When Does a Package Deal Become Illegal Tying in the Healthcare Context?

By Marshall L. Wilde, J.D., LL.M. candidate

We live in a world of package deals.  “Rent three movies, get a free bag of popcorn!”  “Book your flight with us, receive 50% of Vegas Hotel Rates!”  Even the healthcare context has some familiar variations, such as a single price for a complex course of treatment.  For the most part, these deals are marketing ploys or pragmatic arrangements based on convenience.  However, when a vendor of healthcare services exploits its market power in one product or service to leverage dominance in another, tying becomes a concern.

The Microsoft antitrust suit presents the most familiar instance of this phenomenon.  Microsoft allegedly used its dominant position in operating systems (OS) to leverage a larger market share for its Internet browser, Internet Explorer, to the detriment of Netscape, an arguably better product with a much higher initial market share.  The case did not turn on Microsoft’s establishment of a monopoly with its Windows line, but rather on how Microsoft used that monopoly to the detriment of a competitor in another product line.  Extending this to the healthcare field, a tying issue could arise if the only nephrologist providing inpatient dialysis services in an area required all purchasers of his inpatient services to purchase his outpatient services, despite competition in that market.

A pending Oregon case shows the limits of packaging when combined with market power.  The Eugene-Springfield area has two major suppliers of inpatient healthcare: PeaceHealth, a Washington state non-profit that owns a large hospital and several smaller clinics and facilities, and McKenzie-Willamette, an Oregon non-profit that owns a medium-sized hospital.  Ninety-six percent of Lane County residents obtain their acute care hospital services at one of these facilities.  Seventy-three percent of patients seeks care PeaceHealth facilities, while 23% seek care at McKenzie-Willamette.  PeaceHealth provides the only tertiary cardiovascular care and level III neonatology facilities in the county.  Consequently, PeaceHealth provides 90% of all cardiovascular services and 97% of all neonatology services delivered to Lane County residents. McKenzie-Willamette provides some services at lower intensity levels in these areas, accounting for all of the remainder that seek care in the relevant market. 

In 2001, Regence Blue Shield, insurer of about 35% of Lane County residents, began negotiating with PeaceHealth for a Preferred Provider Agreement (PPA).  PeaceHealth allegedly made two offers.  The first offered an exclusive agreement providing primary and secondary care services at a certain price and tertiary cardiovascular and neonatology services (tertiary services) at a deeply discounted rate.  The second provided for a non-exclusive PPA with similar price for primary and secondary care services, but a much-inflated rate for tertiary services.  Bowing to market realities, Regence opted for the first option.  After unsuccessful attempts to negotiate its own PPA with Regence, McKenzie-Willamette sued PeaceHealth for $35 million in federal district court, alleging, in part, that PeaceHealth used its market dominance in the tertiary services market to leverage an illegal advantage in the market for primary and secondary care services, contrary to the Sherman and Clayton Acts.  McKenzie-Willamette Med. Cent. vs. PeaceHealth, CV No. 02-6032-TC (U.S.D.C. Oregon 2002).

A plaintiff in a tying case must generally prove three elements: 1) a tying of two distinct products or services; 2) sufficient economic power in the tying product market to affect the tied market; and 3) an effect on a substantial amount of commerce in the tied market. Roberts v. Elaine Powers Figure Salons, Inc., 708 F.2d 1476, 1479 (9th Cir. 1983).  To meet the first element, McKenzie-Willamette must show that the two products, in this case tertiary services on one hand and primary and secondary services on the other, were indeed separate.  Part of the Microsoft defense, although ultimately rejected at trial, was that the browser and OS were not distinct products, as the browser served as an integral part of the OS.  That attempt failed, as an attempt by PeaceHealth to do the same in this case probably would, since PeaceHealth itself allegedly drew a distinction between these services in its negotiations.  In Jefferson Parish Hospital District No. 2. v. Hyde, 466 U.S. 2, 23 (1984), the Supreme Court addressed a similar issue, finding that anesthesia services were separate from hospital services, defining two separate product markets.

The court will have to determine whether there was illegal tying by PeaceHealth.  McKenzie-Willamette alleges that Regence was coerced and that PeaceHealth essentially conditioned the sale of their tertiary services on the purchase of their primary and secondary services by charging above market rates for the tertiary services in the absence of an agreement to exclusively use their primary and secondary services.  PeaceHealth argues that there was no explicit conditioning of the purchase of one product on the purchase of the other, and therefore the tie was simply an incentive, or package deal.  The Supreme Court, in Jefferson Parish, wrote, “the essential characteristic of an invalid tying arrangement lies in the seller’s exploitation of its control over the tying product to force the buyer into the purchase of a tied product that the buyer either did not want at all, or might have preferred to purchase elsewhere on different terms.”  Id. at 12.  McKenzie-Willamette believes that Regence would have preferred to purchase primary and secondary services at their facility, but for the inflated prices PeaceHealth threatened to charge.

Market power, the second element, also raises an issue in this case.  PeaceHealth dominates the relevant market for tertiary services.  Aside from a few percent of the population who choose to go outside the market area for their care, everyone in the market uses their tertiary services.  They also have a motive for increasing high proportion of the primary and secondary care market, as they plan to expand into Springfield, where McKenzie-Willamette is located, with a new 500 bed facility in the next few years.  Regence has no option other than to deal with PeaceHealth for tertiary services if it is to provide a complete range of health care services to its clientele. 

The tying plaintiff must also prove that the action will have a substantial effect on commerce in the tied market.  McKenzie-Willamette needs only point to the 35% of the population that will now have a much greater financial incentive to go to PeaceHealth for primary and secondary care.  Indeed, McKenzie-Willamette claims that losing this case will force a reorganization tantamount to withdrawing from competition as an organized entity, leaving PeaceHealth as a monopoly in all acute care hospital services. 

Taking a look at the first two elements, the only ones open to debate in this case, no clear conclusion emerges from the alleged facts.  While PeaceHealth did not expressly condition the sale of their tertiary services on the sale of their primary and secondary services, it certainly used its market share in tertiary services coercively in the primary and secondary market.  The case will probably turn on the degree of coercion.  If PeaceHealth threatened to charge ten times the market rate for their tertiary services in the absence of an exclusive agreement, then their argument that they did not expressly condition the sale would be plainly disingenuous, as the combined purchase would be the only viable economic means to purchase the tertiary services.  See, e.g. Ways & Means, Inc. v. IVAC Corp., 506 F. Supp. 697 (N.D. Cal. 1979).  However, precedent does not establish whether a smaller difference between the exclusive and non-exclusive prices, perhaps only 20%, would sufficiently establish a conditioned sale.

In sum, PeaceHealth has skated into the unknown.  While it arguably used its monopoly in tertiary services to expand its share of the primary and secondary markets, it may not have technically violated antitrust law.  We certainly will not see the end of package deals anytime soon.  However, healthcare industry executives in small to medium sized markets should carefully consider how they bundle their services, especially expensive specialty services, since business expedience from one perspective can be seen as exploitation of a dominant market share from another.

10/18/02