The healthcare industry is among the most prominent and dynamic sectors globally and has undergone significant consolidation over the last years. Partnerships and mergers in this sector have become increasingly popular ($533 billion in 2019, up 26% from 2018, according to Fortune).1 The profitability of these deals has been facilitated by factors like strong demographic tailwinds, high industry fragmentation, innovation, evolving regulations, and new business models to manage medical care.

Industry actors, such as hospitals, pharmacies and insurance companies, often make strategic investments and acquisitions to improve healthcare access, reduce costs, and improve quality: Dranove and Lindrooth (2003), examining mergers of previously independent hospitals, find that they experience post-merger cost decreases of 14% on average.2 These potential efficiencies, which are likely to benefit consumers, often come along with increased concentration, which may consolidate market power and raise competitive concerns in a sector historically exposed to media and public opinion attention. As a result, many mergers in the healthcare sector undergo close scrutiny by competition authorities on both sides of the Atlantic.

Yet, many of the existing economic techniques to evaluate mergers in fully privatized industries (e.g., Diversion Ratio, Merger Simulation and The Gross Upward Pricing Pressure Index) are unsuited for the healthcare sector. The reason lies in the mixed-oligopoly nature of this industry. In most developed and developing countries, private healthcare providers compete with public providers whose objective is not necessarily profit maximization, and whose conduct is usually distorted by regulatory constraints meant to improve access to high quality healthcare services: Barigozzi and Burani (2016), Barros and Siciliani (2011), and Laine and Ma (2017), among others, offer an account of the empirical evidence showing substitutability between public and private healthcare providers.3

How should mergers be evaluated in mixed oligopolies? Does the presence of public healthcare providers make it more likely that a merger between privatized providers benefits consumers? What is the impact of alternative public providers’ regulatory constraints and motivations on the competitive effects of these mergers?

To answer these questions, we build a mixed-oligopoly model in which a publicly owned healthcare provider competes for patients with two privatized providers, who may eventually merge. Our main task is to assess the effects of such a merger on consumers’ well being. We consider a circular-city model à la Salop (1979) in which patients are uniformly distributed around a circle of unit perimeter and buy a single treatment from healthcare providers that are located equidistantly around the circle and compete by setting prices and healthcare quality.

We contribute to the growing literature on mixed oligopolies in the healthcare industry by showing that the assessment of the competitive effects of horizontal mergers between private healthcare providers facing competition from a public provider requires identifying: (i) whether the public provider is free to choose its price and quality or those are given by regulation; and (ii) the objectives of the public provider and, in particular, the extent to which it is mandated to maximize its own profits or, instead, to ensure that consumers have access to low-price and high-quality services.

When the price and quality of the public provider are regulated, the merger eliminates a competitive constraint as in fully privatized markets, but the reaction of the public healthcare provider is very different from that of a third private competitor, as the public healthcare provider cannot increase its price or reduce its quality in response to the merger, as a private competitor would do. Thus, the merged entity will be less likely to increase prices or reduce quality post-merger for fear of losing significant volume to the public sector. Furthermore, a more substantial share of any merger synergies will be passed on to consumers, who are more likely to benefit from the merger when the price-adjusted quality standard imposed on the public provider is sufficiently high. In short, other things being equal, the merger is more likely to be consumer surplus increasing (hereafter, CS-increasing) in a mixed oligopoly with a regulated public provider than in a fully privatized marked (without the public provider).

When, instead, the public provider can adjust its price and quality in response to changes in its rivals’ choices, and maximizes a weighted sum of its profits and aggregate patients’ well-being (i.e., it exhibits ‘semi-altruistic’ preferences),4 the merger is less likely to produce material anticompetitive effects if the public provider is sufficiently altruistic. When the public healthcare provider mostly cares about the well-being of patients, its response to the merger will be to cut its prices and increase its quality. Anticipating the procompetitive response of the altruistic public provider, the merged entity will also have the incentive to pass on a more significant share of any cost-synergies to consumers.

We then consider the more realistic intermediate case of a semi-regulated public provider, who can adjust the quality of its services in response to the merger, but is mandated by regulation to price below costs. We find that the merger is more likely to benefit consumers when the public provider is price-regulated than when it can change its price in response to the merger. This is because, prices being strategic complements, the merged providers have weaker incentives to increase their prices when knowing that their publicly owned rival cannot do the same.

The level of efficiencies required for the merger to be procompetitive drops also if consumers cannot observe services’ quality before choosing which provider to patronize, or there is asymmetric substitutability between public and private healthcare services, with the former being a stronger competitor. Provided the public provider is sufficiently altruistic, efficiencies may not be required for the merger to be CS-increasing when, alternatively: (i) private providers also feature semi-altruistic preferences; (ii) consumers’ aggregate demand is elastic to prices and quality levels; (iii) all prices are regulated, hence providers only compete on quality. Taken together, these results show that ignoring the presence of the public sector may lead to excessive enforcement (Type I errors) and harm consumers — i.e., mergers that should be blocked in fully privatized markets may be CS-increasing when the public sector is a key player.

We also consider a few aspects related to the industry post-merger dynamics. First, we examine the incentives of the merged parties to relocate. We find that they have an incentive to move closer to the public provider to gain more ‘captive’ consumers. This strategy hurts the welfare of the consumers who are served by the public system pre-merger and by the private sector post-merger. Therefore, the analysis implies that possible remedies public authorities may consider is to mandate merged providers not to reposition their products in the market. Finally, we show that the effect of the merger on entry is ambiguous and depends on the location choice of the entrant. We characterize a non-empty region of parameters in which the merger is profitable, spurs entry and benefits consumers at the same time. In this region, when entering the market, the new provider will contest for consumers that would buy either from the public provider or from one of its rivals in the absence of entry.

The rest of the paper is organized as follows. After reviewing the related literature in Section 2, we describe the model set-up in Section 3. Section 4 develops the analysis under different regulatory regimes for the public provider. Section 5 considers several extensions of the model. Section 6 concludes. Proofs are in Appendix A. Further material is presented in the online Appendix.