks. We want redundancies. We want high volume. And yet we want enough choice that we can make them compete against each other so we get a competitive price.

Could two do it? I really don't have the empirical answer to that. I defer to some of the people who are looking at this. I think that you could have markets which are very differentiated and very hard for collusion to occur; and if people are purchasing as a powerful purchaser in the right way, maybe two could do it.

But I think it may differ with your General Motors or your Phil's Pizza Parlor as to whether or not you're going to succeed in getting that.

I think the best thing is that, given what minimal efficient scale is, you want as many minimally efficient scales -- as many efficient competing networks as you can in the marketplace.

MS. VALENTINE: Okay. I guess I would have asked you to get at that same question by commenting on Mr. Scott's two proposals, whether eliminating the use of the concentration presumptions and presuming that two or three are a sufficient number of hospitals to maintain competition would be things, you know, things that you would find acceptable for ensuring adequate competition to pass these efficiency savings on to consumers.

So if you want to add one more thought on that, go ahead.

My question, separate from that, is: There are two theories in our efficiency literature. One is that, sort of the Areeda/Turner version, in declining or stable markets, we should allow consolidations for efficiencies. I think our Chairman looks sometimes to efficiency gains from mergers in expanding markets so that we can be stronger competitors globally.

Does it make any difference in the hospital context for us whether we are looking at a declining or a stable or expanding market in terms of realizing real efficiency gains?

MR. PROGER: Well, the first part first.

I'm not sure the Alliance for Managed Competition necessarily has looked at that particular issue.

My own view is that -- it's the point I was making earlier -- which is analytically, I think it makes a lot of sense to look at the concentration in the marketplace. Whether or not 1,000 or 1800 make a lot of sense in the hospital industry, particularly on the in-patient side, I think is an entirely different question.

The fact of the matter is, as Mr. Scott points out, in many markets -- he pointed out Salt Like City -- if we take that position and we apply a mechanistic rule to it that that's the bright line, it will be very predictable, but there will be no transactions.

So I think you've got to go beyond it. I think you've got to get to the market power, you've got to get to the collusion issue, and that you can't get yourself stymied on the bright line of 1800.

On the other issue you raised, I confess, you have been kind enough -- some might say "foolish" -- to invite me back next week when that's the question we are going to be talking about; and I'm not sure how much you want to get into it.

I don't think that you can really say this is necessarily a declining industry. What it is, is an industry in dramatic transformation where parts of it are growing and parts of it are declining.

Clearly the in-patient hospital side is an ailing industry where it is important that the capacity be rationalized and be done so in an orderly way. You can do that, it seems to me, from a regulatory standpoint, which I don't think would be successful; or you can do that through a competitive standpoint.

Competition is a relatively slow way to do so. In the meantime, there are many -- just like there's a monopoly rent, there's a corresponding rent that's due to inefficiencies. And I think the policy in antitrust enforcement, again, needs to allow the market, this ailing in-patient industry, to wrench out the efficiencies as quickly as possible, keeping in mind the need to preserve competition.

Not an easy task. I don't envy you.

CHAIRMAN PITOFSKY: Well, on that "not an easy task," we'll move on. Thank you very much.

Our final participant is here to prove that all of antitrust policy is not health care, although sometimes it feels that way sitting where we are.

Bill MacLeod is a partner in the law firm of Collier, Shannon, Rill & Scott here in Washington. And from 1986 to 1990, he was at the Federal Trade Commission as Director of the Bureau of Consumer Protection.

In addition, he served as Director of the Chicago Regional Office at the Federal Trade Commission from 1983 to 1986.

Bill, welcome back to the FTC.

MR. MacLEOD: Thank you very much, Mr. Chairman. And thank you very much also for convening these hearings and giving the Grocery Manufacturers of America the opportunity to comment today.

In all that I have heard about efficiencies today, I have not yet heard the contribution of efficiencies of GMA members in the assistance of the industry that we have been talking about all morning long. But I would like to go back through a little history here to consider how innovation, efficiency, and progress in the grocery industry has indeed a very substantial impact and can have an impact on the health care system here.

I remember back in the 1950s when I used to go to grandma's house, when she was still around, and she was cooking one of her legendary Sunday dinners, normally what she would take for her cooking fat was whatever had been saved from the last serving of bacon that was sitting in the ice box.

When the bacon grease was getting a little bit low, she would go into her can of lard and add a little bit of that lard to whatever recipe needed a little bit of fat to acquire the taste that she was so good at putting in there.

Well, we all know that around the '50s and '60s we started seeing vegetable shortening largely taking over for the cooking fat that was going into our foods. And more recently canola oil and even more exotic formulations of cooking materials that GMA manufacturers have come forward with.

I dare say that it is probably a safe assumption that we are far better off today by virtue of the grocery manufacturers concentrating on moving from lard to canola oil than we would have been if they had been concentrating on reducing the cost of producing lard and making that a little cheaper, a little less expensive for American consumers.

I know you have had a good deal to hear on innovation markets over the last couple of weeks. I remember back in 1983 when I was an attorney-advisor in the Chairman's office we had to deal with an innovation market. There was a transaction that was being opposed by the Bureau of Competition that it proposed to challenge. And the Commissioners, including the Chairman, had to decide on that challenge.

One of the issues involved in that transaction was about the research and development in these two companies where there would be significant overlap and where the next generation of products might emerge in this industry.

We took a careful look at that issue back then. We asked what would happen to these resources if there were a consolidation between these two firms? What was the synergy that the firms offered? And what was the opportunity for these resources currently employed in R&D in those two companies to continue in that work in other pursuits?

As I recall, the transaction was ultimately challenged, but it was settled. But it was not on the basis of the innovation markets, where the conclusion was that probably those markets were reasonably safe from the transaction.

What I think is very encouraging and which the members of GMA take with, perhaps I should say "hopeful concern," is that we now have a label for this concept. The label being "innovation markets." And we have been devoting a great deal of attention and study to the issue, which indicates to me that there is almost certain to be a far more sophisticated understanding and treatment of this in transactions that go forward today.

Among grocery manufacturers, far and away the most important efficiencies that we have to deal with are the efficiencies that probably get less respect in the literature although, I am glad to say, more recognition among the staff of the Federal Trade Commission than we occasionally see in the literature, but something that I think can still benefit tremendously from a more considered treatment and perhaps more symmetrical treatment.

Innovation markets right now we have seen as an issue that has been primarily elevated to a new means that might provide an avenue to attack a transaction, to challenge a transaction. That, of course, is one half of what innovation markets and efficiencies can accomplish.

The other half, of course, which we would like to see equally well recognized is that, in transactions where R&D or innovation is at issue, whether that innovation is a cost-lowering innovation or a product-introduction innovation, that the benefits of the transaction to those R&D functions, in those innovation markets, be given equal weight in the consideration of the pro-competitive and potentially anti-competitive consequences of the market.

We do not believe that recognition of the efficiencies that are most important to the grocery manufacturers -- and those are the dynamic efficiencies, not the cost-lowering efficiencies, but the ability of a manufacturer to recognize in another manufacturer of grocery products or consumer packaged goods, that there is a product either in the pipeline or currently being produced, which product could be produced far more effectively, which could be marketed far more effectively and which could be expanded dramatically if it were in the hands of a firm that had some abilities that the current holder of those assets did not have, whether those abilities are access to national advertising, whether they were simply a professional, well-experienced marketing group or sales group that has access to distribution or access to information, that could make the product or the research and development far more valuable than it is in the current holder's hands, that is the kind of efficiency that we would like to see recognized equally with those efficiencies that we might be able to demonstrate a 3 percent or 5 percent reduction in the cost of production.

Are they difficult to measure? Yes, they are.

Are they any more difficult to measure than the relevant market definitions that we have to engage in in every merger analysis? We don't think so.

How can they be measured? I agree with Phil that there is a very easy and formulaic way to demonstrate some of these things. I think that those ways are occasionally worthwhile, but they are very seldom persuasive in the context of a requirement that evidence be clear, that the evidence be particularly compelling, that we might be able, in the course of the next two or three years, to take this particular product that this company has not been marketing very effectively for us to market it far more effectively than before.

Is it important in an anti-competitive or a competitive analysis of a transaction? It is very important.

How important was it when the Kellogg Company decided, back in 1983, that it was going to start to market with regard to the health claims, the health benefits of increasing fiber consumption and increasing that fiber consumption by virtue of eating high-fiber cereals?

We know that, number one, that from the studies from the Bureau of Economics that not only did the consumption of the Kellogg cereals increase, the consumption of high-fiber cereals generally throughout the industry also grew dramatically.

We are talking about situations, we are talking about markets where, by and large, in the grocery manufacturing industry, when a transaction is being considered, when products are being considered as candidates for consolidation, it is a market-increasing proposition for a particular brand or a particular product.

I have performed a modest, unscientific survey of antitrust council for the Grocery Manufacturers in preparation for my testimony today. And what I discovered was that not once in the memory of any antitrust lawyer currently representing the industry have we presented to the agencies a transaction where we thought that the ability of merged firms would be to reduce quantity and raise prices in order to reap the benefits of the merger.

That's not to say that we haven't seen a few of those in which at least thoughts were entertained by an occasional executive or sales folks in organizations.

We don't present those to you. And the very reason is, because we know that those are the kinds of transactions that run into antitrust difficulties.

What have ripened into transactions that the FTC has considered and that the FTC has passed upon are transactions in which the parties can present a credible case for growing a brand, for introducing new forms of a brand, and for growing markets into areas where the brand has not been seen.

These are the kinds of efficiencies which are much harder to document, much harder to predict, and envision -- or receive much less attention from the academic literature to date.

One question that I think is very important -- or at least one distinction that I think is very important is in the question that Phil raised as one of the most important questions of considering efficiencies in health care.

One of the advantages of dynamic efficiencies, marketing efficiencies, efficiencies in innovation is that we do not have to ask whether those efficiencies are going to be passed on to consumers.

We tend to share the position of the Chairman a little bit more and that the question might be asked a little more often than it needs to be asked. But at least we can say this: When the issue is efficiencies that are taking the form of new products, new marketing, and new distribution, expanded markets, we are already dealing with the assumption that has troubled a great deal of the efficiency debate in antitrust law. We are already dealing with passing the benefits of those efficiencies on to consumers.

One of the areas where we find there to be some peculiar asymmetries is that the efficiencies that are recognized somewhat grudgingly but increasingly in merger analysis are efficiencies that are protected very jealously in overall horizontal analysis.

There is no question -- and the Federal Trade Commission has been a major player in the development of this -- that any horizontal restraints that in any way interfere with the efficient marketing or other forms of non-priced competition of products are restraints today that receive almost as serious a treatment as naked restraints that deal with price themselves.

We have seen this going back to the Indiana Federation of Dentists cases. We have seen it in the Mass. Board of Optometry case. We are seeing it now in a case that you, of course, can't discuss because I believe it is still in Part III before you but in an initial decision that recently came out of the California Dental Association case.

A tremendous deal of attention is now being paid at the horizontal level to the kinds of efficiencies and the kinds of competition that efficiencies can drive in the non-priced areas.

These are the very efficiencies that the Grocery Manufacturers are trying to project and trying to accomplish, sometimes through mergers and sometimes simply through the ability to market their products on a national and global scale.

And that takes me to the third issue -- and I'll conclude with that issue -- in what we believe is one of the more significant threats that remain to those kinds of efficiencies today. And that is the uniformity of an enforcement of consumer protection laws.

Like Phil, I will have a chance to address this issue a little more fully a little bit later on in these hearings. There remains a significant concern, not only for the basis of national marketing but also for the basis simply of the transactions that can lead to national marketing that there be constant dialogue between the Commission, the states, and the United States, and other countries so that the benefits that the Commission has obtained in developing its policies with regard to merger analysis as well as consumer protection analysis be benefits that can be shared and understood by others.

We believe that one of the finest moments of the Federal Trade Commission in the last few years was the Commission's development and issuance of the Environmental Marketing Guides which have led to a tremendous increase in harmony among the various states, including most recently the State of California where expensive First Amendment litigation over the ability of manufacturers to make green claims has finally come to a conclusion -- or is likely to come to a conclusion -- I shouldn't speak too quickly -- because there has been a change in California law that mirrors the change -- that mirrors the guidelines the Commission has set forth in environmental claims.

We would like to see the Commission continue this kind of leadership, and we would like to see this kind of leadership extended in one additional area.

We believe that in the area of consumer protection regulation, where the achievement of dynamic efficiencies and non-priced competition is at its most vulnerable, is in the area of claims interpretation.

We would like to see the Federal Trade Commission develop a policy statement in which the Commission would address the kinds of practices, the uses of evidence, and the weight that it would give to competing interpretations of evidence so that when companies come forward with campaigns like the fiber/cancer campaign of the last decade, there will be some understanding that these kinds of claims are interpreted in a fashion that is consistent, that adheres to the precedent, and that can be reasonably assumed will be applied throughout the United States.

We think that there in part is kind of a vicious circle: The more that we recognize dynamic efficiencies, the more that we recognize the importance of non-price competition, the importance of the market for information and the role that plays in the non-price dimensions of competition, the more that will inform the antitrust analysis and the merger analysis and the more that will inform the development of policies in consumer protection so that these kinds of efficiencies can be achieved on a national and even a global scale.

Those conclude my comments. Thank you very much.

CHAIRMAN PITOFSKY: Thank you.

COMMISSIONER STEIGER: Let me join in welcoming you back.

MR. MacLEOD: Thank you.

COMMISSIONER STEIGER: We still miss you, Bill MacLeod.

Always fearless. You do address a very difficult issue, and you do address potential competition and how we analyze it.

What guideposts should we follow if we are confronted with a need to analyze a transaction that involves a potential competition issue where, to simplify, each party is pursuing a similar R&D development?

And the second part of that question is: Do you think those guideposts should be or are different if you are analyzing high-tech industries?

MR. MacLEOD: We think high-tech industries are important to the economy, but we are not convinced that the high-tech industries are any higher tech than many of the grocery manufacturers.

There is a great deal of attention these days because we herald every couple of years the generation or the next generation of a computer chip that has far more memory and far more speed.

I'm not sure that is any more important to American consumers than foods that now have no fat where we had low fat before and foods that had low fat where we had a great deal of fat before.

I think that the issue of how to deal with overlapping or complementary or substitutable R&D efforts is something that can be done with perhaps a little more recognition of the various phases of R&D and the extent to which we are truly talking overlaps. And we're talking more about something that might be better classified as a vertical relationship.

It is seldom the case -- and once again, if it where the case, it would probably be in the documents; and if it were in the documents, you probably wouldn't see the merger. It is seldom the case where in two grocery manufacturers, they each realize that both is on a race to produce the next version of non-fat, good-tasting bread that is going to sweep the market, and therefore let us try to combine our resources so that neither of us beats each other up and we get out there on the marketplace with our products.

Much more often, there is an element of the research in one company that is complementary to another element of the research in another company or to the ability of the other company to put that research into some type of production so that the combination of those two will create a tremendous advantage, sometimes a year or two sooner to the market with the product.

That advantage is far more likely to outweigh the possibility that some of the resources that were perhaps overlapping resources in the R&D functions might not otherwise be continuing their independent efforts to come up with slightly different products or come up with two lesser products that are producing in far less efficient a fashion.

I think a useful analogy is the two hospitals at 40 percent apiece. If we can deliver a product to the American consumer that is 80 or 90 percent better than two products but each of which were unable to achieve the nationwide marketing efficiencies, distribution efficiencies, or information efficiencies, we are probably better off, especially if we can identify that in those R&D departments, as we found back in 1983 with that merger that I had to consider, that very often those resources were not going to disappear; those resources were not going to lose their productive efficiency in the innovation market. They were simply going to be redeployed and would probably be surfacing in the next generation product to come out of the industry.

COMMISSIONER STEIGER: One follow up, if I may, then: Do you think that intellectual property considerations weigh more heavily in what has been called the high technology industries as compared to the industry that the grocery manufacturers operate within?

MR. MacLEOD: Judging by the discussion and the attention, one would certainly think so.

I will say this: I will say that we have been generally very encouraged among the grocery manufacturers at the sophistication that the Federal Trade Commission staff takes to the issue of developing brands, developing R&D, looking at what two companies together might be able to do that the two companies separately might not be able to do in bringing the next generation of product on line.

But there is, I think, still a sense that if you don't win that argument at the staff level or if you don't win that argument at the Commission, it will be a little more difficult to win that argument ultimately because there is simply not as much respect paid to those types of efficiencies in grocery manufacturing, for example, as there may be in high-tech computer markets.

In saying that, I ought to mention a reference that I did put into my prepared testimony and a reference that I think redounds to the credit of the Federal Trade Commission as well as to a very sophisticated analysis recently done by a federal judge in a merger case in the recent acquisition of the Nabisco Shredded Wheat products by Post.

The Commission declined to take action. Nonetheless, there was prosecution by a state attorney general that was brought in Federal District Court in New York, the sum result of which the transaction being upheld and the judge recognizing that far and away the most vigorous form of competition that is prevalent in this industry is competition for innovation, the product introductions, new brands.

In one step, the federal judge made the point that I have tried to make today. And the federal judge also vindicated a decision the Federal Trade Commission made a couple of years ago.

In preparing for this testimony, Mr. Chairman, I went back to your predecessor, Madam Chairman's speech that she delivered at the 1990 spring meeting of the Antitrust Section, when the Commission undertook to look at a few mergers that the Commission had not challenged and asked the question whether the predictions the Commission had made were predictions that, by and large, were coming true after a year or two following the transaction.

The conclusion that she reached was: Yes, they were; the Commission had probably guessed right in those cases -- or certainly predicted right in those cases. "Guess" is not quite respectable enough a term to use.

I think, in the Nabisco matter, that is another case in which the Commission can take credit for making the right decision.

We would love to see more of those kinds of analyses done, but we would much rather have them done by the Federal Trade Commission in a speech than by a federal judge after long litigation.

COMMISSIONER STEIGER: Thank you.

And thank you, Mr. Chairman, for the opportunity.

CHAIRMAN PITOFSKY: Thank you.

Bill, your thought, that some efficiencies might not involve reductions in unit costs, there are other things that might serve that, is an interesting one.

Let me refer back to Phil Proger. His suggestion was that efficiencies be taken into account only in a situation where there's enough competition left to ensure that the efficiencies will be passed along and maybe that they're really there and so forth.

That suggests to me -- and Phil, you may want to comment on this if I'm not right -- but that suggests to me that you would take an efficiency case into account only in a fairly marginal case.

You wouldn't let firms claim efficiencies whether they're financial or innovative in defense of moving to monopoly or duopoly but rather, if a case were close and there's a fair amount of competition left, then an efficiency might make the difference.

Is that what your position would be on this efficiency issue?

MR. MacLEOD: My position, I think, is much closer to the position that you have laid out in the past.

And I think what makes different the consideration of what I'm calling the "dynamic efficiencies" -- and those are efficiencies passed on in the forms of improved products or better information about the products, that are, by definition passed on -- they could be passed on and could be so effective as to render competition obsolete or at least to suspend competition for a while because a firm with a particularly innovative product might be a firm that is serving a market that was served by a number of competitors in the past.

If the difference between achieving that efficiency and failing to achieve it is the ability of two firms to combine their resources in a joint venture or some kind of acquisition and the recognition of this joint venture was that it would probably create a new firm with a new product that would have very few competitors, I submit that the welfare analysis of that transaction should still favor the transaction because we would all be better off with vegetable shortening produced by one than with lard produced by low-cost producers.

CHAIRMAN PITOFSKY: So you would focus on whether it's a substantial efficiency rather than whether it's likely to be passed on?

MR. MacLEOD: In the cases where pass-on is already an issue, I think that's correct.

Pass-on, to me, is only a difficult issue when we're talking about the cost-lowering types of efficiencies.

The difficulty with pass-ons of dynamic efficiencies, of course, is that we never know for sure whether or not the market is going to buy this proposition that we are offering it. Fiber could have fallen on its face in the 1980s and we never would have heard about it again.

CHAIRMAN PITOFSKY: Good.

MR. MacLEOD: But we did give that market the opportunity to receive those efficiencies; and as a consequence, the cereal industry was very substantially transformed.

CHAIRMAN PITOFSKY: Phil, have I fairly characterized what you had said earlier?

MR. PROGER: Well, I think so.

I still think the essential issue in weighing this -- and this is the whole antitrust paradigm -- is, if you're going to allow a transaction to go through, is there some mechanism to ensure the consumers are going to obtain the benefits of that transaction?

The only comment I would make -- and I really don't disagree with Bill; I've known him for many years -- is that I think you've got to look at competition in a dynamic way that Mr. Scott did in his testimony.

To go back to that, he was talking about what Columbia HCA is doing in the area of communication management information services, where the physicians are directly hooked into their computer system. Those are real benefits to the consumer.

Those are real benefits not only in cost savings but if the physicians beep wherever he or she is and the tests immediately go in so that it doesn't wait until tomorrow morning when they make their rounds, they're real benefits.

I presume that Mr. Scott -- I don't know -- and Columbia HCA has made the determination that there is benefit in offering their product to the consumer to, frankly, my clients from testifying here on behalf of CIGNA, Aetna, Prudential, and United in offering this. And this is a part of their competitive dynamic.

One must ask the question: If there wasn't that competitive dynamic, do people make the investment? Do they spend the money?

So I still think whether it's regulation or competition, there's got to be some mechanism to ensure that the efficiencies are passed on.

If they're not passed on, it's just a higher margin, and you're dealing with a wealth transfer.

CHAIRMAN PITOFSKY: Debra?

MS. VALENTINE: Yeah, actually one question. Commissioner Steiger's questions made me start thinking along these lines.

When we're looking at dynamic and innovation efficiencies normally, if you take health care with the FDA, defense with DoD, and I suppose even in health care we have Phil Proger's and his clients, or Mr. Cubbin's, we have a very sophisticated customer, generally.

Who do we turn to in your industry? Who helps us make the assessment as to whether these innovation efficiencies and benefits are desirable ones, let's say, from a merger as opposed to keeping two research tracks or two products going?

MR. MacLEOD: I think here, the ultimate consumer has the sophistication, generally, that we need -- and probably more than we need -- to ensure that the markets are going to deliver the valuable innovations and are going to penalize the frivolous innovations.

If there is a better way of making low-fat or non-fat cookies, cakes, or bread or salad dressings, that is an efficiency that is involved not only with delivering the information to the consumer, getting the fat out of the product, and keeping the taste in the product, it doesn't require a very sophisticated bulk purchaser to tell us whether or not that salad dressing, that cake, is going to deliver far more benefits to consumers than what they would have purchased otherwise.

Consumers can tell us that themselves. The dynamic efficiencies are written all over the products.

They are, in part, expressions of what consumers desire in products. When they're successful, they're correct expressions. When they are failures, they are incorrect expressions.

But that's something that consumers generally can determine in consumer goods manufacturing.

CHAIRMAN PITOFSKY: Well, thank you very much. Not only did we have a fascinating morning of discussion, but we finished on time.

And I do really appreciate your coming, and we look forward to your coming back in another guise on another topic.

We'll adjourn and resume at 1:30.

Thank you.

(Whereupon, a luncheon recess was taken at 11:30

a.m. until 1:30 p.m.)

A F T E R N O O N S E S S I O N

1:40 p.m.

COMMISSIONER STAREK: Well, I think we can begin now.

Good afternoon, everybody. This is the afternoon session of the 10th day of our hearings on global competition. And this afternoon we will continue the discussion on the role of efficiencies and the analysis that we do here at the Federal Trade Commission, asking whether or not a more skeptical approach is appropriate or whether the current policies regarding efficiencies and the measurement of efficiencies are relevant to the markets that we are looking at in mergers and other transactions.

In the afternoon sessions, what we have been doing generally -- and I think we'll continue this procedure -- is to hear from each of our speakers then take a short break and come back for a discussion, a debate, questions, from either the audience, if you fill out a card and ask a question, or from the group assembled here.

Our first speaker this afternoon is Terry Calvani. Terry is a partner at the law firm of Pillsbury, Madison & Sutro here in Washington and in San Francisco.

Before he joined the law firm, Terry was a Commissioner here at the FTC from 1983 to 1990. And during 1985 and '86 he served as the Acting Chairman of the Federal Trade Commission.

Prior to joining the Commission, Terry was a professor of law at Vanderbilt Law School where he taught courses, surprisingly enough, on antitrust and trade regulation.

Terry has also been very active in the ABA Antitrust Section's Robinson-Patman Committee, the Noerr Doctrine & State Action Committee, and the Special Committee on Antitrust Penalties and Damages, and as a member of the Governing Council.

Terry, thank you for coming.

MR. CALVANI: Thank you, Commissioner Starek, members of the staff, ladies and gentlemen.

I'm delighted to appear before you here this afternoon to address the subject of efficiencies and the role they play in antitrust analysis.

But before specifically addressing that topic, I want to take this opportunity to congratulate the Commission on recent changes in the Commission's practice that makes the Commission discharge of its own law enforcement mission more efficient.

I refer firstly to the adoption of a sunset policy for both competition and consumer production orders; second, the announcement that the Commission will no longer necessarily, routinely file administrative actions following a failure to obtain injunctive relief in the federal courts; and lastly, the suggestion that the Commission will no longer routinely insist on prior approval provisions in all merger orders.

I came to appreciate the significance of the latter two policies only after returning to the private practice of law.

These two policies, the prospect of administrative litigation and the prior approval provision made it important -- all other things being equal -- to secure a merger review by the Antitrust Division of the Department of Justice if possible. The costs and delay associated with administrative litigation were such that very few companies could afford to dispute with the Commission. And the very nearly automatic filing of an administrative action when the parties resisted the Commission in federal court made the parties also reluctant to litigate in that forum, too.

The process effectively denied many their day in court by insisting that they received years in court.

Automatic insistence on prior approval effectively removed many companies from the marketplace and may have impeded competition in some instances. I know of companies that have failed to qualify as bidders because they were under an FTC order.

The absence of HSR-like time constraints on Commission action and the arbitrary and capricious standard of judicial review made many sellers unwilling to admit a buyer under order to their auction.

These two procedural aspects of Commission practice made many prefer clearance to the Department of Justice.

The issue of dual jurisdiction is an important one, but one that I will not address today.

Nonetheless, dual jurisdiction is particularly suspect where there is asymmetry in the regulatory costs and where the clearance process may be outcome determinative. That was not good government, and I congratulate you, Commissioner Starek, and your colleagues on these very important reforms.

Well, are efficiencies a legitimate object of consideration?

The Commission first considered this issue in its decision in American Medical International, where it attempted to parse the law and suggested, albeit in dictum, that efficiencies were a proper subject for Commission consideration.

Having failed to find efficiencies there, the Commission did not address the more interesting question of what to do with them.

And I think it fair to say that Commission guidance on this issue has not progressed much since 1984. While Part 4 of the current Merger Guidelines recognizes efficiencies as a legitimate object of consideration, they provide very little further guidance.

Accordingly, I think it's appropriate that the Commission consider this issue anew.

The contours of this debate have shifted somewhat over time, and I think that's attributable in part to the fact that consideration of efficiencies has, for a long time, been a backhanded way of debating the competitive effects of a transaction when the competitive effects story played a less prominent role in merger evaluation.

The parties urged efficiencies as a way of saying that the transaction did not pose any probable anti-competitive effect.

But while the Supreme Court has not reconsidered the concentration presumption espoused in cases like Philadelphia National Bank, the antitrust agencies -- thankfully, I might add -- have embraced the need to tell the competitive effect story in Part 2 of the Merger Guidelines. Thus, much of the discussion of efficiencies in the context of presumptively illegal mergers may not be as relevant today as it once was.

Thus, for example, the example of a transaction in a concentrated industry which posits no price increase and efficiencies that are wholly passed on to consumers is of less interest today than in an era when the concentration presumption was king of the mountain.

Of some greater interest, consider a merger between two small, inefficient companies in a highly concentrated market where the industry price is fully rent taking and set by a large, dominant competitor. Such a merger may be efficient; and in that event, there will be a net social gain. No additional wealth transfers will take place, and resources will be saved.

The efficiencies defense might be appropriate in this context. I hesitate and use the word "might" because I would prefer to argue that the transaction is not likely to lessen competition to begin with and resort to the efficiencies defense is unnecessary.

I recognize, however, that the Commission may disagree. And I note that the Commission has, within recent memory, authorized the staff to seek a preliminary injunction enjoining such a transaction where there was a consensus on the Commission that the industry was fully exploiting the industry monopoly price.

In that case, in that context, the efficiencies ought to have been considered.

Of greater interest yet is the transaction where there may be an increase in price and where none or only some of the efficiencies are passed on to consumers.

I hesitate at this point because I fear that the discussion takes on an unworldly aspect, an unworldly appearance, an unworldly atmosphere, because in racking my brain over my some seven years tenure here at the Commission, I found it very difficult to identify cases where that would be a fair characterization of the facts.

Nonetheless, there is substantial commentary and support of efficiencies recognition in this context, and I would join those in doing so personally because I find triangles to be more interesting than rectangles.

But I've stated my views on the purpose of antitrust elsewhere and will not tax this audience's patience in that regard this afternoon. Rather, I leave the Bork-Blake -- or more recently Elzinga/Sullivan -- debate to others.

I would rather address the issue in the context of those for whom allocative efficiency is but one of several objectives.

I do so with some discomfort because I don't belong in that charge.

Nonetheless, first, I suspect -- or while I suspect that one can still demonstrate that the average net worth of citizens is less than that of equity shareholders, change in the demographics of shareholders have made the redistributive consequences of antitrust policy less important, even for those who embrace the Robin Hood School of Antitrust. It would be interesting to see how the presence of pension plans and eleemosynary institutions in the market have changed the landscape. This may reduce the importance of redistributive goals of antitrust policy for those who embrace a social agenda.

Second, in this age of internationalization of markets, domestic employment policy has a stake in the success of domestic enterprise. These interests have a stake in the ability of domestic organizations to succeed on the field off world competition whether or not efficiencies are passed on to consumers. And this is particularly true in situations where efficiencies are treated more harshly here than by antitrust enforcement agencies elsewhere.

Before concluding, permit me just a couple of minor points. Indeed, I think I'll skip through a good number of -- or at least part of this.

Let me just make a point on the debate on the issue of whether a different standard of proof exists with reference to efficiencies.

Spokespersons for the Department of Justice have suggested that the requirement that efficiencies be demonstrated by clear and convincing evidence was eliminated in the Guidelines, while officials at the Commission suggested otherwise.

Surely, the position of the Division is more correct. The fundamental nature of a Section 7 inquiry is speculative. What are the likely welfare consequences of a transaction? And it seems to me at least, inappropriate for the government to base its case on inferences largely taken from market structure but require the parties to make a more clear and convincing case on the efficiencies point.

Well, it's a bleak afternoon outside. People probably find it difficult listening to me carry on anyway, so I think I will stop here and toss the baton to you, Mr. Commissioner.

COMMISSIONER STAREK: Well, thank you very much, Terry. As always, it was extremely enlightening. And even though it is a bleak afternoon outside, I found your comments extremely interesting and very helpful.

Our next speaker this afternoon is Kevin O'Connor. And Kevin is the Assistant Attorney General in charge of antitrust enforcement in the Wisconsin Department of Justice where he litigates criminal cases and large multi-state civil antitrust cases on behalf of the State of Wisconsin.

Kevin serves as the current Chair of the Multi-State Antitrust Task Force of the National Association of Attorneys General. And he is in the business of guideline authorship. He has co-authored a revision of NAAG's Horizontal Merger Guidelines. And then in 1993 and then in 1994, into this year, he also served as a co-author of the revision of NAAG's Vertical Restraint Guidelines.

Kevin, thank you for coming.

MR. O'CONNOR: Thank you, Commissioner Starek.

I'm extremely pleased to be here as a representative of the National Association of Attorneys General.

I have to, first of all, give the disclaimer that I always have to give that, even though I'm Chair of a multi-state organization, I can't speak for anybody.

COMMISSIONER STAREK: We have those disclaimers, too.

MR. O'CONNOR: With that said, let me continue.

The question today is whether the current antitrust policy towards efficiencies is an appropriate one.

In order to frame the question properly, I think we first have to understand what the policy is at the federal and state level considering efficiencies and merger analysis in particular.

And let me do a brief overview of what I understand to be the federal policy as it is in the federal guidelines, the DOJ-FTC Horizontal Merger Guidelines.

They seem to incorporate efficiencies in two places, first in the general competitive effects section of the merger analysis, in the five-part analysis; and then later in the analysis, assuming that later portion of the analysis is reached and the merger has not already been screened out, efficiencies are dealt with separately and explicitly in Section 4 of the federal guidelines.

Hence, even where concentration thresholds are exceeded and a competitive effects story can be told, it appears that the federal agencies, at least on the face of the guidelines, will consider efficiencies where the merger may be reasonably necessary to achieve sufficient net efficiencies.

The federal guidelines seem to suggest that efficiencies constitute a defense to a merger that would otherwise be challenged if: one, efficiencies fall into certain categories; two, the cost savings cannot be achieved by the parties in any other way; and, three, that the net efficiencies expected are greater than the anti-competitive effects and risks identified in other sections of the federal guidelines.

Also, consistent with the elimination of burdens generally in the federal guidelines, the 1992 revision eliminated the language that required the merging parties to produce by clear and convincing evidence, evidence of the efficiencies.

Although on the surface the federal agencies appear to be attempting to operationalize the so-called Williamson model for efficiency trade-offs, they don't say so explicitly.

It is possible that the net efficiencies language was meant to suggest that the federal agencies would not consider, simply, small efficiency gains as a sufficient offset to the high HHI's or changes in the HHI's.

In fact, subsequent cases seem to suggest a reluctance by the federal agencies to dismiss the issue of whether efficiency gains are passed on to consumers. And I'm referring specifically to the Honickman case and others like it.

Let me turn to the NAAG Guidelines.

Approximately a year after the federal agencies revised their Merger Guidelines in 1992, the National Association of Attorneys General adopted revised Horizontal Merger Guidelines -- which, as Commissioner Starek has pointed out, I was one of the principal co-authors of -- NAAG revised its guidelines in many respects.

In several respects, our guidelines converge with those of the federal agencies. In particular in the market definition area and in the section dealing with entry analysis, we simply adopted the federal agencies' approach either in total or at least as an alternative to our approach. We were very persuaded -- we were persuaded that their approach had a lot of merit.

However, because the federal guidelines did not appear to articulate clearly the role and weight to be assigned to efficiencies, the states were reluctant to adopt that approach to efficiencies. Indeed, it seemed to many in the states that the federal guidelines seemed to give too much weight and credence to efficiency arguments in mergers where those mergers were likely to reduce competition and, hence, be of interest to antitrust enforcement agencies; that is, those mergers that were in excess of HHI's of 1800, where all the firms are equally sized, only five or six firms in a particular market.

Briefly, the NAAG Guidelines -- taking that as a departure point, the NAAG Guidelines started with the assumption that when the Congress passed the Clayton Act, they made it a basic presumption that, where there's more competition in a market, there is likely to be more efficiencies realized, technical efficiencies, or what Liebenstein used to call x-efficiencies.

The NAAG Guidelines also state that there does not appear to be any substantial empirical support for the proposition that mergers that exceed the concentration thresholds set forth elsewhere in the NAAG Guidelines: "Usually -- and this is a quote: "Usually, or on average, result in substantial efficiencies," unquote. That's what our guidelines provided.

In addition, the NAAG Guidelines did five things. I won't go through the entire statement of them, but I will simply hit the highlights.

First and foremost, most mergers that come under review by either the federal government or the states do not involve any efficiency review, simply because they do not exceed the concentration thresholds or because no competitive effects story can be told or because entry looks like it could be timely, likely, or sufficient to offset any anti-competitive effects. The issue of efficiencies is not reached in most cases.

Secondly, the states decided, for the reasons I'll get into in a moment, to disavow expressing the efficiencies issue as, quote, "defense," unquote.

Third, the states decided to preserve the clear and convincing burden of proof on the merging parties simply because they are the ones who are likely to be in possession of that information and extraordinarily detailed information that may be necessary to evaluate an efficiencies claim.

Fourth, our guidelines, quite frankly, express skepticism about efficiencies, that efficiencies can be proved in most cases.

Finally, we explicitly rejected the Williamson trade-off model for evaluating efficiencies and adopted a price model.

What's the rationale for this approach to efficiencies? There are a number of reasons.

First, the states believe that redistributive effects matter in merger analysis. We believe that an analysis of the original legislative intent of the Clayton Act Section 7 provides that. And I won't get into the legal history or the statutory history here, but our guidelines do cite some of that legislative history. And we believe that that is something that cannot simply be disregarded.

That leads directly to the implication that the Williamson trade-off model where allocative efficiency is simply traded off against or measured against productive efficiencies is not appropriate.

Moreover, when we were revising the NAAG Guidelines in 1993, the states were aware and researched the industrial organization literature as it related to the likely effects of mergers in markets that could be characterized as oligopolies.

Mergers in these types of markets are, by assumption, the kinds of mergers that typically cause a problem in terms of the concentration thresholds or raise red flags that there could be a problem there, not that there automatically is a problem but that there could be.

Typically, an industry characterized by an HHI in excess of 1800 will have just a few firms possibly able to exercise market power independently or, more likely, able to affect price through tacit or express collusion.

Generalizing about oligopolies is always difficult. However, even when one considers a wide range of oligopoly models, which characterize these kinds of markets where HHI thresholds are breached or exceeded, it appears that efficiency gains would have to be fairly large to offset the likely impact of mergers in concentrated markets on allocative efficiency and price.

In a study expressly measuring the price/efficiency trade-offs that occur in oligopoly markets that are of most interest to antitrust enforcers, Fisher, Johnson, and Lande concluded that the NAAG Guidelines most appropriately matched up with the economic theory, the IO literature, that tested the various models against the types of efficiency gains that would have to be realized to off-set the lost allocative efficiency and transfers.

I won't quote the entire article. In my paper, I have a more extensive quotation. But in one small part, Fisher, Lande, and Johnson concluded that the mergers that resulted in much higher HHI levels or larger changes often required extensive savings in marginal costs, frequently much larger than one could expect from any merger, and certainly larger than one could predict reliably in advance.

The NAAG Guidelines implicitly use the concentration thresholds mentioned as benchmarks regarding efficiencies. As we discussed the revision of our guidelines, we asked the question: How likely is it that a merger that's less than our guidelines is going to have efficiencies -- a problem with efficiency?

And we concluded that, for the most part, we wouldn't even reach that question because we would simply pass on the merger so that that wasn't a concern. It was those mergers that exceeded the guidelines, sometimes substantially, where we would -- the issue might come up. And we concluded that, based on research like Fisher, Johnson, and Lande, that the efficiency gains in those cases would have to be fairly large to offset the likely anti-competitive effects.

In other words, our -- the concentration thresholds implicitly include an assumption about efficiencies.

Because of these concerns and because of the concern about redistribution, the states explicitly adopted a policy of efficiencies which incorporated the so-called price standard for evaluating efficiency claims; that is, where significant efficiencies are claimed, "The merging parties -- and I'm quoting from the guidelines here: "The merging parties must demonstrate that the efficiencies will ensure that consumer prices will not increase despite any increase in market power due to the merger," end of quotation.

In other words, where concentration is high, the NAAG Guidelines place the burden on the merging parties to demonstrate claimed efficiencies, offsetting the impact of the market power increase.

The NAAG Guidelines express -- contain a clear presumption or statement that it's unlikely that this test will be met in most cases. Thus, the 1993 revisions of the NAAG Guidelines left the door slightly ajar for such a showing, but they accurately indicate that, where post-merger concentration figures are in excess of the concentration thresholds, efficiency claims are likely to be, at best, a tie breaker in very close cases.

Let me turn to another reason for our position on efficiencies.

Efficiencies are often very difficult to measure on a case-specific basis.

Notwithstanding this, the federal guidelines appear to call for a case-by-case analysis of this and some kind of a trade-off between efficiency and market power.

However, the states concluded, based on their experience evaluating mergers, that such a detailed case-by-case review is very difficult to do with precision, given the difficulty of modeling the industry involved and determining ex ante the cost savings that might accrue from the merger.

Oftentimes, merging parties have provided little more than ephemeral stories about possible efficiency gains. The one that comes to mind, in my personal experience, is the two hospitals that came in and, after a fairly long meeting, started talking about efficiencies. And when asked what they were, talked about the merging of their laundry facilities. And that was it. And we quickly wrote that one off as something they could do without having to merge. I mean, it was obviously an efficiency they could gain in a lot of other ways.

But even when the stories have more substance, one encounters numerous theoretical and factual issues assessing efficiencies, such as factoring in product heterogeneity, allocating joint costs in a multi-product firm, measuring changes in quality and variety, and a number of other factors.

Moreover, the states were unable to find much empirical work which allowed for accurate predictions about characteristics of mergers. Indeed, the states' skepticism about alleged synergies seemed to be warranted not only by the states' concern with individual merger cases but also by the academic literature.

And I'm referring back to the time when we were doing the guidelines analysis looking -- I recall looking at the Porter studies of corporate synergies, Michael Porter's studies of corporate synergies, and being unable to find a lot of convincing evidence that efficiencies were present in many of these transactions.

In preparing for this hearing today, I attempted to find the most recent studies that I could dealing with synergies from recent corporate mergers; and the one that I found that was most recent is a recent Business Week Mercer Management Consultant study that basically concluded that the synergies expected to be realized from any of these larger deals in the early 1990s have yet to be realized.

And without quoting all of the excerpt that I put in my paper, I should note that the analysis also concluded -- and I'm quoting here: "...that most of the '90s deals still haven't worked. Of the 150 recent deals valued at $500 million or more, about half destroyed shareholder wealth, judged by stock performance in relation to the Standard & Poor's industry indexes. Another third contributed only marginally to it. Further, says James Quella, director of Mercer Management Consulting, 'many deals destroy a lot of value.' Mergers and acquisitions, he declares, 'are still a slippery slope.'"

The NAAG Guidelines reflect the states' own sense of fallibility in the efficiencies area, given the difficulty of predicting efficiencies or the lack of efficiencies and how such a finding would interact with changes in market power caused by the proposed transaction.

That should not be read to suggest that the states are hostile to efficiencies. I mean, we believe that efficiencies are present in many deals. It's simply that when you're establishing policy and benchmarks, one needs to take into account the limitation of both the theory and the data that might be available to apply that theory in particular transactions.

And as we wrote the guidelines and tried to formulate our policy towards this particular issue, we had trouble coming up with a strong foundation on which to present a policy that was more, shall we say, "accommodating" of efficiencies.

Let me briefly address this issue of guidelines, because that is where the policy of the agencies and the states is generally ensconced.

A related reason for the NAAG approach to efficiencies is that -- the reason enforcement agencies adopt guidelines to begin with, is to give clear benchmarks where benchmarks are possible of the type of cases that would interest an enforcement agency.

In the exercise of prosecutorial discretion -- because that is what we do -- the antitrust enforcers ought to bring to bear the most sophisticated IO economic theory tools possible, provided there is data present to support the application of the theory.

The FTC and USDOJ have demonstrated an extraordinarily high level of sophistication in the merger analysis and in the exercise of their prosecutorial discretion.

However, where the theory and the related empirical work are not sufficiently developed to extrapolate the clear benchmarks, it is best not to suggest in guidelines that every approach will or ought to be applied with respect to mergers in general.

Guidelines which provide that everything is relevant do not provide much guidance and may potentially undercut enforcement, in my view.

For example, such guidelines may invite the courts to attempt to engage in such sophisticated analysis or place the burden for such analysis in a litigation setting on the government, even though the merging parties are the ones in possession of most of that information, and even though such an undertaking is not likely to be done, in the words of Richard Schmalensee who looked at this specific issue back in the late '80s, "accurately, predictably, or quickly in such a litigation setting."

Let me turn briefly to the issue of trade concerns or export concerns.

Finally, it's been suggested that an efficiencies defense ought to be invited where it can be shown that a merger could enhance the ability of the merging entity to compete in international trade even where it may raise prices in domestic markets.

Obviously, if it didn't raise prices in domestic markets and there was no market power problem, obviously, this would not be a concern to antitrust enforcers. It's only in the case where the exports are at the expense of lost competition or the increased market power in the domestic market that this becomes an issue.

The NAAG Guidelines do not establish appropriately, in my view, a separate and distinct provision for the situation. It does not seem to be wise policy to permit mergers that raise prices in domestic markets to subsidize, in effect, exports.

First, the trade-off of domestic consumer injury against domestic job creation implicit in this analysis would seem to rival the Williamson efficiency trade-off in complexity.

Second, the redistribution of income from consumers to exporters and their employees, presumably, seems inconsistent with the goals of the Clayton Act.

And, finally, it would seem more appropriate to deal with this situation by modifying market definition methodology to take account -- if needed, to take account of markets where foreign trade is likely to be an issue. In other words, deal with it by defining the markets in a more realistic and accurate way than simply allowing that kind of a trade-off.

Let me turn briefly to a comment, and I won't go through all of my statement on this; but I would be happy to respond to questions about it.

Although the NAAG Guidelines discourage a case-by-case approach to the balancing of provable efficiencies against increased market power, the states have, on occasion, carefully weighed claimed efficiencies against anti-competitive effects of an acquisition and also examined whether a less restrictive alternative, such as a joint venture instead of a merger, could be fashioned to achieve the efficiencies but avoid the anti-competitive effects.

Also, in declining markets, the states have formulated remedies to ensure that alleged cost savings are passed on to consumers, especially where the transaction results in only one or two competitors in a given market.

The two cases cited in my remarks deal with the Williamsport Hospital case and the Morton Plant Health Systems case, both of which were state cases. And in the latter case, was a case brought by the State of Florida with the -- and the U.S. Department of Justice, jointly.

In the Pennsylvania case, the Pennsylvania AG negotiated a consent judgment which provided that the merging hospitals, three of the four hospitals in Lycoming County in north central Pennsylvania would be allowed to merge on the condition that their claimed efficiencies of $40 million over the five years would be passed on to consumers in certain specified ways.

The consent judgment then went on that, if those provable cost savings were not passed on, the parties would have to pay to the Pennsylvania Attorney General's office the difference between what they could prove that was passed on and what they had claimed at the outset. And then the Pennsylvania AG's office would then distribute that money to the benefit of the consumers who may have been -- who had not realized those efficiencies.

In the Morton Plant Health Systems case, the proposed merger was not allowed simply because the USDOJ and the Florida Attorney General's office concluded that most of the efficiencies that had been claimed could be achieved -- if they could be obtained at all, could be obtained through a consolidation of certain types of services without an outright merger of the two entities.

Now, the remedies that I just described were not explicitly contemplated by the NAAG Guidelines when we re-drafted them in 1992. Such an approach, however, is consistent with the observation of Areeda and Turner that such efficiencies -- such an efficiencies defense should be permitted where an industry is declining.

Where market demand is increasing, internal expansion usually offers a viable alternative to a merger as a way to realize efficiencies.

Similarly, the Morton Plant settlement underscores the states' reluctance to accept a merger if an alternative to outright merger can be crafted which will achieve the claimed efficiencies.

Simply put, it remains to be seen whether these kinds of conduct-oriented injunction provisions can accommodate -- can be administered effectively.

I know that some have suggested that, as an alternative remedy, that mergers ought to be permitted subject to being unraveled several years later if the claimed efficiencies were not realized.

And that situation seemed to pose the problem of the proverbial unscrambling of the egg. Whereas these remedies, I think, hold out the promise that perhaps they won't require a massive review later on but simply some sort of a clear analysis -- a clear-cut analysis at the end of the day.

However, it remains to be seen whether this is going to be an effective way to deal with the issue of efficiencies.

Having said that, I think I will stop there.

COMMISSIONER STAREK: Well, thank you. Very interesting. I wonder how that conduct remedy deals with the cost of health care to consumers.

But, anyway, I think what I heard in your statement is that we now have two votes for the interpretation that clear and convincing evidence was eliminated from the guidelines. So I think you agreed with the previous speaker on that.

I will be interested in the discussion period to hear our two speakers who have gone so far discuss the redistributive effects and the importance of that. I think that sets up an interesting discussion.

Shall we move on to academia?

Our first professor this afternoon is another returning alumnus. Tim Muris is the George Mason University Foundation Professor of Law, George Mason University.

And before he joined the law school faculty at George Mason in 1988, Tim served as the Executive Associate Director -- one of the Executive Associate Directors in the Office of Management and Budget.

And before going to OMB, he worked here, first as the Director of both the Bureaus, the Bureau of Consumer Protection, from '81 to '83, and the Bureau of Competition from 1983 to 1985.

Tim also serves as a Senior Fellow at the Progress and Freedom Foundation. He is the Coordinator of the regulatory law track at the George Mason School of Law and is an adjunct scholar at the American Enterprise Institute.

Tim, welcome back. Thank you for coming.

MR. MURIS: Thank you, Commissioner Starek. It's certainly a pleasure to be back in Room 432. In fact, it was 21 years ago this month I had the first matter that I dealt with as a staff member before the Commission; and I've seen several configurations of the table in the room here. So it's interesting to see another one.

COMMISSIONER STAREK: Yeah, this is a new one, isn't it.

MR. MURIS: Yeah. I don't know if it's true that the difference between republican and democratic chairs was that the republican had a bigger chair than -- does Chairman Pitofsky use a regular chair? The same as everyone else?

COMMISSIONER STAREK: Absolutely. But he does like to sit sometimes at the end of the table as opposed to the middle.

MR. MURIS: Yeah, that was a -- that was a configuration once, too, with the chairman at the end.

I spent a lot of time over the years on this efficiency issue, and I think it's important to understand that if anything comes out of what the Commission is going to do, I suspect it will be something like guidelines.

And hearing what the discussion of what guidelines should do, I'm reminded of the scene in the first Ghostbusters movie where Sigourney Weaver, possessed by some demon, comes on to Bill Murray; and Bill Murray says: "I have a rule against being involved with clients." And after further events he says: "Well, it's not really a rule. It's more of a guideline."

So I think whatever comes out of this, there will be -- if the Commission does -- which I hopes it does -- issue some statement on the role of efficiencies, there will be some ambiguity.

It's clear that over the years, the government has been hostile to efficiencies defenses. And I -- although, I don't mean to limit what I have to say to mergers, most of the arguments have been in the merger context, so I'll focus on mergers.

And I think it's time for the government to re-evaluate the efficiency arguments and to approach efficiency without undue skepticism.

And let me focus on three issues that are frequently raised as standards that I think are part of that undue hostility.

The first is the so-called "pass-on defense." I think where that comes from -- it comes out of the academic debate about the so-called Williamson issue and whether we ought to have consumer standard, price standard, or an allocative efficiency standard.

Although I think that's an interesting issue -- and I've written about it myself -- I think it illustrates a typical academic tendency to focus on interesting issues that are empirically relatively trivial, because the truth is that there are few cases that, in my experience as Bureau Director, in following mergers that both raise -- where you're talking both about a price increase and a reduction, in fact, if the government had the burden to show, even in a likely sense that price would rise in a typical merger transaction, it couldn't meet that burden.

Instead, the government bases a presumption of anti-competitive effect using concentration thresholds and usually belief that entry is difficult; but the empirical work provides at best -- and really at best -- only a weak basis for that presumption.

To the extent that the current research -- if you were looking for a consensus in the current research -- to the extent it supports any thresholds, you would have to have considerably higher concentration than the so-called "highly concentrated" now; and it would have to involve the leading firms.

Now, I don't object, given the prophylactic nature of Section 7, to allowing a weak presumption to prevent a merger absent efficiency evidence. But if you do have likely evidence of efficiency, then what the pass-on test does, it presents an additional hurdle to the merger when no obstacle is justified, even -- and I think this is true -- if we accept the pass-on standard. Because what the pass-on requirement is it's a clever method to require the merging parties to show that the merger will not increase prices, because the theoretical justification for that standard is to ensure that the merger will not, in fact, result in an increase in price.

And so what that standard effectively does is turn what should be a weak presumption, in the typical case, into a strong one.

So I think that requirement ought to be eliminated, and it ought to be eliminated even if you believe in a so-called consumer standard.

The second issue -- and like Commissioner Calvani, I'll try to be brief.

The second issue is: What types of cognizable efficiencies ought to be recognized?

And here again, the agencies have -- particularly at the staff level -- have fought broadening an efficiency defense. The guidelines talk about production efficiencies, transportation efficiencies, give some grudging recognition to administrative expenses.

But I think the empirical literature shows there are other types of efficiencies and practical experiences in cases that ought to be recognized. And let me just list a couple.

Capital raising efficiencies. It's clear that they are one of the most persistent advantages of corporate size. I cite in my testimony some estimates. In a world of positive transaction costs, which is the world that we live in, I think that sort of advantage is inevitable.

Second, are promotional economies. I know Bill MacLeod discussed the strange ambiguity towards those economies that's exhibited by those who oppose recognition of those economies.

The Commission has a long and proud history, going back to when Bob Pitofsky was Director of the Bureau of Consumer Protection, of striking down barriers to promotion and recognizing the importance of promotion.

One of the things that then BCP Director Pitofsky did was get the networks to drop bans on comparative advertising.

The work of George Stigler and many others has convinced economists and the Commission that barriers to advertising and promotion ought to be struck down.

And I think that's one of the most bipartisanly consistent and best aspects of the Commission's enforcement, again going back into the early '70s.

Yet, when it comes to an efficiencies defense, there's some unwillingness to say: Well, but that's different; that's on a different level than other types of efficiencies. I don't think that should be the case.

Managerial economies I also think are very important. I was the Director of the Bureau of Competition when Terry Calvani was in the Commission majority when the General Motors/Toyota joint venture was approved.

One of the reasons it was approved was because of a chance to apply what was felt to be and I think has been shown to be superior Japanese management techniques.

More recently, ADM acquired Clinton Corn Processing. And during the Reagan administration, the Antitrust Division vigorously fought that merger and tried to throw every obstacle it could in front of an efficiency defense.

But one of the government's own witnesses when asked, if you could pick one company to do the most good for Clinton, what would that company be? And the witness said: ADM.

Now, part of what's going on here is sort of hard to separate managerial from production techniques from other kinds of efficiency. But if you say managerial doesn't count, then you get into that strange box that the government tried to get itself into in the ADM case.

The government lost the ADM case, but the judge didn't feel that he had to -- in his opinion, get into the efficiency issues.

The last issue I wanted to discuss is this question about whether efficiencies have to be unique to the transaction, which is sometimes thrown up as a standard. And I disagree with that standard because it's one of capability or feasibility and not one of cost benefit, when cost benefit is what Section 7 is all about.

The focus should not be on whether one method -- another method exists to obtain lower costs but whether -- but comparing the two methods in terms of their cost to the two methods and the relative speed of implementation of the two alternatives.

The mere possibility that cost savings could be achieved through an alternative means is not the right issue. In particular, internal expansion -- which is frequently said, well, let them expand internally -- is unlikely to occur in certain cases.

Indeed, one of the benefits of the new guidelines was recognizing what additional capacity could do to a market in terms of focusing on entry. Additional capacity might drive down price and create a disincentive to make such an investment in the first place. And that's found to be relevant in the entry context. And it certainly ought to relevant in the efficiency context in talking about the relative attractiveness of internal expansion.

I think the Supreme Court in GTE/Sylvania, when it said that antitrust law shouldn't channel transactions into one form or another, that that's unlikely to further significant social goals. I think that's something we ought to remember in the efficiency context.

Well, here we are in 1995 where most people -- I think the debates of the '60s where efficiency was thought to be a reason to strike down mergers -- I mean, we have moved beyond that. It would seem to me axiomatic that merger laws should be interpreted to realize the further realization of such efficiencies. The government, unfortunately, still presents obstacles to an efficiencies defense. And I think that it's time to end this last vestige of the bygone era of antitrust law when the law too often serves competitors and not competition.

Thank you.

COMMISSIONER STAREK: Thank you, Tim. Very helpful. Appreciate it very much.

Well, it looks like we're going to have an interesting and lively debate here after the break.

But before the break, we need to move on to our final speaker this afternoon who is Joseph Brodley.

Professor Brodley is a Senior Associate Dean for Research, Professor of Law and Economics and Kenison Distinguished Scholar of Law at Boston University.

Also, from the 1989 to 1990, Professor Brodley served as the Dean ad interim of the Boston University Law School.

Professor Brodley has served as a consultant to the Antitrust Division of the Department. And from 1992 to 1993, he served as a consultant to the United Nations Development Project, People's Republic of China on issues relating to drafting their competition laws.

Professor Brodley, thank you for coming.

MR. BRODLEY: Thank you, Commissioner Starek.

I'm going to focus my remarks on the issue of how can we best make an efficiencies defense operational?

Thus, I'll assume that it would be desirable to have an efficiencies defense and try to set up -- or state the framework of such a defense, focusing on how actually to try to use these tests that could be applied.

It seems to me the essential structure of an efficiencies defense must involve a two-stage proceeding, an ante review to identify cases where efficiencies are plausible; and an ex post verification that efficiencies have been realized.

I think there are many advantages in such an approach. It substitutes for what are now often extravagant but more importantly difficult to assess advance claims the actual test as to whether efficiencies have been realized. Of course, no test such as this will be perfect, but it is a lot better to do so before the fact.

Such an approach is information-conserving; that is to say, it allows the agency to use an over-inclusive approach at the ante stage when information is scarce because later when information is more plentiful, it can correct any overextension.

It also serves as a separating mechanism in the sense that parties, knowing that their claims will be subject to review, will rationally desist in making claims that they don't feel they could later verify.

The essential framework of this would include, I think -- and I agree, I think, in substantial part with Tim Muris -- all types of productive and innovation economies -- not necessarily everyone he mentioned; but in general, I think he has expressed himself that way in the past -- I would not require pass on for the reasons that, I guess, he and Terry Calvani stated; but I think also for two other reasons.

One, I think the conditions for screening such an efficiencies approach at the ex ante stage can provide for some eventual pass on by structuring relationships -- restraints so that they are not perpetual.

And second, because when we are talking about productive and innovation efficiencies, these have effects on other parts of the economy; and even from the consumer standpoint may actually create more wealth than would be harmed by a deferred failure to pass on efficiencies.

The interim period, I would suggest, it would be from three to five years between the ex ante and ex post.

And finally, such a proceeding would be based on the consent of the parties who would agree to it and would

agree to accept a remedy which ideally should be specified in advance and I think I would go farther and ask them -- parties to actually suggest the remedy they think would be adequate. They wouldn't necessarily get that remedy.

Now, turning to the two proceedings, the ex ante procedure is designed to screen the proposed collaboration, meaning either a merger or a joint venture. So some standard has to be established for that.

And I think the -- a showing -- a prima facie showing, not a conclusive showing that this transaction is likely to produce efficiencies of 5 percent or greater would be a good benchmark.

Secondly, the ex ante proceeding should eliminate high competitive risk cases. In the recognitioin of economies area, and referring specifically to mergers, I think a good cutoff as any is that that's been proposed by the Chairman before he became Chairman, the 35 percent market share or 1800 HHI; albeit, that won't save too many mergers, since most mergers below that amount aren't in trouble, as I understand it.

But clearly that approach, to my mind, should not apply to joint ventures. A higher limit is needed for them because of the lesser nature of the restraint; and clearly, it won't apply -- shouldn't apply to innovation joint ventures -- or innovation collaboration.

Innovation collaboration, I think the standard or cutoff should be either single firm dominance or less than 4 R&D centers, actual or highly potential, something along those lines.

The prima facie proof, what would that consist of? Well, it first, I think, would consist of the parties' own plans and, even better, engineering studies indicating that these efficiencies are promising.

Second, it could consist of past experience in the industry or comparable industries of similar mergers or joint ventures.

Third, if available cross-industry studies would be useful.

And fourth, of more limited use but still of some use, would be a stock market study showing how the market anticipated the increase in value following the announcement of the merger. Only a prima facie showing, though.

A less restrictive alternative I think is an important condition, but it shouldn't be extended in the ways that Tim was suggesting. I think, it would simply mean that any other alternative, which is suggested, would involve significantly higher costs relative to the efficiency gain.

So if the efficiencies -- well, I think that's clear. I won't explain it.

Now, turning to the ex post proceedings, other parties are free for a period of three to five years, depending on the nature of the case.

The issue at the ex post proceeding, essentially, I think should be, have the costs of these merging or joint venturing firms fallen relative to rivals? It's not enough if their costs fall over time, because the costs of firms generally fall over time.

Now, breaking that issue down, let's first look at plant level economies.

Here -- and I want to bear down on how this is going to be proved, or how I suggest it could be proved.

At the plant level, the data could be pretty good. Engineering studies are available, which are expensive but quite effective, and statistical cost analysis is also available because there are sufficient observation points when you get to plants to actually make such studies.

There are other tests that could be used and they would be admissible of course, but I think those tests could be the primary approaches and could be effective.

The problem is that the impact -- the social impact of this is limited because, as I read the literature, most plant scale economies are realized at pretty small market shares. So it's worth doing, of course; but if we're going to make an impact, we have to get to the firm level. And there it gets much more sticky with respect to tests.

And what I would like to suggest for your consideration is a multiple test approach. And the multiple test would be broken down into sort of three kinds of tests: First, input based tests which provide a screen, an initial screen, as I'm going to suggest; second, comparative tests which will test how this collaboration compares with what's going on elsewhere in the industry; and third, confirming tests.

Okay. Looking at the first, input based tests, the input based tests are very limited because, in some ways, if you say this is -- if you do these things, apply these R&D resources, you pass the efficiency test. Of course, all effort focuses on the inputs, not the results.

But nevertheless, it may be clear that certain inputs are necessary -- not necessarily sufficient -- to get an efficiency result.

If that's so, then those could be initial hurdles which would be necessary for the parties to confront.

For instance, if two hospitals, say they are going to, in effect, consolidate their operations and they don't consolidate, then they haven't met this ex ante condition and would have failed at the first stage.

Second, comparative tests are needed. And this is where it's necessary to get beyond the engineering studies and statistical cost analysis which aren't as effective in terms of comparing one firm with another. They can tell you what's going on within a firm. But to actually make this comparison, it would be extraordinarily difficult and the data often not available.

Here, I'd rely, first, on the survivor test; and not as a sole test but as one among several tests.

Basically -- it's hard to explain this very quickly, but basically the survivor test simply asks whether a firm has grown relative to its rivals?

Actually, the survivor test asks, in economics, whether the firm has survived in the market; so I'm pushing it a step further. Whether the firm has grown, has proved through the market that it has superior qualities over time.

Now, to the extent -- that test has some problems in it, to be sure. To the extent that test is doable, it fits very good in the legal process. It's something that an agency could apply. It's something the courts find congenial. They use that type of analysis already in cases such as BMI and Aspen have aspects of this. And it has some drawbacks, to be sure. But as I specify in at length in my paper, I think all of these drawbacks are manageable.

It's over-inclusive; but that's okay, too, because other tests will be applied as well. And I think it, therefore, is a very effective test within the group of tests.

A further test that could be applied is a stock market test, although now made more difficult because we were talking about stock market values over a period of years; and there's an awful lot of noise in that sort of thing.

Nevertheless, you would expect that if the efficiencies have been realized that the stock market values would increase, provided that you can actually compare the firms. Of course, if it's just one division of a firm, stock market won't be very useful.

Other tests are not very effective, but one that might be different is, if particular assets that are -- as to which the efficiencies were claimed have been sold off in the market, that might provide -- for instance, in the credit card field, credit card assets when sold off command values three times the value of other banking assets. That's some sign that there's profitability in such assets.

Now, of course, profit doesn't equal efficiency. Profit could be gained through cartelization, through pecuniary economies and so forth. So some confirming test needs to be applied to try to connect this with real efficiencies.

And here's where we can go back and, I think, use the engineering studies and statistical cost analysis but at the firm level. You then ask whether this firm has increased its own efficiency as significantly. And these studies could actually, plausibly, reasonably effectively, identify whether, within the firm, efficiencies have been obtained.

So, if you find that comparatively it's done well on tests which are admittedly over-inclusive but then confirmed by showing that historically, within the firm, it's doing well. Indeed, even a profit test might not be out of the question because firms are not free to simply change accounting standards willy-nilly. So on their accounting standards if significant improvements are seen, that might help. Again, none of -- no one of these can be sufficient. They'd have to be put together as a group.

Well, I'll just say a couple of more things because I've used up my 15 minutes. But if I could just take another minute or two, I would like to.

Should interim anti-competitive effects be admissible at the second proceeding? Objection, of course, that they shouldn't be because you're re-litigating the case; and that shouldn't be.

But it seems to me that -- and it should be relevant if, with respect to the very calculation that's involved, anti-competitive effects have emerged.

On the other hand, as in the General Motors/Toyota case, if it's shown that restraints are no longer a real

oncern, that should be free to be considered, too.

The burden of proof on the ex ante proceeding should be on the parties to show that the efficiencies have been realized but on the Commission to show if, in fact, there are any anti-competitive effects emanating from the approved collaboration.

A final consideration I would like to suggest to you is that these policies, if viewed favorably, can be adopted incrementally.

First of all, the case -- the FTC can be extremely selective in the cases in which it applies this.

Second, it can adjust its approach to the type of efficiencies. If it thinks plant efficiencies are the most salient, it could admit more of those cases. If they find more of them where it makes a difference, they can utilize the defense less frequently for firm productive economies and firm innovation economies.

However, I think they -- and I guess my final point is, I don't think it would be wise to just limit it to plant economies initially, because it's inevitable that cases are going to come along where large claims are made at the productive and innovation level; and the economies are going to have to be dealt with, of course, not necessarily by this approach. But it would be valuable to start on a very -- on some basis, applying the two-stage ex ante, ex post approach in the productive and innovation level where, I would suggest, the economies to be gained are so much larger.

COMMISSIONER STEIGER: Professor, one question, if I may, although, it's got a couple of parts, your suggestion that -- your regime, if I may, could be applied selectively at the discretion of the agencies is a very interesting one.

How would you counter criticism, should they arise, that this was uneven enforcement and somewhat quixotic, that this option was not extended to all industries?

And the second potential criticism would be uncertainty for industry, that they would have to live through a defined period of time, presumably looking at us over their shoulder, and not knowing the end result, that this could be wasteful, so to speak, of innovation efforts.

They may not be real criticisms, but I suspect we would hear them.

MR. BRODLEY: Well, no, no. I agree, they're real criticism.

Well, as to the first question, that it wouldn't be applied to all industries, I mean, I think it would be applied to all industries; but what you mean, if you only take a few cases, you won't be applying it to everybody. So put it that way.

Well, the cases that you would apply it to would be those where you find the efficiency claims are largest. So you would be applying it to those where the efficiencies are the greatest.

I mean, there's always going to be -- whatever you do, there's going to be judgment in which cases, in a sense, pass the ex ante screen.

In other words, it's how you -- at the ex ante stage, what do you set the ex ante level at? Well, the words would be "substantial" efficiencies. But if you find that, for instance, innovation efficiencies are more problematic to predict, then your substantiality level would justifiably be high at that level.

I think the differentiation might be between types of efficiencies in the sense that you would order the efficiencies. If you found plant level the most solid, then the degree of conviction -- or the degree of evidence that might have to be shown there might not, say, have to be as powerful -- or let's say overwhelming. If you find the production to be less and innovation to be even less in terms of the difficulty of proof, it seems to me, you simply differentiate that based on the parties' ability to prove them.

But I think it would be even handed as to type of efficiency, to summarize that. And your judgment on the type of efficiencies would be your view as to how difficult they are to prove.

I don't think you need to take that approach. I'm suggesting, I think that's an option you could take. You could decide not to qualify your approach to any of them. Indeed, I might do that if I were making the decision. But I'm just suggesting an option would be to order your thoughts that way.

As to the second question, as to the uncertainty, I think that that falls into place when one realizes that this procedure takes no right from any party that they now have. No party need submit itself to this procedure. It can go through the normal type of review where it can present its efficiencies, as it now does; and the Commission will recognize it or not recognize it. It can utilize all those rights.

This represents an option that they don't have, and it's an option that any firm could seek to do. And if it they don't like the conditions that the Commission wants to put on it, that is to say the kind of relief they expect if doesn't go through, they could say: Well, gee, we prefer not to do a two stage; we'll just present this as it is for the normal examination. They won't have lost anything. They will be presenting the same efficiencies in either case. And then they can avoid this uncertainty.

So it's only -- and, finally, it's only as to a transaction that you would have opposed in the absence of an efficiencies defense.

So you give them an option they don't have. And that, it seems to me, places them in a better position, not a worse.

COMMISSIONER STAREK: Thank you, Professor. Thank you for a very detailed explanation of a very interesting approach to measuring and analyzing efficiencies.

I would like to point out that we're fortunate today to have Dr. Roberts from our Bureau of Economics who also has recently expounded, at some length, on very interesting ways to look at and measure innovation efficiencies that result from certain transactions. So I will enjoy the discussion after our break between the two of you.

I would like to, just before -- we need to give our reporter a rest. But I would like to say that I think the one thing we all seem to agree on is that -- and there's not much, but there is one thing -- and that is that in some transactions, efficiencies are produced.

And the problem that we face, and that you have been addressing today is: When are these efficiencies produced? And how are these efficiencies measured? And how are these efficiencies to be analyzed? Are they part of a competitive effects analysis? Or are they a defense to the prima facie case?

So I would like to concentrate on that.

And the other thing I would like to concentrate on this afternoon was a scenario -- or not a scenario, but a description by one of our previous witnesses who is an active practitioner before the enforcement agencies.

And he basically said that it's his experience and a lot of other practitioners' experience that, when they come to the agencies and they begin to talk about efficiencies, the first thing they hear is: Oh, well, those aren't cognizable; and they're really difficult to measure.

And then if they get past that hurdle, the next thing is: Well, those aren't merger-specific. Some of the points that Professor Muris raised.

And then, finally, the agencies will go: Well, yeah, maybe they're merger-specific; but, you know, they're not going to be passed on to consumers.

So I -- and as I said, Professor Muris addressed this; and I'd like all of us, after a 10-minute break, to take up these points.

Thank you.

(Recess.)

COMMISSIONER STAREK: Okay. I think we're ready to reconvene. I think Commissioner Steiger will be rejoining us shortly, but I think we ought to move on.

So let's take up a couple of the points that I raised right at the conclusion of the first part of this session.

Let's say that we have a transaction, maybe a merger, where it looks like it's likely that there's going to be an anti-competitive effect here, that output is going to decrease or there is going to be a 5 percent or more rise in price.

How is it, then -- but the parties are arguing that we have substantial efficiencies.

How are we, how are the enforcement agencies supposed to analyze this? Are we supposed to analyze the efficiencies as part of the competitive effects analysis? Or are we supposed to analyze this as a defense to the prima facie case?

Any takers initially here?

Tim?

MR. MURIS: Well, I understand that in previous panels, there's been some suggestion of looking at it in terms of the competitive effects; but that doesn't seem to be particularly logical at all.

There would seem to be no need to get into justifications unless you think you've got a problem in the first place; and, so, therefore, you ought to look to see if you've got a problem. If you've got a problem, then you look to see if there's something on the other side.

I mean, it seems to me to be as simple as that.

MR. ROBERTS: I guess I'm a little surprised, just to follow up on that, in that one view that you hear expressed -- and I'd like your comments on it -- is that a problem with doing efficiency analysis only in the second stage, only after you have decided that there are significant potential anti-competitive effects, is that it imbalances the analysis in that -- for instance, I think Kevin Arquit, among others, has suggested that, perhaps, we ought to look at efficiencies more in the initial evaluation of a merger in trying to determine whether it's primarily efficiencies versus market power implication that is driving the transaction, in the first place.

Do you feel that that's a viable alternative and that that has --

MR. MURIS: Well, look, if what you're talking about is what happens at the staff levels, theoretically, big underline, theoretically, the staff is supposed to present the Commission with -- you know, having been here, I know this doesn't always work that way in practice -- you know, with as unbiased a view as possible of as many issues as possible.

And now that, given that people are people, is not -- you know, doesn't work 100 percent well. But I think, for the most part, when I was here, the staff at least tried.

And in that context, I think the staff ought to -- if it thinks it's a -- you know, if it thinks it's a close case ought to try to take a look at efficiencies.

But even at the initial level, it seems to me the staff is going to make some cut. And the first cut is going to be, at least in its mind, on some idea of anti-competitive effects, isn't it?

And if they don't think there are anti-competitive effects, isn't it going to be over.

MS. DeSANTI: I guess, I thought that Commissioner Starek was asking a really important, more fundamental question. And I might think about it in the context of two possible scenarios. And let me lay them out, and one I'm going to crib from Terry Calvani, which is his short example in his testimony of imaging that you have a market where there are three or four firms but you've really got one predominant producer with 70 percent of the market who's setting the price and the others are price takers.

If Number 3 and 4 get together, is there any anti-competitive effect that comes about through that, is one of the questions raised in his testimony?

And should we think about it, then, in a sense, do you need to get to cost reductions and efficiencies in order to answer that question? So that's one example that I would like to have people speak to in terms of whether they think that efficiencies are relevant in that context.

The second is a case in which you have an anti-competitive effect; but under some assumptions, which Kevin O'Connor may not agree with, having to do with the Williamson model, if there are going to be large cost reductions, then there is, in certain circumstances, a substantial likelihood that those cost reductions will be passed on to consumers.

And in that case, should we be looking at the transaction in terms of efficiencies? Or should we be trying to assess more, in some sense, when the competitive effects model doesn't apply as we have thought about it in terms of coordinated interaction or unilateral effects?

COMMISSIONER STAREK: Kevin, speak up.

MR. O'CONNOR: Let me respond to that first with a general comment. And I think the thing that drives both the NAAG guidelines and the federal guidelines is a question of who has the information about efficiencies.

And when you first hear about a proposed merger and you read the Wall Street Journal or the paper, I mean, everyone has an intuitive sense of what markets may be involved, what products may be involved, and so forth. You may not have the detailed information yet, but everyone has it.

You don't know about efficiencies simply because that information is internal to the firm. It's also often regarded, essentially, as our experience has been, as a trade secret and kept close to the vest. And so consequently, that is not something you're going to learn at the outset or even have an intuitive understanding of when the merger is first announced.

Now, having said that, that doesn't answer the issue; but that simply poses the problem, that is, that you don't have that information up front oftentimes; and so you're starting off, in your analysis, looking at the things that you can measure, that is the market definition, the potential competitive effects that aren't related to efficiencies and so forth.

You may eventually get some information concerning efficiencies. But presumably -- and that's one of the reasons why the NAAG guidelines call upon the merging parties to produce the information regarding efficiencies and puts the burden on them, at least at the stage where discretion is being exercised by the agency.

Now -- and I believe that that -- if you look at the federal guidelines as well, efficiencies are sort of off to the back of the guidelines in Section 4, I believe is; and I think there's a reason for that. I think it's implicit that that information is going to be difficult to obtain.

Now, let me respond to your hypothetical about the 70 percent with the two small rivals merging.

I think it would be appropriate, in those cases, if the parties can produce some evidence that shows that the two merging firms, the small firms, are going to be able to lower their prices and become more competitive with the dominant firm and somehow become more of a thorn in the dominant firm's side, you know, obviously, it's going to be a very fact-specific test, however.

And I think it would be appropriate to put the burden on them to show that they can come in with a lower price. I mean, I wouldn't rule out efficiencies at the competitive effects stage of the analysis. But I think it would have to be fairly compelling evidence that it is, in fact, going to induce more competitive rivalry among the remaining firms.

MR. CALVANI: I don't think that's Ms. DeSanti's hypothetical. As I understood the hypothetical, as re-posed, it was that there's no assumption that the two smaller inefficient firms that merge ultimately produce a reduction in prices.

MS. DeSANTI: Let me just attempt to clarify. This is the problem with trying to restate someone's testimony, and I'll let you restate it any way that's accurate to what your original hypothetical was, Terry.

I think it's my perception that your testimony was that you could say that, you know, regardless of whether firms could come in, as Kevin suggests, and have some stories about how they would be able to reduce price and become more effective competitors that there would be no reduction in competition because there isn't a very competitive market to begin with.

MR. CALVANI: Well, that brings me to answer the question that I thought you asked. And -- let me make two points, if I might.

I think there are two different kinds of questions on the table. The question that Commissioner Starek asked at the very beginning might present a situation where we're talking about apples and oranges.

I find myself in agreement both with Professor Muris and Mr. Arquit and agreeing with Mr. Muris -- Professor Muris on the way that ones goes about making the legal analysis. That is, a prima facie case before you get to the defense.

On the other hand, I think what Mr. Arquit was suggesting is that, as a practical matter, the way that the staff -- and for that matter -- private parties ought to analyze mergers when they're first presented to them is to say: Why do the parties want to merge? And that that may be a useful technique of beginning one's analysis.

I know that -- since coming to private practice, that's very often the very question I ask my clients, even though I fully recognize that, in terms of steps one takes doing a legal analysis for a brief, that would probably not be the first question that one would present.

With reference to your question as to whether there is a diminution in competition or an efficiencies defense in the first hypothetical, I'm not sure that it frankly matters a whole lot the way one approaches it.

In my own view, Section 7 talks about a reduction in competition. And if there is no competition to reduce, I don't know how you can be faithful to the statute and claim a prima facie violation of Section 7.

So I would not find there to be a problem in the first instance.

Nonetheless, the last time the Commission -- the last time of which I am aware that the Commission addressed that it reached a different conclusion. And if that were the way that one chose to proceed, then at least in that event I would say that the efficiencies defense ought justify that transaction.

One last word, and I will be quiet.

I find myself a bit like Alice waking up in Wonderland this afternoon because curiously, I find myself in substantial agreement with Kevin O'Connor's characterization of Merger Guidelines. The way that he believes that Merger Guidelines read today and the way I would like them to read are strikingly similar.

And so I'm willing to confess error this afternoon and say that he's right and to cite these hearings in the future for that proposition.

At the same time, I find myself curiously disagreeing with Professor Muris on the relevance of the redistributive consequences of antitrust. I fully agree that the Williamson trade-off is one that's more interesting in the academy than it's ever been in this room or in private practice.

However, it becomes important because so many people embrace redistributive policies as a rationale for posing efficiencies. We've seen that here this afternoon. And I think that makes the redistributive goals important if for that reason and no other.

MR. BRODLEY: Could I reply to your question, Mr. Commissioner?

COMMISSIONER STAREK: Please.

MR. BRODLEY: I think it's helpful to contrast the Sherman Act and the Clayton Act.

In the Sherman Act, it's clear that the efficiencies analysis is a part of liability and the two go together, and sometimes it's more feasible even to start with efficiencies if that issue is simpler than the anti-competitive effects.

But anyway, they are blended into a single judgment. But that's because -- that works, I think, because you're dealing with real effects. But in the case of the Clayton Act, you're dealing with incipient anti-competitive risk; and it's been pointed out, there isn't any necessary effect at all, simply a feared future effect.

Then it would, I think, hopelessly complicate the analysis if, at the same time, you apply into that beginning analysis whether the feedback of efficiency. It's much better to see if there is first such a probable future effect, based usually mostly on structural factors. And then say, yes, but is it overcome by the efficiency potential in the transaction? And separating, it seems to me, helps to make that clearer.

As to the hypothetical of moving from four to three firms, no effect on competition or efficiencies, I'm not so sure that that is innocuous. It's true that the small firms are small, but you'd move the centers of decisionmaking from four to three. You've made a -- in game terms, you've made it a much simpler game for the parties to coordinate activities.

So if there are no benefits, you know, I'd want to look at that pretty closely before saying it doesn't present a problem.

MR. MURIS: If I could say one thing, I agree with Commissioner Calvani's reformulation of the legal issues versus the, you know, sort of sitting around and trying the -- and the strategic issues. That's a good way to put it.

And part of what happens is, in the face of uncertainty -- well, let me back up. As a logical matter, anti-competitive effects, in terms of looking at unilateral or possible collusion or whatever, that is a separate issue, from an efficiency defense; but obviously, in a world of uncertainty, if you have a good story about why the parties merge, I think that, inevitably you know, given uncertainty about the competitive effects, that inevitably may weigh on your mind.

So I mean, I think in an investigative stage, if that's what Kevin Arquit was talking, that makes -- you know, that makes some sense. Since I didn't hear him, I'm not sure what he was talking about.

MR. O'CONNOR: I would like to comment on that point as well.

COMMISSIONER STAREK: Sure.

MR. O'CONNOR: I guess when you look at the reasons for merger, that's something that can be manipulated to some extent and at least the stated reasons for the merger. And I guess I'd be somewhat cautious about that simply because -- for the same reasons that Posner's cautious about attributing motive to predatory pricing.

I mean, it's very difficult to subscribe a motive, where you look at intent in these kinds of transactions. I think to the extent that there's documentary evidence of the rationale for the transaction that is objective and pre-exists the actual decision to merge, I think that may be somewhat probative of the reality.

But again, intent evidence is sometimes a slippery slope. And I think that that's where this suggests we ought to be going.

COMMISSIONER STAREK: Thank you.

COMMISSIONER STEIGER: Kevin, first of all, thank you for being here. You have been a great supporter of the Chairman's effort here from day one, including helping at the steering committee to frame these various questions.

MR. O'CONNOR: Thank you.

COMMISSIONER STEIGER: Let me suggest that you pose a rather stark contrast in the treatment of efficiencies. To paraphrase, although not completely clear, federal policy appears to suggest that efficiencies are considered in all cases -- I'm making this very stark -- as compared to NAAG merger guides, which indicate that efficiencies will only be considered where clear and convincing evidence exists, that a showing of significant efficiencies can't be merely predicted; therefore, would constitute a defense.

Let's look at efficiencies a different way. For merger enforcement, in general, if the contrasts are as stark as I am suggesting the interpretation of efficiencies, what is the impact on antitrust enforcement nationwide here?

MR. O'CONNOR: I'm sorry. I'm not sure I understand the last part of your question.

COMMISSIONER STEIGER: First of all, would you agree that you have drawn a rather stark contrast between NAAG treatment of efficiencies and your perception of the federal agencies' treatment?

And, if so, what does this say for antitrust enforcement in general on a nationwide basis?

MR. O'CONNOR: Okay. Actually, I don't believe that the difference is all that stark. I think that --

COMMISSIONER STEIGER: I was pushing you to answer that.

MR. O'CONNOR: Okay. First of all, the clear and convincing language was drawn, originally, in our original draft -- in our original guidelines passed and adopted in the mid '80s from the DOJ guidelines of 1982.

And there are commentators, including Richard Schmalensee and others who think that it was a mistake for the federal government to abandon that language and the burden language. And because -- for the reasons I said in my opening remarks -- that it's the merging parties who have the information on efficiencies. And typically, courts assign burdens based on that kind of a factor.

Okay. So that's number one. I don't believe our position is all that stark.

And if I might, I would like to, you know, contrast our position with that of Professor -- from what I understood Professor Brodley to be suggesting earlier, that he, at least with regard to production efficiencies, would not, in a sense, permit -- or not consider an argument for efficiencies where the HHI was 1800 or the single firm ratio was 35 percent.

I know those numbers are -- I mean, he's not -- I don't want to bind him to those numbers or to anything of that sort.

But what we're talking about in our guidelines are mergers in excess of those, that where we did leave the door open to an efficiency showing, we did leave the door open a bit. We did express skepticism, however, that given the theoretical work that's been done on oligopolies and so forth, that a showing by clear and convincing evidence of efficiencies in excess of the likely anti-competitive effect would be possible, that that's going to be difficult to do; and our guidelines express that.

Now, having said all that, I don't think that's a fairly -- an extreme policy at all or even -- I think what our guidelines do is send a clear signal about how we're going to treat efficiencies.

Last point, if you look at cases like the Morton Hospital case that I cited in my testimony and other cases where the states have worked with the federal agencies on merger enforcement, I think the actual practice of the federal government agencies and the states has been very close, notwithstanding the language differences in the guidelines.

And I think that the results -- I think that there is a general reluctance to consider the first story that's offered when the parties come in and say this transaction ought to be approved because, in the case of two hospitals in Wisconsin, they're going to merge their laundry facilities. I mean, we tend to view that kind of story with skepticism.

Now, that does not mean that our guidelines rule out the possibility that parties will come and be able to show substantial cost savings, especially in a declining market like in north central Pennsylvania or in many health care markets where the demand is simply going down, that they will not be able to make a showing that this merger would be in the public interest, in effect, if it was permitted to go through.

So I don't think our guidelines are all that starkly different from the federal guidelines in practice.

MR. BRODLEY: If I can just reply to one thing?

COMMISSIONER STAREK: Sure.

MR. BRODLEY: Just for the record, I would not apply that criteria of 1800 HHI and 35 percent to a joint venture. I think it should be higher for a joint venture.

And I would not apply it to an innovation merger where it might very well be higher.

COMMISSIONER STAREK: Tim?

MR. MURIS: I want to make one practical point based on my experience.

I think there's a fear -- usually more implicit than explicit, but occasionally made explicit -- that if we really allowed an efficiencies defense that didn't throw all these obstacles at it, we would be deluged with efficiencies. "We" being the government.

Well, my -- you know, I was Bureau Director for almost three years. I had written an article, which at the time, was the most far out, if you want to put it that way, support of an efficiency defense. And maybe this is a comment on the sloth of the bar, but very few people came in making efficiency pitches to me. Very few.

COMMISSIONER STAREK: That's our experience on it as well.

MR. MURIS: Yeah. And I'm saying when it was well known -- or should have been -- that I was enthusiastic about efficiencies defenses or willing to look at them, there were very few.

And we had roughly 10 mergers a year that were challenged or abandoned; and I can only think of two in almost three years that would have been challenged otherwise that were not challenged because of an efficiency defense. And there was a third that there was some argument about.

So I think that fear is there, and I think it's not justified. I mean, I don't think that there will be reams of documents or specious claims.

I mean, to the extent that people come in, which they frequently do, and they say there's some kind of efficiency, if they can't back it up, then they lose, I mean, on that issue. It's pretty straight forward.

MR. O'CONNOR: Can I ask a question?

So, I mean, you would agree that the burden ought to be on the merging parties?

MR. MURIS: Well, the burden, if you go back to Wigmore and the great evidentiary treatises, the burden -- the burden --there are two burdens. There is the burden of producing evidence and the burden of persuasion.

Clearly the burden of producing evidence ought to be on the parties that have the evidence, and that's the merging parties.

I don't object to the idea of, in the legal setting, the issue we were talking about before, that the burden of persuasion ought to be on the -- you know, ought to be on the party making the defense. I would not, in terms of these subsidiary issues, like, pass on and all of that, I wouldn't add those additional burdens to the merging parties.

MR. BRODLEY: Could I ask a question as well?

I'm wondering if the lack of efficiency claims is due to perceptions that they wouldn't be received hospitably?

I can think of, for instance, statements that, for instance, Tom Kauper has made about the efficiency claims and others. I believe that Baxter has made some statements which were not very hospitable.

So despite your own writings, you know, it's work, it's time to do one of these things. And if you don't think it's going to work, wouldn't that be --

MR. MURIS: Well, I agree that -- that would have been true -- Bill Baxter was at the Antitrust Division for part of the time when I was here. Maybe that was true of the Antitrust Division.

But, you know, if you had a merger at the FTC for those two and a half, three years, I was receptive. I mean, everything I said before and during the time indicated I was going to be receptive. So I don't think there was any reason to believe there was an inhospitable atmosphere. And, yet, we just were not deluged.

And, again, maybe it's a comment on what you're saying, that -- you know, that they're hard to do. But I think, you know, it's a non-trivial number of merger cases that would be influenced. But I don't think it would radically alter merger law.

MR. O'CONNOR: Well, could that be because most mergers aren't challenged because --

MR. MURIS: No. I'm talking about the ones that --

MR. O'CONNOR: -- the ones above the 1800 --

MR. MURIS: -- of the -- yeah, of the 10 or so a year, where we said we'd challenge. And I can't remember how many second requests we're dealing with. 30. 25. 40. I just can't remember the number.

But we're talking about a very small number of people who came in with efficiency defenses. And I only can remember -- there were a lot more people that came in with efficiencies defense than two. But I'm saying in only two cases was the efficiencies defense decisive. One of them, I think, being GM/Toyota.

MR. O'CONNOR: Perhaps they concluded they couldn't make the showing.

MR. MURIS: Well, sure. No, I'm saying that's -- I'm saying that's possible. Sure.

But I'm saying the fear which exists among -- I heard it expressed many times by people at the agencies, that they're just going to be deluged with this evidence that's going to be hard to sort through.

I mean, my experience, it just did not -- it was not borne out.

COMMISSIONER STEIGER: You mentioned GM/Toyota, which all of us had the enjoyable task of reviewing, as a matter of fact, in lifting all provisions of the consent order somewhat ahead of the end of the consent order.

In mentioning it, you cited areas of efficiency that, I take it, Tim, you believe are not taken account of frequently enough of, one being managerial skill or abilities and the other, promotional efficiencies.

And I wondered if you could expand on that a little bit and why you think it is that those particular types of efficiencies are ignored by the agencies?

MS. VALENTINE: Actually, could we maybe expand that question? You know, I think it was one of the ones that we left off with at the end of this session of what types of efficiencies should we care about?

And Terry Calvani, I think, said he felt as if he had woken up in Wonderland because he may be disagreeing with you in terms of what efficiencies one should recognize.

And I would be interested in hearing from each of the four participants whether there are production and innovation efficiencies that we should value more or recognize more, whether anything that would cause price to go down, including tax savings should be recognized, how you would deal with that.

MR. MURIS: Well, I would accept -- I mean, I don't think my views have changed significantly since the article I've written. But to summarize, I would accept the pecuniary, non-pecuniary distinction.

And on the question of management, one of the reasons I'm troubled by trying to say we won't recognize managerial efficiencies is, it causes the government to do what it did in ADM, which is take a set of efficiencies that could be characterized in several ways and dismiss them as managerial efficiencies.

What happened there is, whatever ADM had led to a lower per unit cost. Now, you could try to put that in a bag of saying it was productive; you could try to put that in a bag -- of a box of saying it was management; and the government tried one, and the defendants tried the other.

In GM/Toyota, the Japanese, for a whole variety of reasons had tremendous cost advantages. Part of it was the management techniques that they developed. But those management techniques came down to, in many cases, specific things, specific differences in work rules, the so-called -- you know, their inventory practices.

I would rather look at people saying -- firms coming in and saying: We think we can lower costs, and here's why. And it's obviously the most credible when they can show, you know, something else, their own plants, and not get into the debate of trying to call it managerial or something else.

That's what I'm talking about.

In fact, there are lots of situations. I do a lot of consumer goods industry is what I've probably done the most of over the years. I've written about a variety of industries and studied them both academically and as a consultant. And in a lot of those industries, for whatever reasons, some firms are better than others.

You know, for a long time organization -- you know, the Dallas Cowboys organization has been very good for a long time. Harvard Law School has been good for a long time. I mean, there are certain organizations, for reasons that are very hard to characterize, seem to have advantages over other organizations for a long period of time.

And what we call that -- I'm less interested in what we call that than in being able to show that those advantages exist and they can be transferred in some way.

COMMISSIONER STAREK: Others?

MR. BRODLEY: I'll start.

I would recognize scale economies, transactional economies, informational economies, innovation economies. I would not recognize pecuniary economies. And I'm inclined not to recognize capital-raising economies.

I've been persuaded there by the findings of Scherer and Ross that capital markets sometimes discriminate against small firms for reasons that don't reflect on lower costs of dealing with such firms. So I would be less inclined to recognize that.

That also might meld over into actual pecuniary economy and the ability of a large firm to simply use its buying power.

So -- as to promotional, I didn't actually put anything in the paper on that because I'm not sure I have a definite answer.

I think what I'd say on promotional is that, I wouldn't rule it out; but I'd want the agency to look at the nature of the economy. And perhaps it might be there, but it might not produce the social gains, say, as compared with an innovation economy, which tends to compound, through industries and through the economy generally.

COMMISSIONER STEIGER: Professor, may I interrupt and ask you how you would define "promotional"? Are you referring only to marketing? Or would you add product distribution, product service? How narrowly would you be --

MR. BRODLEY: I was thinking in terms of promotion and advertising.

When you get to things like distribution, it seems to me that is an economy of -- is a production economy. So there would be no problem there.

The question is whether things which are purely, say -- advertising promotional, whether they should be treated on a parity with others.

I guess, as I talk out loud, I wouldn't disregard them. But whether they should be treated -- I guess the standard would be how much -- what's their net effect on social wealth? And some economies have a bigger effect than others. And I think that that ought to be recognized.

I guess I agree with -- I think, with Tim Muris on the -- for instance, the managerial. I mean, GM doesn't -- the label isn't too significant.

I saw GM/Toyota's economies as innovational primarily, in the sense that it was innovational to be able to take Japanese productive methods and make them work here with our workers and -- who had never -- you know, in a -- and with a union operating and so forth. That was a true innovation.

Of course, the claim was, you know, in the case, was beyond that, which is that this innovation would actually capture the other -- and be effective in the other GM plants as well. And that, of course, is something that one could test on ex post basis.

MR. CALVANI: I think the discussion this afternoon where we have characterized the efficiencies that would flow from a General Motors/Toyota joint venture, in various and sundry ways, goes a long way toward demonstrating the poverty of this kind of debate. You can characterize efficiencies in lots of different ways.

Most of the commentary, at least prior to these hearings, on segregating the various efficiencies has had to do with the difficulty of demonstrating them to the satisfaction of any reviewing party. And I think that's a perfectly appropriate point to make.

But that only says that some are harder to prove than others; and, where it's hard to prove, the person that's going to have to prove it has a tougher task. And I'm comfortable with that.

I guess at the bottom line, in this area, I don't find myself in disagreement with Professor Muris. Where I disagreed with Professor Muris earlier was on his reluctance to want to talk about the redistributive consequences.

MR. O'CONNOR: I find myself almost agreeing with everybody.

MR. CALVANI: Then obviously I'm on the wrong side.

MR. O'CONNOR: Yeah, right. Oh, come on now. Come on.

No, I think it comes down -- I particularly agree with Terry on his characterization of the problem as being one essentially of proof. And when you're looking at the hard core efficiencies of economies of scale, integration, product facilities, transportation economies, that sort of thing, you generally have some hard numbers to look at. You can actually put your finger on it.

I think the federal guidelines got it just about right with the other types of efficiencies; and I'll quote right here from Section 4: "The agency may also consider claimed efficiencies developing from reductions in general selling, administrative, and overhead expenses or that otherwise do not relate to specific manufacturing, servicing, or distribution operations of the merging firms, although, as a practical matter, these types of efficiencies may be difficult to demonstrate.

I think going in the direction of what it is they can prove is an important one. But I would tend to leave the door open for -- if you're talking about the case with the HHI in the stratosphere and you're looking at the efficiencies as tie breaker, I think you tend -- why not open the door to a full-blown discussion of all the potential efficiencies and evaluate them no matter what -- you know, whatever box they might happen to fit in.

Although I think there are some, such as pecuniary and other types of efficiencies, that probably would not be given great weight by anyone who is looking at it objectively.

MR. ROBERTS: If I might, there's a little bit of tension in the descriptions here -- or that I sense or feel in that, on the one hand, for instance, Professor Muris argues or claims that during a time, for instance, when there was a general perception that the agency or that the FTC might be more hospitable to efficiency claims, it had very little impact on the number of efficiency claims and the types of efficiency claims made.

At the same time, there's a lot of pleading that we've heard from people that we ought to consider different kinds of efficiency claims or be clearer about identifying the types of efficiency claims that we will consider and how we we'll consider them.

The question I have for the speakers -- and I'll address it to Professor Muris, although I hope that you'll all answer it -- and that is whether or not you think that it would be useful for us to develop more -- as I think you suggested earlier, some kind of more specific guidelines in terms of how we are going to do efficiency analysis and what exactly we are going to consider and whether or not you think that currently, what some perceive as a failure to have done so has influenced the nature and type of efficiency claims that are made for it.

MR. MURIS: Well, I mean as an academic, I have never accepted the view, which a lot of attorneys who have been at the FTC have had, which is: We don't want to tie our hands. You know, we want to be able to have discretion. And, therefore, we don't want to -- you know, the less we tell people the better about how we make decisions.

I mean, as an academic, I've always thought the opposite: The more we tell people about how we make decisions, the better.

And if that means -- and I think in this case it does -- trying to clarify some of these questions about efficiencies, I think that would be ultimately good. And, obviously, you have a limited number of staff resources and you can't try to clarify everything.

But I think this question is important enough, it comes up in enough areas -- hospital mergers probably being the most prominent one right now -- that the Commission ought to go ahead and take a stab at addressing the issues.

I don't think it will have -- I mean, at the margin, as economists like to say, I think it will have a difference. But we're not talking about, you know, a major difference. You know, if it's a couple of cases a year or something where you really have to delve into this -- I don't think that's a sea change.

COMMISSIONER STAREK: Other responses to Dr. Roberts's question?

MR. CALVANI: I think it's a good idea.

On the other hand, I think the changes that you have made in prior approval and not filing administrative actions as a regular matter of course, dwarfs -- immensely dwarfs this issue in terms of its overall importance.

COMMISSIONER STEIGER: Can I respond?

COMMISSIONER STAREK: Sure.

COMMISSIONER STEIGER: I think all of us who have worked through this period of time very much appreciate, Terry, your favorable comments on our attempts at internal efficiency, if you will, in the areas of sunset, Part III, and prior approval. They were extremely well researched and studied issues, and a great amount of resources were devoted to them.

Would you care to add any further suggestions, while we're on this subject of efficiency? You were one of our most distinguished alums here as a Commissioner.

What else is it that we should do to internally become more efficient in the process?

MR. CALVANI: Well, thank you for the invitation. I will respond in writing after I have had a chance to --

COMMISSIONER STEIGER: I knew I could depend on that.

MR. CALVANI: -- to collect my thoughts on that subject.

I really do think the changes in sunsetting -- but more important the changes in prior approval and the changes in the administrative process are, in my mind, the most significant developments in merger law practice in 15 years, bar none.

It is -- as someone returning to private practice, it was incredibly important to me to -- ceteris paribus, which is never the case, but assuming all other things being equal, to secure review by the Antitrust Division. The asymmetry in the costs of review between the two agencies was such that you just simply could not afford to litigate against the Commission. Because the day that you darkened the door of the federal courthouse, you confronted an administrative action. And the only way of getting rid of an administrative action was to sign a prior approval provision.

And as much as we said, representing private parties, that we would litigate until hell froze over and see you on the steps of the United States Supreme Court, nobody believed that because it wasn't true. Very few companies had the stomach or, perhaps better, the resources to endure six, eight years of administrative litigation.

So the changes that the Commission has made in this area are exceedingly important, and I would just simply urge that you give more thought to these same subjects.

It remains to be seen, frankly, exactly how those two will shake down. The announcements, as I read them from the agency, do not indicate that the agency will not file administrative actions. It simply says that we won't always file administrative actions, or routinely file administrative actions in a certain setting; and we won't always insist on prior approval provisions. And it will be interesting to see how all that shakes down.

I also think it's not a bad idea to revisit the issue periodically of how long orders ought to remain before they do sunset.

I'd just simply commend to you on what it is that you have done to date. I think they are very important, and they are the most important changes in the agency in a very long time to render at least Section 7 enforcement more efficient.

MR. O'CONNOR: I would like to go back to Mr. Roberts' question about how much detail you want to put in policy statements about what efficiencies to consider, if I could?

COMMISSIONER STAREK: Sure.

MR. O'CONNOR: I am of the belief that a good prosecutor, for lack of a better word, or a government enforcer, ought to consider all the factors that go into a particular transaction.

And, again, remembering that we are only talking about here, apparently, the transactions that are going to cause anti-competitive concerns. And that -- the question then becomes: Should, as a policy matter, we make a laundry list of every conceivable efficiency that we might consider?

My concern with that approach is informed not just by merger enforcement but by general practice as a government attorney doing criminal cases, the securities fraud area, and other areas is that, when you put that kind of statement out there, that you're going to consider all these factors, judges have a way of reading those standards and saying, but Mr. O'Connor, you didn't talk about these six factors when you were doing this case; you don't point out this; you didn't do that.

As you know, the federal government has had its problems with its Merger Guidelines in cases such as Baker Hughes where the Guidelines are cited back as part of the rationale for the decision in those cases.

And so I would --

COMMISSIONER STAREK: That's why they were changed.

MR. O'CONNOR: Pardon?

COMMISSIONER STAREK: That's why they were changed.

MR. O'CONNOR: Yeah.

I guess -- so, where I'm going with this is, as long -- I don't have a problem with guidelines if there is a laundry list of that sort as long as burdens are assigned.

And see, I guess as long as it's clear in the guidelines themselves that the burden in this area, where the information is in the possession of the merging parties, is on the merging parties to bring in the evidence showing that there's actual efficiencies there.

Then, I guess I'm less concerned about it than a documents that simply says: These are the factors we're going to consider. But we're not going to talk about burdens.

MR. BRODLEY: Could I speak to the question, too?

COMMISSIONER STAREK: Sure.

MR. BRODLEY: I think it would be desirable, at some stage, to have guidelines as to efficiencies. But the question, I suppose, is when you feel that you have the experience to make those meaningful and buttressed by the consideration that Kevin gave as well?

In other words, it may be that those are better done after you've had some experience in evaluating them, particularly if you adopt a new procedure for evaluating efficiencies so that you get more of these cases and that perhaps informal advice could be given; but in terms of getting it into guidelines, it might -- you know, I'd just raise the question: Would it be better to wait until there's more experience?

COMMISSIONER STEIGER: Professor, thank you for that observation. Those of us who struggled hard in two sets of health care enforcement policy efforts came to the conclusion that the only areas in which we could offer a safety zone statement were those in which we had experience sufficient to give us a very high degree of confidence that, absent some extraordinary circumstance, an anti-competitive effect was not likely.

We were all careful to say this does not mean that conduct outside of the safety zone is suspect, simply that we do not know enough to guarantee for ourselves that it will not result in an anti-competitive effect.

COMMISSIONER STAREK: Comments?

MR. MURIS: Well, one thing that troubles me with merger law in the last 10, 15 years, it's become an increasingly highly specialized form of regulatory law, dominated -- well, "dominated" is too strong -- but where a few law firms have a -- do a large bulk of the second requests and have an advantage -- and I think it's incumbent upon the Commission to try to release -- and the Justice Department -- and they've done a lot of this; and I think they ought to be commended for that -- to try to release as much information as possible about what it is that they're doing.

One of the things that wasn't done by the government that came out of government data is the paper that Fred McChesney and a few other people did a few years ago where it was controversial here; but they took Commission challenges for a four or five year period of time and looked at, to what extent the guideline factors influenced various cases and did some statistical work on it.

You don't have to go that far. But, I mean, I don't think it would hurt at all for the Commission -- and there has been more of an effort to do this in the Division -- to talk about its experience, without violating confidentiality, with its merger investigations.

And the more steps that can be taken in that direction, the better. And, obviously, a statement about how they apply efficiencies, I think, would be very helpful.

COMMISSIONER STAREK: Thank you.

In addition to Dr. Roberts from our staff, we also have with us today Laura Wilkinson, who is the Deputy Director of one of our merger shops here in the Bureau of Competition. And since she was trained in this Commission by Steve Newborn, among others, I'm sure she's not shy and probably has a line of excellent questions.

Laura?

MS. WILKINSON: I just have one question, and it is from my practical perspective.

I've enjoyed the policy discussion that we've had today; but practically, how can we actually implement these policies?

And I would like to hear from the panelists, is it realistic that companies will be able to provide evidence of these efficiencies that will allow us to evaluate the efficiency arguments that they offer?

I have heard Professor Brodley talk about, perhaps, industry studies and things like that; but they don't seem to be merger-specific. And, in fact, in many industries, there are no such studies.

So, what kinds of evidence would you suggest that companies bring in? And would they be able to actually bring in evidence?

MR. BRODLEY: Well, I gave a list of evidence that I thought would be appropriate; but that doesn't mean that, if they don't bring their evidence in, their claims can't be considered. So they bring in the best evidence that's available.

But say at the ex ante stage, they certainly have made some studies of the efficiency properties of the transaction, if that's their main claim.

So they could, to begin with, bring in -- and those studies ought to have been made before they anticipated litigation. In other words, those should have been in the planning stage. So I think they could bring that kind of study in.

They can also undertake a study that's firm-specific, which -- such as a -- particularly at the plants level, such as an engineering study or a statistical cost study.

The survivor test studies are ones that -- where the data should be available in terms of the growth of the firm relative to other firms in the industry.

So, it's true, your point is well taken. If you're talking about inter-industry studies, they can't make a -- can't be expected to make an inter-industry study. But they may exist. For instance, past experience in similar mergers may exist.

So they should -- when they bring -- I'm talking about those things. They bring in the data which is already available. Not -- they don't have to -- they're not expected to create new data outside the firm itself.

And so I think -- I mean, I wanted to be comprehensive and suggest all the kinds, because it's -- they won't have these things in all cases; but they'll be available sometimes, in some cases, and some of them will be available. And I think the totality could tell a good -- make a good representation and picture.

COMMISSIONER STAREK: Other thoughts?

MR. O'CONNOR: I would agree with Professor Brodley on that.

MR. CALVANI: I think the question is a very hard question. And the best I could do for an answer is: It depends.

I recall when I was here at the agency, some -- very few, but some cases where the efficiencies were really patent on the face of engineering plans. It could be laid on top of one another.

I remember one case where it was dramatic and everybody stood back and said: Gee, this is very interesting. Let's look at it more.

I remember countless other cases where people said: Well, it's smoke and mirrors, and we went on to the next thing.

So I -- it's not always a tough job. Sometimes it's easier; sometimes it's more difficult. And I think the question maybe is too hard to answer other than just to say it's going to depend on the circumstances of each case.

COMMISSION STEIGER: May I go back to Professor Muris on that regard?

I think you mentioned that in your time here at the Commission as Bureau Director, I think you said there were two, maybe three, transactions that turned on efficiencies or in which they were a critical element.

Can you tell us what particular efficiencies were the most striking? Was there a market basket of them that appeared in the two or three? Or did they vary all over the lot? From your experience.

MR. MURIS: Well, it -- partly there's this problem of trying to characterize efficiencies in various boxes.

But in the cases that I'm talking about -- and throw in ADM as another example that I have studied; and the case was going on at the Justice Department at the time -- people were able to show, I think with high conviction, that they had low per unit costs and that they could translate, by taking over these other plants, they could translate those efficiencies, whatever their source, and have lower per unit costs.

I think a tougher kind of efficiency but which I've seen in a few cases is where somebody, for whatever reason, has, you know, a group of people that are better at growing a market, a so-called niche market; I mean, they figured out a way to prosper in the niche and have various ideas; and they're trying to merge with somebody else who's old and staid and has not been so innovative. That's a more difficult and qualitative kind of assessment to make.

Again, I mean, there are lots of issues that are hard. This doesn't strike me, quite frankly, as any harder than product market definition, maybe because I spent a lot on time on both. You know, they both can be difficult, and they both can be relatively easy. But I mean, you've got to -- you've got to, obviously, make the call. And there's no magic, but I think smart people working at it can form a reasoned judgment. Sometimes reasonable people will disagree; but, you know, they can form judgments.

And instead of doing that, I think we spent too much time saying -- you know, worrying about what would happen if we actually spent time looking at efficiencies.

MS. DeSANTI: Let me see if I can probe farther because I think that Laura's question merits more of a response than she's gotten so far.

It's all very well for you, Commissioner Calvani, now outside the agency to say: Well, it's hard sometimes, sometimes it's easy.

But it seems to me if we're going to be responding to people coming in and saying: You really need to take efficiencies more into account and you've been automatically, agency, taking too skeptical a view of these because you're so concerned about the proof.

And then we ask: Well, what should we look to for proof; and you say: Well, sometimes it's hard, sometimes it's easy.

What kinds of documents, in your experience -- and you've had experience in this kind of area, for most people on this panel, both as government enforcers and in private practice -- in your experience, what kinds of business documents should the agencies be expecting companies to come in and show us in order to validate efficiency claims?

MR. MURIS: Well, I guess -- and I don't know the right way to phrase this; but if you deal with business documents -- and everybody here has dealt with business documents a lot -- I mean, accounting is -- take the relatively easy case, the case I was talking where we were talking about per unit costs. There's something that businessmen worry about. They worry about -- other than in the context of the merger -- I agree with Professor Brodley that, obviously, documents that are prepared in a normal business context are a lot more reliable.

The kind of rules that you apply to product market definition documents, one of which I just mentioned, are the kind of rules you would apply to efficiencies. I mean I don't think it's substantially different.

There are times in a product market definition where somebody is claiming, you know, something that seems far-fetched, competes and should be in the market, where you require -- you know, you require more evidence because it seems intuitively implausible to you.

And I think that's the same with costs. I've seen lots of industries -- I ticked off some; the beer industry is another one -- where the Justice Department in the '70s stopped -- changed its enforcement procedure because it became convinced that there were substantial economies in that industry; and it was stopping a trend that was inevitable.

Again, that's a relatively easy case, I suppose, because you are dealing with per unit costs and something that's relatively quantifiable. But I don't see any reason why because there are relative easy and relatively hard cases; it's different than market definition.

MS. DeSANTI: Let me press you a little bit more and just ask you about one possible reason.

In product market definition, we're usually looking at current product market sales to answer the question of what is the appropriate relevant product market.

Whereas, as to efficiency claims, we're looking prospectively at: What are the efficiencies that will be generated by combining these companies?

Isn't that --

MR. MURIS: But almost invariably an efficiency claim is going to be based in the current experience of the firm, at least almost all the ones that I have seen.

Now maybe sometime, you know, somebody makes the first move to build a bigger plant; and that's relatively speculative. But then they don't build the bigger plant without considered judgment about what the relative costs are going to be.

So the fact that it's prospective, in some sense, I don't think makes it significantly different. Quite frankly, the 5 percent test -- which I think was a wonderful innovation -- is a blindfold and pin the tail on the donkey in a significant number of cases.

In other cases -- I mean, you've got exports coming in and you've got price changes, and you can do econometric analysis.

So, again, I don't think there's anything magically different. And if it turns out -- and this is the key with the allocations of burdens -- if it turns out that it's speculative, it's speculative. They lose.

MR. O'CONNOR: I guess the problem I'm having with this question is that the type of documentation you want is going to vary from case to case very radically.

If you're looking at a hospital merger case, I might be very interested in seeing if Hospital A has undertaken a study to see why its number of heart by-pass surgeries has been going down over the previous years; and, you know, what they can do about it. What is -- and then they start looking at what's happening in the rest of the hospitals in the area and so forth.

And, you know, if I saw that kind of documentation, I might be persuaded that there's something going on here in the market that would explain why this Hospital A wants to merge with Hospital B and lower its unit cost in heart by-pass surgery.

If you're looking at an innovation market where you're talking about some sort of high-tech product that's coming down the line, it might be a completely different type -- I mean, they might have tried for years to develop a particular kind of product; or they have the product and they haven't been able to get it to the marketplace for some reason; and now they're looking at a merger for some other reason, and you're looking at a different kind of document that may be intertwined with the competitive effects of the transaction more directly than in the hospital case, where -- where the -- let me just stop there.

I mean, I'm not sure I can generalize to -- give a generalized answer to the question that's been posed here, as to the category of documents? I guess, it's sort of the: I know when I see it standard.

What you want are objective business documents that explain what's actually happened in the market and why they might be doing what they're doing.

Although, as I mentioned earlier, I'm a little -- I get a little concerned if a documentation that gets closer to the time the merger was proposed and they're sort of self-serving representations as to why they want to undertake the merger.

MR. BRODLEY: Could I respond to that briefly?

COMMISSIONER STAREK: Sure.

MR. BRODLEY: Doesn't this illustrate the advantage of a two-staged approach?

That is to say, at the first stage, if all you have to show is you've got a plausible account that efficiencies are likely to occur, then you don't have to agonize in the same way as if you're making a final judgment.

Later, you will be looking at documents that actually exist as a transaction that have had an experience, and then you can apply the normal methods to documents. In other words, you have contemporaneous documents.

COMMISSIONER STAREK: Well, we certainly talked a lot about the -- how difficult it is to measure efficiencies and present them to enforcement authorities. What about the other two points that I made at the outset?

Do efficiencies have to be merger-specific in order to be recognized?

And what does "merger-specific" mean? I mean, it means different things to different people; and we've heard that in previous sessions on efficiencies.

And, secondly, do mergers have to be -- do efficiencies have to be passed on to consumers? If so, do they have to be passed on immediately? Or can we look at diffusion and innovation markets? Can we look down the line? Follow a two-step approach that Professor Brodley asked?

Anybody want to take those on?

MS. VALENTINE: And can I add one little thing to your "merger-specific," because I agree with you, we have heard so many different formulations of that.

But because today we're also hearing a lot about burdens and how important they are, that's one place where we hear many different stories about who should have the burden.

So assuming that one were to have some standard like that, where should the burden be as well?

COMMISSIONER STAREK: Any takers?

Kevin.

MR. O'CONNOR: Well, assuming we're talking about efficiencies showing, say, mergers that have anti-competitive effects. Okay?

By assumption, then we have a merger that is going to impose a cost on the economy by some increase in allocative inefficiency, okay? as well as redistribution of some sort. Okay. So you have, by assumption, that going on. Now the question is: Should the merging parties be required to show the efficiencies, the technical and production efficiencies, are merger specific?

When you frame the question that way, I think the answer has to be: Yes. I mean, that what you're talking about is an offset of some sort to the merger-specific harm. So you need some merger-specific gain in that analytical sense.

I mean, if you're talking about a merger below the threshold that you've concluded hasn't caused a problem, then you don't care about the efficiencies as such. I mean, it's passed the filters, so you're done.

So I guess that's -- now, what do you mean by "merger-specific"? That gets back to a proof question. And, again, because I'm the lowly government attorney sitting here waiting for the parties to bring me information, for the most part -- although, I can go out and do some interviewing of third parties and so forth -- most of this information about efficiencies is internal to the merging parties. I'm waiting for them to provide me the information that will allow me to make this assessment.

So, I mean, that's where I come on the burden question. And that's one of the reasons why we were so -- you know, we felt very uncomfortable eliminating that part of our guidelines.

COMMISSIONER STAREK: Any other thoughts?

MR. BRODLEY: I have a question, Mr. Commissioner.

How is "merger-specific" different from the phraseology "no reasonably less restrictive alternative"?

COMMISSIONER STAREK: Good question.

MR. BRODLEY: I mean, if it's -- I would think that it is the same thing; but I'm wondering if that's what you mean. You don't mean anything different by that really?

Anyway, it's an important question; but I'm just trying to get that in mind.

And, I mean, the question of burden, of course, is difficult on that issue in the sense that it seems pretty arduous to require the parties to come in and prove, as against all possible transactions, this is the least restrictive.

And I have come out with the idea that if they have discharged their burden of showing that the transaction is efficiency justified that it's really up to the agency -- well, of course, aided by discovery and so forth -- to suggest what are these less restrictive alternatives that exist; and then I think the parties can then meet the burden of showing, well, no, Plan A is not a reasonably less restrictive alternative nor is Plan B or C.

It seems to me that might be the way to deal with the problem of burdens so that the burden then -- that the agency has named things that are plausibly things within the ballpark of less restrictive, then the parties could come forward and show that that's not the case.

MR. CALVANI: I wonder whether this is a real issue. I mean, I can see where you would say: Well, we're not going to take account of efficiencies.

If it's an efficiency which you the company could accomplish if you did absolutely nothing more than just simply implement these changes internally, well, that sounds nice. It also assumes that government reviewing agency is a better manager of the company's assets than are its current management. And I find that a difficult assumption to make.

I think people generally try to profit maximize; and if there are just efficiencies that they're stumbling over out there and they have chosen not to make them but the government can help identify them and help them run a more efficient organization, perhaps; but I'm skeptical.

Then there's another alternative. And that is, well, let's think about other things you might do other than this merger. We've been thinking about a joint venture that you might do over here. And I have the same problem with that.

I can come up with a great hypothetical if you'll let me make all the assumptions I want to make that would clearly, I suppose, to the satisfaction of some demonstrate that we ought to require mergers to be specific. It requires all kinds of assumptions that I think in real life are very difficult to do.

So I guess I come out pretty at much the same place that I understand Professor Brodley comes out on that issue.

MR. O'CONNOR: Can I respond to that?

First of all, by "assumption" here -- at least the assumption that I have been making is that we deal -- we get to the efficiencies question only after we found that a merger has some anti-competitive harm and causes some harm. And that's the job of the government enforcers in this case, is to deal with that issue. Clayton Act Section 7 says: Thou shalt not merge if it will substantially tend to reduce competition.

So it isn't a question of the government, you know, willy-nilly going out and intervening in private business decisions. For the most part, most of these rationale for merger aren't even an issue in the review because they're below the thresholds, there's no competitive effects story, entry is easy. For any number of reasons, you don't even get to this issue.

So, you know, I guess I take issue with the characterization that when you get to the efficiencies questions, it's government intervening in this private decision as a matter of course.

So, you know, I guess I just have a problem with that characterization of what's going on here, since the number of mergers in which you would have this kind of efficiency review is probably fairly minimal, fairly small.

MR. MURIS: On that question, I mean the Congress clearly had prior approval statutes before it rejected them. I mean, this is the -- I mean, they are allowed to merge unless the government can stop them.

And I think Professor Brodley's characterization is correct as to the allocations of burdens. I think that's a good way to go on this question.

MR. O'CONNOR: One more point that I wanted to make, going back to the hypothetical, at times I wear another hat in our office; and that is representing some of our state agency clients. And I remember a time long before the states were ever in the merger business when our university hospital came to me and said: Can we buy a lithotriptor with the competing hospital down the road.

And, you know, after looking at it and after reading BMI again for the 12th time, I decided, well, you can do it; just price out the services separately, you know, obviously makes sense. Neither one of you can afford it independently ta-dah, dah, dah and on and on and on.

Now if they had come to me and said: We want to merge. And I would say: Why do you want to do that. We want to merge with Hospital A down the road because we want to buy this lithotriptor.

I'd have a problem with that. I'd probably take off my counseling hat and put on a different hat, my enforcer hat, and say: I don't think that's such a good idea because, obviously, you can do this in a different way if that's the limited purpose for which you wanted to undertake this. I think there's a way to distinguish what's merger-specific and what's not in most cases.

COMMISSIONER STAREK: Passing on to consumers? Any more comments on that? We have Professor Muris's views.

MR. BRODLEY: I'm sorry. I didn't hear you.

COMMISSIONER STAREK: Passing on to consumers. How should enforcers deal with the question that -- or the assertion that, for efficiencies to be considered, they need to be passed on to consumers immediately?

MR. CALVANI: I think that brings us back to where we started on the redistributive issue where I agree with Professor Muris that it ought to be unimportant; but I think it is important because those that would minimize the role of the efficiencies defense often resort to the redistributive consequences of antitrust as a justification for doing so.

I would assume -- let's just assume for purposes of argument that we all embrace some sort of social agenda for antitrust, including redistributive consequences.

I'm willing to admit that there's probably not a lot of yacht companies in highly concentrated industries that are owned by blue collar pension funds. There may be some, but there's probably not lots of them.

However, if we're going back to 1914 and we're looking at the purposes of the Clayton Act and we're seeing -- which I don't see -- but assume we see redistributive objectives there, I suspect that if we looked at the average equity -- the average earnings of Americans generally and the average earnings of American equity shareholders in 1914, we might see some striking difference.

And the question that I would pose for those that do embrace redistributive goals or a social agenda for antitrust is: Is it not appropriate today to go back and take a look at that issue and to see precisely what are the well -- what are the transfer payments, the size of the transfer payments and the identity of transferors and transferees today, in 1995, when we have a radically increased presence of pension funds in the market and eleemosynary institutions and the like.

I'm not suggesting that it's going to flip flop. But I am suggesting that the difference between 1914 and difference today, if you embrace those goals to start off with, is striking.

And I think that there is -- there ought to be an injunction for those of us -- or those of you who would play Robin Hood. And that is, before we get out our little green tights and start putting them on and start dashing into Sherwood Forest, it might be a good idea that we make absolutely sure that we separate Maid Marian from the Sheriff of Nottingham. Because it would be perverse, if having adopted redistributive goals, we were out there robbing Friar Tuck and giving to the evil Prince John.

And it seems to me that that's an exercise that's worth undertaking for those of you -- for those of you who would subscribe to that agenda. It's probably something that ought be done.

MR. BRODLEY: I'd like -- could I respond?

COMMISSIONER STAREK: Sure.

MR. BRODLEY: I don't think we should try to be Robin Hood. I agree.

But let me suggest that there's no escaping that consumer benefit is an important objective. The question is whether it's an immediate objective, and that's the issue that pass on poses.

As long ago as 1916, Judge Learned Hand said in one of his earliest antitrust cases that the consumer benefit does not require an immediate pass on of benefits.

And I think the question is whether there is going to be some ultimate pass on of the benefits of -- to consumers.

And in my proposal, I have had two conditions on an efficiencies defense designed to assure an eventual pass on.

First, that in allowing a combination at some level of the productive process that competition be retained at some other level. The idea there is that having competition say at a vertically related level, assures that there will be pressures for competition at the restrained level.

Second, even at the restrained level, that the -- that the restraint not be permanent unless it's an indispensable condition, like it was in Broadcast Music. But in other cases it would be limited in time, as a joint venture, for instance could limit it in time.

So building, so far as possible, those conditions ensures that eventuality of consumer benefit.

Further, the trade-off, I think that was -- Judge Hand didn't say this, but the trade-off motivates -- the temporary sacrifice of the consumer benefit are the possible great welfare spillovers from some kinds of efficiencies, like better productive process which would resonate through other parts of the economy.

And I guess, finally, I would just remind people of something that the Chairman put in an article in 1992; but, in any event, a complete pass on isn't possible except in a competitive market. And in that case, you don't have a restraint so that, in a sense, you know, it's almost impossible to get.

So for all those reasons, it seems to me that immediate pass on -- I put it always that way -- that immediate pass on is not required in order to benefit consumers.

COMMISSIONER STAREK: Tim?

MR. MURIS: In response to something Terry said, let me go back to my original point.

I think if we looked fairly and objectively at current merger law, we realize the very tenuous basis of that law from an economic standpoint.

The old market concentration doctrine is dead. Attempts to buttress it in the modern game theory economics has not gotten us very far and almost nowhere empirically. Earlier drafts of the 1992 Merger Guidelines in the Department of Justice made some attempts to try to bring in game theory notions more than they ended up; and it was just very hard to do.

And I think we have to realize that because the current standards, in most cases, give at best a very weak measure of anti-competitive conduct, that's what I think the main message that I'm trying to say today is that efficiencies, when they can be shown, tend to be revealed with stronger evidence than the anti-competitive story that comes out of the merger. And we ought to pay all the more attention to them.

If we were really believers in the market concentration doctrine, you know, as they were in the '60s and early '70s, it might be a different story. But that basis just does not exist any more.

COMMISSIONER STAREK: Well, final word?

MR. O'CONNOR: Can I just comment on pass on briefly?

I agree with Professor Brodley that the timing of the pass on is a critical question. But I think it underscores the difficulty of making the measurement of the trade-off of the technical efficiencies that are achieved by the merger against the allocative inefficiency and redistribution problem.

And, obviously, ours don't -- the NAAG guidelines don't expressly give a time frame for the pass on or what needs to be done; but it ultimately comes down to a very case-specific analysis.

COMMISSIONER STAREK: Thank you.

Any other thoughts or comments?

Well, thank you. This has been truly a very interesting afternoon. I actually learned a few things. I appreciate it. It was very, very helpful.

Thank you for coming. Thank you for taking the time to prepare very thoughtful statements and for taking time this afternoon to share your thoughts with us.

(Whereupon, 4:27 p.m., the hearing was recessed.)

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C E R T I F I C A T E

DOCKET/FILE NUMBER: P951201

CASE TITLE: GLOBAL AND INNOVATION-BASED COMPETITION

HEARING DATE: November 7, 1995

I HEREBY CERTIFY that the transcript contained herein is a full and accurate transcript of the notes taken by me at the hearing on the above cause before the FEDERAL TRADE COMMISSION to the best of my knowledge and belief.

DATED: November 7, 1995

SIGNATURE OF REPORTER

GREGG J. POSS

(NAME OF REPORTER - TYPED)