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Medicross Healthcare Group (Pty) Ltd and Prime Cure Holdings (Pty) Ltd (11/LM/Mar05) [2005] ZACT 66 (13 October 2005)

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COMPETITION TRIBUNAL

REPUBLIC OF SOUTH AFRICA

Case no.: 11/LM/Mar05

In the large merger between:

Medicross Healthcare Group (Pty) Ltd

and

Prime Cure Holdings (Pty) Ltd _____________________________________________________________________

Non-Confidential Reasons for Decision

_____________________________________________________________________

Order

1. The Tribunal issued an order on 15 September 2005 prohibiting this merger.

Our reasons for the order follow.

The Transaction

2. The transaction on which the Tribunal has ruled envisages that Medicross, a company discussed below, will acquire the entire share capital of, and loan claims against, Prime Cure, also a company discussed below. firms are managed healthcare companies providing primary care healthcare services to medical aid schemes through a network of doctors or “service providers”. Post-merger, Prime Cure will become a wholly-owned subsidiary of Medicross.

The Parties

3. The primary acquiring firm is Medicross Healthcare Group (Pty) Ltd (“Medicross”). Medicross is owned as to 80% by Network Healthcare Holdings Limited (“Netcare”), which is listed on the JSE in the health sector, with the remaining 20% being held by Netpartner Investments Limited (“Netpartner”). Netpartner is owned by doctors and other healthcare service providers and holds a strategic shareholding in Netcare as well as having other functions. One of them is the ownership of 100% of the share capital of Netcare Direct Managed Care (Pty) Limited ("Netdirect"), a company which undertakes risk-transfer managed care - a concept explained at some length below.

4. Each of these entities is described more fully in the section below dealing with the structure of the Netcare group,

5. The primary target firm is Prime Cure Holdings (Pty) Ltd (“Prime Cure”). Its shareholders are:

Brait Private Equity 34.2%

Praxis Private Equity 29.30%

CDC Financial Services Mauritius Ltd 11.3%

Total Support Management (Pty) Ltd 8.22%

Other minority shareholders 16.95%

6. Prime Cure’s subsidiaries include Prime Cure Health (Pty) Ltd, Prime Cure Management Services (Pty) Ltd and Prime Cure Occupational Wellness (Pty) Ltd. Prime Cure operates chiefly in that part of the healthcare industry serving low-income patients.

6. Prime Cure manages and administers 45 primary healthcare centres or clinics. They are located in residential townships or industrial areas conveniently accessible to the homes or work-places of low-income earners. Prime Cure centres accommodate 47 general practitioners (GPs), and nurses play a large role in providing primary healthcare services at these centres.

6. The healthcare professionals at Prime Cure's centres are grouped into “incorporated practices” and are charged rental by Prime Cure and fees for equipment use and staff and administration costs. These practices treat patients who are members of the medical schemes with which Prime Cure has managed care contracts, and also other patients who have no connection with Prime Cure and who may or may not be members of medical schemes.

6. The Prime Cure healthcare centres receive about 800,000 patient visits annually.

6. Prime Cure also manages and administers four independent GP practices which operate outside its healthcare centres.

6. In addition to these operations, Prime Cure has a contractual network of some 2,000 GPs and 800 associated healthcare professionals, such as dentists, optometrists, and specialists, who provide medical services to members of the medical schemes which have managed healthcare contracts with Prime Cure.

6. Prime Cure's managed healthcare contracts cover primary, primary plus secondary, or full-risk (i.e. primary plus secondary plus tertiary) capitation.¹ Capitation is a concept explained below.

6. Prime Cure has managed care contracts with 24 medical schemes, covering approximately 115,000 "lives" (principal members plus dependants).² We emphasise that, in contrast to Medicross, these contracts are chiefly designed for health insurance options having low-income earners as members, although there is evidence that Prime Cure has made an entry into the "buy-down" market, serving higher or middle-income earners.³

6. Prime Cure is also involved to some extent in providing occupational health services under contract to employer organisations. These services comprise undertaking medical examinations and on-going health screening, issuing health certificates, and operating employee-assistance programmes, on-site clinics and related services. Prime Cure's turnover from this business is not large.

The Netcare Group Structure

6. Disentangling the complex web of cross-holdings and management contracts in the Netcare group is not a simple matter – in fact, Mr. Pieter Dorfling, an executive director of Medicross and CEO of Netdirect, and one of the witnesses at these hearings, often had to explain which hat he was wearing.⁴ It is nevertheless clear that the acquiring firm, Medicross, is a member of a group of companies that has the Netcare private hospital network at its centre.

6. The Netcare group comprises a number of companies supplying a large range of healthcare services. Among these are private hospitals and specialised clinics, pharmacies located within the hospitals, emergency ambulance services, pathology and dialysis units, and the compilation and dissemination of healthcare management information. For the purposes of evaluating this transaction – as will become apparent later on - the Netcare activities that are of particular pertinence are, firstly, the network of 64 private hospitals which is the largest in the country and which we shall refer to as Netcare. Secondly, Medicross, the clinic network which provides a range of primary care services and is the primary acquiring party in this transaction. Thirdly, Netdirect, a managed care company which has been in existence since June 2003, and which targets low-cost medical scheme options. All these entities are discussed more fully below.

Netpartner

6. Netpartner is owned as to 48% by Netcare and as to 52% by healthcare professionals who numbered 9,000 at the time of the Commission's recommendation. Netpartner, with a holding of 16.2% in Netcare (at the time of the merger notification – it had risen to 17,5% at the time of the hearings) is the largest single shareholder of Netcare. Netpartner is controlled on the operational level by Medicross in terms of a management agreement.⁵

6. It has several functions, one being to serve as the entity through which doctors and other medical service providers associated with Netcare hold shares in the group, and it also acts as an assembly point for these professionals in their relationships with Netcare.

6. Netpartner owns all the issued shares of NetDirect.

Netdirect

6. In the sphere of managed healthcare Netpartner operates through its subsidiary, Netdirect, which is the Netcare group's “entry vehicle” into the low-cost end of this arena.⁶ Netdirect is controlled by Medicross in terms of a management contract.⁷

6. The merging parties supplied remarkably meagre information on Netdirect when filing their merger notification. No information whatsoever was proffered on the existence and extent of Netdirect's operations and Netdirect's focus on low-cost medical scheme options, at least in the version of these documents which reached the Tribunal. The only evidence available is that Netdirect has a network of more than 800 doctors.⁸ The significance of Netdirect, as the Netcare group's existing contracting entity for low-cost medical scheme options, emerged only during the course of the merger hearings.

6. We deal more with Netdirect below when describing the activities of Medicross.

Medicross

6. Medicross is a primary healthcare entity engaged in four areas of activity:

1. providing primary healthcare through the operation and administration of medical centres;

6. Medicross has 53 centres (clinics) around the country, specifically targeted at higher income patients. GPs, dentists, optometrists, pharmacists and other healthcare professionals work at these centres. Most of these centres have day theatres for minor surgical procedures, and other services ancillary to primary healthcare, such as radiology and pathology, are available.

6. The GPs and other medical professionals working at these centres are not employed by Medicross and not obliged to work exclusively at Medicross centres. They are however required to comply with clinical guidelines specified by Medicross. Medicross centres accommodate 413 GPs and 153 dentists.⁹

2. practice administration services

6. Medicross provides administration services to 21 independent medical practices in return for fixed monthly management fees.

3. development of clinical guidelines and disease management programs

6. These are services aimed at maintaining consistent clinical standards at Medicross centres.

4. Managed care services

6. From Medicross' merger documentation as filed with the Commission, it emerges that Medicross has managed care contracts with 15 medical schemes, covering some 35,000 lives, and extending to a multi-part formula arrangement for the remuneration of service providers. Apparently these activities fall considerably short of capitated primary care.

6. Both Mr Strauss, the witness from Discovery who negotiates directly with the Netcare group with respect to managed care contracts, as well as counsel for the Commisson, referred to the confusion which exists regarding the identities of Medicross and Netdirect in relation to their respective product offerings. The record shows the difficulties experienced by all concerned in establishing the boundaries between Medicross’ activities and those of Netdirect.

6. As indicated above, Medicross manages the operations of Netdirect under a management contract, and Medicross and Netdirect contract with medical aid schemes to provide various forms of managed care. Netdirect appears to be at least the nominal contracting party in relation to low-cost medical scheme options. Medicross handles the administration of all the arrangements and the management of relationships with healthcare service providers with whom the scheme members consult.

6. According to Mr Dorfling, there is little overlap between the roles of Medicross and Netdirect. NetDirect utilises the Medicross managed care infrastructure for its operational capability. He describes Netdirect as a “facilitator of risk transfer, network arrangement, network management” whilst Medicross is a practice management administrator, deriving the bulk of its income from practice management.¹⁰ He distinguishes Netdirect and Medicross thus:

“Medicross fulfils the administration function, 100% correct. But again, Medicross never entered into the kind of total risk taking environment where that is the core objective of NetDirect. But the management capabilities and functionalities performed by Medicross in terms of an administrative agreement, correct.”¹¹

6. Unfortunately the Tribunal does not have information about the scale of Netdirect's activities in conjunction with Medicross in terms of number of lives or turnover.

The Rationale

6. Medicross believes that there is likely to be significant growth in demand for managed care services for those medical scheme options servicing low-income earners. This predicted growth in demand will derive from government’s efforts to extend medical insurance to its lower income employees and from its stated commitment to a system of ‘social health insurance’ which is intended to extend health insurance coverage to uninsured South Africans in the lower paid part of the labour market.¹²

6. In this context, then, Medicross advances two primary reasons for the transaction. First, Prime Cure brings to the merged entity an established base of low-income lives covered. This would enable the merged entity to, in the words of Mr. Dorfling, ‘hit the ground running’. As we shall demonstrate, a new entrant’s ability to weather the initial period where it builds a base of lives sufficient to incentivise its doctors to assume risk or, even to offer discounted fees, is a critical determinant of sustainable entry. Secondly, the merged entity will be able to take advantage of Prime Cure’s established relationships with the medical schemes and with institutions, notably trade unions, which are an important source of access to the medical schemes. In short, as we shall elaborate below, Medicross believes that the transaction will enable it to overcome two critical barriers to entry, viz, ‘lives’ and what we will refer to as ‘social capital’ being a web of relationships, notably with trade unions, but also, as we shall elaborate, with doctor networks. Note that the acquiring party makes it absolutely clear that its entry is not dependent upon the merger. That is, it can, through Netdirect, enter the market anyway.¹³

6. We were informed that the institutional investors who own the significant majority of Prime Cure’s shares wished to exit from their investment.¹⁴ It appears that Prime Cure’s shareholders have, over the past three years, been involved in a number of discussions regarding the possible sale of the company. These included far-reaching discussions with the large hospital group, Afrox Healthcare (since renamed Life Healthcare). There have also been several detailed discussions with Care Cross, Prime Cure’s largest competitor. There were also discussions in September 2004 with empowerment parties who had expressed an interest in taking control of Prime Cure.

6. However, as we show below, the stated rationale neglected to outline the unitary interests between the three chief protagonists in the Netcare Group.

The unitary interests of Medicross, Netpartner and Netdirect

6. The merger notification and competition analysis documents filed by Medicross, again in the form in which they reached the Tribunal, convey the impression that Medicross will have to make an entirely fresh entry into the low-cost area of managed care operations, relying entirely on Prime Cure to achieve this entry, and that Medicross alone will benefit from the merger. Yet it is clear to the Tribunal that for the purposes of competition analysis in this merger there is no distinction between Medicross, Netdirect and Netpartner. They all operate in unison to enhance the commercial interests of the Netcare group. Further, Netdirect is already a competitor in the low-cost part of managed healthcare.¹⁵

6. The true picture emerges only from such documents as the Netpartner prospectus, dated August 2003, in which the overall strategy of entry into low-cost managed care by group entities is announced,¹⁶ and from the annual report of Netcare for the year to September 2004, where Netpartner's "substantial progress in developing its business model" is described in the operational review of the group.¹⁷ This progress is said to have included the formation of Netdirect, a company which "has facilitated the assembly of a national network promoting and providing managed care products". Netdirect is recorded as having concluded contracts with Discovery, Liberty, Momentum, and Eclipse medical schemes, all of which were to become operational in January 2005.

6. In response to a letter from the Commission, Medicross' attorneys produced the standard agreement which apparently prevails between Netdirect and the healthcare service provider groups with which Netdirect contracts. This is a comprehensive document clearly indicating a bias towards the interests of Netpartner.¹⁸ The names of what appear to be Netdirect's customers or putative customers, and certain details of transactions or impending transactions with them, are also revealed in this document.¹⁹ These entities include Day 1, Ingwe, Momentum-Pulz, Transmed, Nimas, Pathfinder, Spectramed, Protea, Siswe, Xpresmed, Bestmed, Discovery, Medicross itself, Liberty, and Eclipse (various options). It is not clear to us that agreements with all these entities were concluded, but clearly an ambitious programme of action was under way, growing from the initial contractual base described in the annual report for the year to September 2004.

6. In the light of this information the statements of Medicross in its merger notification documents about the rationale for the merger and of the motives and competitive position of Medicross, described below, must be treated with extreme caution.

6. As an example of the contrast which pertains between the merger notification and less guarded expressions of the role players, we have taken note of a due diligence report on Prime Cure prepared by a committee on which various Netcare group entities including Medicross, Netpartner and Netdirect were represented.²⁰ Mr Dorfling, the CEO of Netdirect and an executive director of Medicross, was one of the committee members, and he was cross-examined about some of the information in this report. One of the pages of this report is headed "1. Purpose", and under its first bullet point it contains the statement that:

"the purpose of the limited due diligence performed by [Medicross] was to gain an understanding of the business processes of [Prime Cure] and to determine to which extent Primecure [sic] could add value to the current Medicross service offering with a specific view to enhance the Managed Care capabilities of [Netdirect] as envisaged in the Netpartner venture". (our emphasis)

6. It is also significant that the original sale agreement for the merger was entered into between NetPartner and the shareholders of Prime Cure. That agreement enabled NetPartner to nominate another party to undertake the transaction and that party subsequently came to be Medicross.²¹ Medicross was apparently chosen at the last moment, for no other reason than that it had the available cash. Again, the importance of the identity of the acquiring party is revealed to the Netcare group.

6. The triangular symbiosis between these companies in regard to the merger is thus clearly revealed.

6. In the parties' market and competitive analysis report, forming part of the merger notification, the rationale for the merger is stated in paragraph 2.²² After mentioning possible back-office savings, this document states that the principal reason for Medicross' interest in acquiring Prime Cure is Medicross' belief, shared by Prime Cure, that "administration of managed care is an important growth area" and Medicross' belief that "its expansion in this area will be more cost-effective if it can build on the relationships that Prime Cure has already established with medical schemes (as opposed to having to build these relationships from the ground up)". Some other or related purposes are also given, in anodyne terms, none revealing that Medicross is already extensively immersed in risk-transfer managed care in the low-income end of the market through its triangular relationship with Netdirect and Netpartner.

6. On the merging parties' own evidence, Netdirect is already providing risk-transfer managed care to low-cost options. It has stated its intention to offer both primary and secondary managed healthcare for low-income earners in a tender to the Government Employees' Medical Scheme (GEMS).²³ Dorfling states that Netdirect’s product offering is more comprehensive than that of Medicross in that it involves a primary through to a tertiary product offering, whilst Medicross has only a primary care offering.²⁴ Whatever these differences, the purpose of the merger is clearly not as described in the parties' merger notification documents but rather to extend the combined strength of Medicross and Netdirect (and hence also Netpartner) in generating business in low-cost managed care. The contradiction extends beyond the stated purpose of the merger to the assertions made on behalf of the merging parties at the hearing that Medicross operated in a different relevant market from Prime Cure in that Medicross was not active in the low-cost end of the managed care market.²⁵

The Hearing

6. The Commission recommended that this merger be prohibited. The Commission’s recommendation was filed with the Tribunal on 30 June 2005. A pre-hearing meeting was held on the 13 July 2005. We note, for the record, that at this pre-hearing meeting the merging parties asked that we order the Commission to hand over all the notes of the Commission pertaining to its interaction with third parties. The parties were told at the pre-hearing that this request – which embodied potentially far-reaching consequences for the exercise by the Commission of its investigatory powers – could only be determined on proper application before a duly constituted panel of the Tribunal. An application to this effect was then filed and was heard by the Tribunal on 29 July 2005. In the course of the hearing, the applicants withdrew their application.

6. The hearing took place on 11, 12, 15, 16, 17, 19, 31 August and 1 September 2005.

6. The following witnesses were called by the Commission:

Dr Reinder Nauta, of Carecross

Mr David Strauss, of Discovery

Mr Brian Davidson, of Life Healthcare Group

Mr James Hodge, of Genesis Analytics, the Commission’s expert

6. The following witnesses were called by the merging parties:

Dr Laubscher Walters, of Medscheme

Dr Robert Stillman, of Charles River Associates (CRA), the parties’ expert

Mr Sean Patterson, of Brait Private Equity and a director of Prime Cure

Mr Bisnard , Managing Director of Sizwe

Mr Pieter Dorfling, Executive Director of Medicross and CEO of Netdirect

6. The Tribunal called the Council for Medical Schemes which was represented by Mr. Stephen Harrison and Mr. Alex van den Heever.

Competition Analysis

The Healthcare Environment

6. Section 12A(2)(e) of the Act provides that when determining whether or not a merger is likely to substantially prevent or lessen competition we should take account of ‘the dynamic characteristics of the market, including growth, innovation and product differentiation.’ We will indeed do this when we turn to a detailed examination of the impact on competition of the transaction before us. However, because there are several broader ‘dynamic characteristics’ that impinge significantly on the markets implicated in this decision, we thought it appropriate to outline aspects relevant to the general environment in which healthcare is provided before proceeding to a detailed consideration of the transaction itself. Pertinent to our consideration are the general state of healthcare provisioning in South Africa, the policy objectives of the South African government in the realm of healthcare provision, the mechanisms whereby government intends achieving those objectives, and the place and role of the private sector, including the merging parties and many others who participated in these hearings, in this wider context.

6. The provision of adequate health care to all the citizens of the country is clearly an important plank in government’s efforts to tackle poverty and inequality. High and middle income South Africans (and this would include a significant proportion of those in employment) receive healthcare through South Africa’s sophisticated private healthcare system comprising the full gamut of general practitioners, specialists, hospitals and pharmacies. Private healthcare is funded by an array of medical schemes serviced by the administration companies, data processing companies and managed care companies that are an integral part of South Africa’s sophisticated ‘first world’ private healthcare system.

6. However the majority of the population – and this includes a significant number of those in the lower reaches of formal employment – rely on the public health system for meeting its needs. The reality – and possibly the only agreed certainty in the fraught debate surrounding the provision of healthcare in South Africa – is that the private healthcare system, and notably, although not exclusively, the private hospital network, is characterised by significant excess capacity, while the public healthcare system is simultaneously resource-constrained and increasingly unable to cope with the demands made of it. A major thrust of government’s efforts to improve healthcare provisioning is thus to utilise the excess capacity in the private healthcare system, the better to reduce the demands on the public system, to, in other words, move a strata of those presently reliant on public healthcare over to the private healthcare system.

6. The constraint in effecting this movement of people from public to private healthcare is finance. Put simply, the vast majority of those who are presently reliant upon the public healthcare system cannot afford to fund private healthcare. They cannot, in other words, afford the monthly premiums charged by any of the variety of healthcare insurance schemes available on the market. From a public policy perspective the upshot of this funding constraint is that the public sector is increasingly incapable of delivering quality healthcare to those who rely upon it while the private sector remains, as it were, structurally over-capacitated. From the perspective of the private sector, it is unable, despite its excess capacity, to service a potential market of millions of South African whose healthcare needs are not adequately catered for by the public sector. Hence medicals schemes and the array of services that cluster around them, have reached the limits of their market (the number of principal members of medical schemes has remained stagnant at approximately 7 000 000 for some nine years²⁶) and some important elements of the private system – notably the hospitals – are characterised by significant excess capacity.

6. The challenge then is to devise funding arrangements affordable to a large part of that portion of the population that presently utilises the public healthcare system. These would be those thousands employed in the lower reaches of the public and private sectors as well as the self-employed in both the formal and informal sectors – that is to say, the target group for private healthcare provisioning is not the indigent, but it is certainly the poor, euphemistically dubbed the ‘low-income’ sector of the population.

6. The firms involved in this merger are at the centre of this challenge precisely because they are in the business of designing and implementing affordable models of adequate healthcare provision, models that will enable the medical schemes to charge affordable monthly premiums and guarantee a level of service that the consumer is willing to purchase, that the providers are willing to supply, and that the relevant regulatory authorities are willing to sanction.

6. Despite millions of potential customers, the existing market in low-income healthcare provision is extremely small. Certainly, low income earners rely almost entirely on the public hospitals for secondary and tertiary care and although much of the primary care received by this part of the population is from private sector providers this is, in the vast majority of instances, directly funded by the consumer. For the most part, low income earners are not members of medical schemes and hence they are not insured for medical events.

6. A relatively insignificant proportion of the low-income population have bought into the few funds whose design attempts to accommodate them. The simple reason for this is that they are, by and large, still not priced at levels that low-income earners can afford. Enter then, private companies dedicated to providing a service that is aimed at decreasing the cost of healthcare insurance. This they do through attempting to address the two drivers that underpin high health insurance costs, namely the cost of healthcare products and services, and, secondly, the cost of risk.

6. Enter too government, driven by public policy imperatives and capacitated, first, by its huge purchasing power in the shape of many hundreds of thousands of uninsured public sector employees, second, by its ability to subsidise the provision of affordable healthcare both to those within its own employment net and to other low-income consumers of healthcare services, and thirdly by its ability to regulate healthcare costs and medical insurance.

6. The state’s principal initial instrument is the Government Employees Medical Scheme (“GEMS”) a medical scheme comprising a bouquet of high and low-income options which has recently been registered and which government intends rolling out from the beginning of 2006. GEMS is intended to cover those of its employees who are currently insured with other schemes – it is estimated that there are upwards of 60 medical schemes that provide coverage for government employees - as well as those, predominantly low-income, government employees who are presently uninsured and, as such, are dependent on the public healthcare system. There are currently about 1.1 million lives in the public sector. It is estimated that some 400 000 government employees are not covered by any medical scheme. It appears that the intention is to phase in GEMS, focusing first on migrating already insured government employees from their current schemes to GEMS. The second phase will focus on persuading those government employees who are presently uninsured to take up one of GEMS’ low-cost options.²⁷ We were informed that government intends membership of GEMS to be voluntary – however a subsidy will not be made available to employees who choose to belong to a scheme other than GEMS.

6. Government has recently published the GEMS tender document. It calls for bids for the administration of five options, two of which are directed at low-income employees. These latter specify that the bidder is required to provide capitated care. The significance of this will become apparent later but, suffice for the present to note, that this is a scheme where risk is transferred from the scheme to the managed care provider or, ultimately, the providers of medical care, namely the primary care providers, the specialists and the hospitals. The GEMS tender calls for businesses to bid for eight different types of contracts - an administrator; a clearing house; two providers of primary healthcare services ( for the “Sapphire” and “Topaz” options , which are described later on²⁸); an HIV/AIDS management company; a hospital service provider; managed care services and information technology services.

6. This complex background impacts powerfully upon the competition analysis of this merger. All merger regulation is, by its very nature, speculative, or, in the well-known description of Judge Richard Posner, ‘predictive’.²⁹ Anti-trust decision makers have attempted to lend as much science and certainty as possible to the process of merger regulation by utilising evidence of past and current market behaviour in tandem with economic theories and tools, which, in combination, permit of intelligent and relatively reliable prediction.

6. However this merger is characterised by particularly severe analytical problems. We are, in essence, dealing with a new market. As already outlined, the poor have been effectively excluded from the market for private healthcare services by the inability of the health insurance sector to devise affordable funding options and by the inability of the healthcare service providers to reduce costs to the sort of levels that enable the supply of a marketable package of healthcare services.

6. This is not to say that cost has not been a consideration in the supply and funding of private healthcare in the upper and middle-income markets. Of course it has been and cost considerations confronted in these markets underpin many of the debates – as well as the institutions and instruments – that are pertinent to the current efforts to extend these products to the poor. These are all instruments of ‘managed care’. Hence efforts to discourage the ultimate consumers of healthcare products from ‘over-utilisation’ have been led by the introduction by Discovery Health – South Africa’s largest medical schemes administrator – of the ‘savings account’ concept. A variety of managed care concepts aimed at disincentivising ‘over-provision’ by the service providers – these ranging from pre-authorisation for hospital services through to the identification of designated (and, therefore, often discounted) service providers that rely on the utilisation of networks of GPs, specialists and hospitals – have, in relatively recent years, become ubiquitous features of current healthcare provision.

6. However, none of these interventions have brought private healthcare within the range of low-income consumers. Indeed the record shows that they have not been particularly successful in holding down the costs of private healthcare although it is, of course, extremely difficult to construct the counterfactual. What is reasonably clear, however, is that in order to extend private healthcare to the poor, new approaches and products are going to have to be devised. The parties to this merger – and particularly Prime Cure, the target firm - are at the forefront of this thinking and this is why they are counted amongst the small number of firms that have made inroads, slight though they may be, into the untapped market for the provision of private healthcare to the poor.

6. The analytical complexities of this merger are massively compounded by the important role played by regulation in the private healthcare market, not to mention by the state’s role as a critically important direct provider of healthcare services. As already noted, the very notion of extending private healthcare to the poor is catalysed by the state’s decision to adopt this model in its efforts to meet its mandate to provide affordable healthcare to all of its citizens.

6. The poor, of course, have always been with us although this, on its own, has not inspired entry into this market. It is the advent of a state dedicated to providing healthcare to the poor that has created this market. The merging parties have claimed that the expressed desire of key private players – notably the large medical scheme administrators – to enter this market is inspired by the downward pressure on their prices and margins. The Commission has cast some doubt on whether prices and margins in this part of the broader healthcare market have been subject to downward pressure, but even if this is so, then it is fair to say that this has, in significant part, resulted precisely from state intervention - particularly from the imposition of a prescribed set of minimum benefits as well as a range of other regulatory interventions. Nor has the state been content to focus its attention on the healthcare funders. The producers and retailers of pharmaceutical products – another important driver of healthcare costs – have also come in for considerable and controversial attention from the state. These interventions have, in turn, impacted on other providers of healthcare services who are more directly implicated in this transaction, notably doctors and private hospitals, the latter a particularly important component of healthcare costs, who have derived large margins from the sale of medicines.

6. Nor is the regulatory framework settled. Far from it. The state’s intervention in the area of pharmaceutical pricing and provision has been subject to swirling public controversy and wide-ranging litigation that is, as yet, not yet fully resolved. In the area of healthcare funding and management, the state has, predictably, moved most decisively in the provision of healthcare insurance to its own employees. As already elaborated, it has done this by registering a new medical insurance fund – GEMS – and within this framework it has, it appears, prioritised the movement of those of its employees already covered by medical insurance into GEMS and, then, the extension of coverage to those of its lowest paid employees who are, as yet, uninsured. It has indicated that once this has been achieved – itself, as we shall indicate, no mean task – it will seek to extend this coverage beyond the public sector, thus constructing what is generally referred to as a system of ‘social health insurance’.

6. However, while the state’s overall objectives are reasonably clear, the precise tools that will be deployed to achieve these objectives are by no means finally resolved. While it appears, as will be elaborated at length, that GEMS has opted for capitation as the preferred mode of providing cost-effective options for its low-income employees, many commentators, including some who have actually entered bids for the tender, still insist that alternative modes of healthcare management may produce preferable outcomes. There is a strong body of opinion, eloquently articulated by witnesses in these hearings, that insists that the provision of affordable healthcare to the poor is an oxymoron in the context of the present system of prescribed minimum benefits. However the state has not, as far as we are aware, indicated that it is even reconsidering the imposition of prescribed minimum benefits which are generally identified as a cornerstone of a regulatory system that is directed at producing adequate healthcare to all of its citizens. We should also add that past experience, compounded by the huge stakes involved in the GEMS tender, suggests that the award of the tenders will be the subject of intense contestation including time-consuming litigation.

6. How does all of this uncertainty and fluidity impact on our consideration of the transaction that is presently before us? It means, in short, that the past is a particularly unreliable guide to the future. As we shall demonstrate, extreme uncertainty bedevils an analysis of the impact of this transaction even at the most fundamental and elementary level of merger regulation. Hence, as we shall elaborate, we are not able, with any confidence, to predict the response of consumers to price movements in the products offered by the merging parties.

6. It is our view, then, that this extremely fluid context, the absence of an established and stable regulatory framework for this embryonic market as well as for some related and long-standing markets (for example, pharmaceuticals), demands that we adopt a particularly cautious and circumspect approach to private interventions, such as this merger, that will inevitably impact on the development of the market under consideration. Public interest considerations impinging on the outcome of interventions in this area – be they interventions by the state, by regulators or by private market participants – are, for unimpeachably good reason, unusually intense and this also predisposes us to particular circumspection.

6. We are, to state the obvious, dealing with a transaction in a market that is central to the interests of the state, to the private sector and to ordinary consumers. It may well be that in a year’s time, or, more likely, in five years’ time, the regulatory framework and the parameters of the markets implicated in this transaction will be more certain and that the consideration of an identical or similar transaction will produce a different outcome. However, it is in the nature of merger analysis that changing eras and contexts produce different outcomes. There is no single answer that stands for all time.

The Relevant Markets

6. The papers filed in this merger display an unusual degree of consensus between the merging parties and the Commission over the definition of the relevant market. This is particularly unusual in the context of a merger that the Commission recommends be prohibited. One would have expected a deep-seated divergence on the boundaries of the relevant market. However, despite their initial closeness to the Commission’s view, the parties have ultimately argued for a relevant market significantly broader than that contended for in their formal merger filings.

6. It is common cause that the merging parties’ activities overlap in respect of:

1. primary healthcare (through the operation and administration of primary healthcare centres) and

2. the administration of capitated managed care options.³⁰

6. There is thus agreement on the fact that there are two relevant markets. The first can be dealt with relatively easily. This is the market for the provision of primary healthcare services. This consists of the operation of medical centres through which doctors, dentists and other healthcare professionals provide primary healthcare services.

6. The commission examined the geographical locations of the Medicross and Prime Cure medical centres and concluded that the merging parties had overlapping facilities in five centres, namely, Bloemfontein, Bluff (Durban), East London, Kimberley and Port Elizabeth.

6. However, it appears that the Medicross and Prime Cure facilities are directed at markedly different income groups. Prime Cure centres are located in close proximity to low-income communities, such as mass-housing townships and industrial areas, generally within walking distance for potential patients. By contrast, Medicross centres are located so as to target middle-income market earners, within easy driving distance of their residential suburbs.

6. It is clear that the clinics managed by the merging parties represent but a small portion of available primary care in the areas in which they are located – generally urban and metropolitan. Although this availability varies widely as between different geographical locales there is no evidence to suggest that the clinics of the merged entity will acquire market power for the provision of primary healthcare in any single locale.

6. It is common cause between the parties and the Commission that this market presents no competition problems, and we concur with this assessment. This market will not be discussed further.

6. The second relevant market for which the parties, in their initial filings at least, contended is that for the provision of capitated managed care options.³¹ Although the Commission’s market definition is not particularly lucid, it too holds most consistently that the market is that for capitated managed care options.³² However, on several occasions it does refer to ‘the market for the provision of managed care services with a national network of service providers’.

6. This is the problematic market in this merger and it is precisely here that the merging parties have sought, at the stage of the proceedings before the Tribunal, to widen the boundaries of the relevant market for which they originally contended. Their stance at the hearings and in their closing argument was that the relevant market was the market for primary managed care services for low-cost medical scheme options. On this view the provision of any form of managed care at the primary level, and not necessarily capitation, makes the provider a competitor in the market. Throughout the hearings the Commission consistently took the position that the market is that for capitated managed care, provided on a national basis.

6. It is clear that the Commission derived its list of competitors in the relevant market from information provided by the parties in their original filings, where capitation was specified as a feature of this market.

6. As we shall elaborate below, in their initial filings both merging parties informed the Commission that the participants in the capitated managed care market are Care Cross, Prime Cure, Medicross, Faranani, Metropolitan (through, it later transpired, an entity called Qualsa), and ‘other IPAs’, that is, Independent Practitioners’ Associations. As we shall see, the data supplied by the parties indicate that Faranani, Metropolitan and the IPAs are fringe players, with Care Cross, Prime Cure and Medicross accounting for the lion’s share of the market. The Commission’s investigators certainly accepted that the only players in the capitated managed care market were those identified by the parties. Moreover, we note – and elaborate below - that the views of the parties as contained in their initial findings were confirmed in the Commission’s interaction with other parties in the broader health care market.

6. It is clear that whenever, in their initial filings, the parties specifically applied themselves to identifying the relevant market they explicitly and unanimously opted for the provision of capitated managed care as that market. Moreover, they explicitly and repeatedly identified Carecross, Primecure and Medicross as the only significant participants in that market with very much smaller players, including Faranani, Metropolitan and selected regional Independent Practitioners Associations (IPAs), competing on the fringes of that market. In Item 16.4 of its ‘Statement of Merger Information’ (Commission Form CC4(2)) Medicross states quite unequivocally that

‘the merging parties, are in the broadest sense (our emphasis), competitors for the administration of capitated managed care options (emphasis in the original).

6. In the same paragraph Medicross identifies itself, together with Prime Cure, Carecross, Faranani, Metropolitan and ‘other IPAs’ as the competitors in the market. Medicross further estimates that it, Prime Cure and Carecross account for 87,7% of the ‘market share (lives covered by managed care’), with Faranani, Metropolitan and the ‘other IPAs’ accounting for the remainder of ‘lives covered by managed care’, that is, for 12.3% of those lives covered by capitated managed care. These views are then precisely echoed in Paragraph 16.4 of Prime Cure’s equivalent submission.

6. Even though on its face this appeared, on this market definition, to be a potentially problematic transaction from a competition perspective, the merging parties clearly took comfort in their view that they were not competitors because of the different market niches that they targeted, with Medicross targeting middle and high-income consumers, and Prime Cure the low-income consumers. On this basis they held that the merger presented no horizontal problems. Again in Paragraph 16.4 of their respective form CC4 (2) submissions, both parties, having, as indicated above, identified themselves as, ‘in the broadest sense, competitors for the administration of capitated managed care options’, continue:

“However, at the narrower level as discussed in the Analysis, they are not viewed as competitors due to the fact that the parties target different income groups. (our emphasis).”³³

6. This conclusion was cogently countered by the argument advanced in the Commission’s recommendation. This acknowledged the distinct market niches which had existed in the past, but nevertheless, concluded that the transaction would give rise to a substantial lessening of competition, relying on the doctrine of ‘potential competition’. Effectively, the Commission argued that Medicross, through or in combination with Netdirect, was poised to enter the low-income segment of the market and that its competitor in the low-income segment, notably Care Cross, through its associated company, One Care, had already entered the upper-income segment.

6. Clearly the parties recognised in the course of preparing for these hearings that their defence of the transaction rested on thin ice and so have sought to amend their case by expanding the contours of the relevant market.

6. Counsel for the merging parties argued that his clients should not be held to their original definition of the relevant market. He insisted that because these are not adversarial proceedings but rather proceedings in a truth-seeking enquiry, the parties’ filings cannot be given the status of pleadings but are rather their initial contentions in an unfolding enquiry in which their ideas and opinions will evolve as evidence and argument are submitted to the Tribunal. He has sought to characterise the Commission’s defence of its view of the relevant market as unduly dogged and inflexible.³⁴

6. While, in general, there may be some broad validity in these contentions, they are ultimately not persuasive. It is one thing to argue that the Commission should be prepared to confront, with a relatively flexible mind, evidence and argument submitted to the Tribunal to the effect that the Commission had opted for too narrow a market definition. However, it is quite another matter to insist that the parties should be at liberty to broaden or abandon the boundaries of the relevant market for which they initially contended. The view of the relevant market that is contained in their initial filings reflects the merging parties’ understanding of the world in which they conduct their business and this view from the coalface appropriately guides the Commission’s investigation. The parties’ effective definition of the relevant market is in fact derived from their identification of their competitors.³⁵ We can understand why business people may misinterpret a request to identify a ‘relevant market’ – this is a term of art in competition law and economics that may well not be easily understood by one not versed in anti-trust theory. However they are not asked to do this. They are rather asked to list their competitors, and this is the first, and most important, building block in the Commission’s definition of the relevant market. There can surely be few business people worthy of the name who would not understand a request to identify their own competitors.

6. It is wholly conceivable – even likely - that a merging party which is familiar, or is familiarised, with the nature of a competition enquiry may take an unduly expansive view of its competitors and the reason why the Commission then interrogates these submissions further is to establish whether the views they contain are sustainable or not. However the Commission cannot reasonably be expected to believe that the merging parties have inadvertently omitted to mention a host of significant competitors. In the hearings, the witnesses for the merging parties identified companies or divisions of companies such as Solutio, Qualsa and Yarona as competitors in the market, and yet we are asked to believe that they somehow neglected to refer to them as competitors in their initial filings. For example, the legal representatives of the merging parties castigated the Commission at the hearings for failing to enquire of Medscheme, a large medical schemes administrator, whether its managed care division, Solutio, considered itself to be a competitor of the merging parties. Contrary to the merging parties’ initial submissions, in which Solutio warrants not a single mention, they now contend that it is a particularly significant presence in the market. The merging parties having not seen fit to identify Solutio as a competitor, what reason would the Commission have had to pursue this line of enquiry?

6. The Commission in fact approached Medscheme and many of the other medical scheme administrators whom the merging parties now insist are their competitors, because they were identified by the merging parties as their most important customers.³⁶ The Commission’s interrogation of these identified customers is entirely appropriate to that relationship. It approached each of the significant competitors identified by the merging parties – these being Faranani and Carecross – who confirmed the parties’ view that they were indeed competitors and who were then interrogated on that basis. It is noteworthy that in the course of the Commission’s investigations Faranani and Carecross both confirmed the parties’ initial submissions regarding the identity of participants in the relevant market.³⁷ Dr. Nauta was cross-examined at length on the identity of his competitors. While he acknowledged that entities like Qualsa (Metropolitan), Solutio (Medscheme), Sizwe and the IPAs accounted for a smattering of lives on capitated options, he did not view any of them as a significant competitive presence.

6. As indicated above, the parties’ initial view of the participants in the market was generally borne out in the Commission’s interviews with other participants in the broader health care market. Hence Transmed, one of the smaller medical schemes, identified Prime Cure and Medicross as providers of capitated options. Although it had an agreement with Qualsa (Metropolitan), it did not consider Qualsa to be a competitor of the merging parties.³⁸ Spectramed, another small scheme, also listed Prime Cure, Medicross, Carecross and Faranani as well as a firm called Healthcare Alliances.³⁹ A third small scheme, Ingwe, also identified Prime Cure, Medicross, Faranani and Carecross as national providers of national primary care solutions. Ingwe was of the view that the IPAs’ regional character placed them outside the market.⁴⁰

6. In this regard we view the evidence of Mr. Strauss of Discovery as particularly revealing. Here was a witness from South Africa’s largest medical scheme administrator with responsibility for exploring and concluding agreements with service providers. His is surely a particularly privileged vantage-point from which to identify participants in the market for the provision of capitated managed care options. Schemes administered by his company are, of course, significant users of these services.

6. Strauss’ view is that Medicross, Prime Cure and Carecross compete in this low-income market, with Carecross being “the major player”.⁴¹ He acknowledged that Discovery had been approached by many entities claiming to be primary care providers, but added that none of them had proved to be cost-effective or “of substance enough for Discovery to contract with them.”⁴² Regarding Solutio, Strauss’ view was that it was effectively a data management entity.⁴³ Discovery’s view of Qualsa was that it managed in-hospital expenses rather than primary care. Furthermore, having a national footprint is imperative to Discovery’s selection of a primary care provider and Qualsa did not, in Discovery’s view, have such a national footprint nor did it attract enough lives to make it robust. Strauss remarked that Discovery would not use it. ⁴⁴

6. As for Yarona, Strauss testified that this entity had initially spun off as a division of a medical scheme and had previously made an offer to Discovery, but Discovery did not consider it to be a player. Specifically on Yarona Strauss stated:

“Yarona’s proposal relied on a network of contracted providers, but they had to bring in a third party by the name of Calabash to manage the network and to take risk within their proposal. So when we are talking specifically about Yarona, Yarona themselves, as I understand it, have a list of contracts at a particular rate per consultation, but they as an organisation do not take risks and they as an organisation, as I understand it, do not manage the doctor’s utilisation patterns”.⁴⁵

6. Because the merging parties have made so much of Solutio’s alleged presence in this market, it is as well to spell out the precise extent of its involvement.

6. Dr Walters testified as to Solutio’s involvement with low-cost insurance options. He referred firstly to the Bonitas medical scheme, an open scheme administered by Medscheme which has a low-cost capitated option (“Boncap”). This is managed by Prime Cure and Faranani. This option consists of  400 lives, with 4 000 being added in January 2006, making a total of 5 400 lives.⁴⁶ […….CONFIDENTIAL……]

6. Secondly, in respect of the Liberty medical scheme, also an open scheme administered by Medscheme, there is presently a capitated low-cost option, with Faranani as the primary service provider. Similarly, Liberty has a medium-cost option, which is a ‘virtual’ capitated model, with Medicross as the service provider. […….CONFIDENTIAL……]. Walters testified that the number of lives with Faranani was of the order of a few hundred, while Medicross administered some 600 lives.

6. Thirdly, Walters referred to Protecta, a closed-scheme also administered by Medscheme, with the low-cost capitated option currently managed by Prime Cure. […….CONFIDENTIAL……] He could not specify how many lives were entailed.

6. Walters also made mention of Sasolmed, a closed-scheme which also has a low-cost option for which Solutio is presently bidding. It is not a capitated product but a managed fee-for-service option, that is, for the most part, confined to Secunda, Sasolburg and Pretoria. It has about 5000 lives in the low-income option. He also made mention of the AECI scheme where it appears that manages the low-cost option. It appears that Solutio’s role is limited to oversight of the Carecross contract on behalf of the scheme in order to ensure that service delivery is adequate.

6. Ultimately, it seems that the only primary care capitated current business that Solutio itself provides is in respect of the Daimler Chrysler scheme. This is a closed regional scheme where, acknowledges Walters, the capitation fee is exceptionally generous.

6. We concur with the Commission that Solutio’s share of the capitated managed care market, when measured by number of lives, is so small that it cannot be considered a competitive constraint on the major participants in the market. It is limited to schemes administered by Medscheme where, for the most part, it continues to rely on one of the major providers of capitated options. We should also note that most of the low-cost schemes in which it plays a role are small, closed and regionally-based.

6. It is, of course, eminently possible that the exercise of market power on the part of the participants in a relevant market may induce new entry into the market. This will be an important part of our enquiry, particularly when the question of entry barriers is examined. It is also possible that the conduct of existing players in the market may be constrained by potential rivals who are easily able to utilise existing assets and know-how deployed in a related market to enter the market in question - so-called supply-side substitution.⁴⁷ This too will be examined when we consider entry barriers. However we are, on the basis of their own contentions, satisfied to conclude that the parties confidently identified the relevant market as that for the administration of capitated managed care and, more revealing of their view as to the boundaries of their market, they identified the participants in that market - their competitors in other words - as Care Cross, Prime Cure, Medicross, Faranani, Metropolitan and certain of the IPAs. It would be difficult to deny that the data in the parties’ own filing reveal that Faranani, Metropolitan and the IPAs are nothing more than fringe players. We will show that the evidence demonstrates that they are destined to remain on the fringes of the market.

6. We find that the relevant product market is that for the provision of capitated primary managed healthcare products.

6. There are various forms of capitated products. There is the form of capitation where the managed care organisation effectively assumes the risk from the scheme. The most advanced form of capitation is where the managed care organisation then transfers the risk to the service provider. Ultimately this is the desired end-point of capitation because it effectively incentivises the service provider to tailor his treatment regime to the limits imposed by the capitation fee. And there are variations on this theme. In his evidence Dr. Walters of Medscheme/Solutio spoke of ‘gain sharing’ options which combined capitation – where the managed care organisation or service provider assumed all the ‘downside’ risk - with an arrangement that enabled the scheme to share some of the ‘upside’ with the managed care organisation or the provider.

6. Although the merging parties argued that there are managed care mechanisms that are substitutable for capitation, we will show that it is widely recognised that the product that is most effective for the provision of low-cost insurance options is indeed capitation. Variants of this approach are steps along what Dr. Walters described as a ‘journey’ toward the attainment of the provision of a fully capitated product, one in which the service providers assume the risk. Although the precise boundaries of the market for which the Commission contends are sometimes blurred our definition is certainly close to the Commission’s view and to the view for which the merging parties initially contended. It is certainly narrower than the parties’ revised view of the market which effectively argues that all managed care products are substitutable, and are adequate to the task of securing health care options for the poor.⁴⁸

6. Almost as many definitions of ‘managed care’ and ‘capitated managed care’ have been proposed in these proceedings as there were witnesses. Dr Walters’ definition seems to capture the essence of the concept of managed care:

“there are three things about managed care and I am sounding like a professor, but it is quite simple. You set standards, you set financial standards, you set clinical standards. That’s the first thing. The second one is you must have systems, processes and systems to actually administer those standards and the third thing is that you must analyse the outcomes. That’s managed care.”⁴⁹

6. As for capitated managed primary care the most succinct definition is contained in the witness notes handed up by Mr. Dorfling at the hearing. There ‘capitation’ is defined as,

“a method of payment for health services in which a provider is paid a fixed, per capita, amount in advance for each enrolee without regards to the actual number of nature of services provided to each member in advance. This involves a great deal of risk sharing.”⁵⁰

6. The Medicross website also offers a succinct insight into the content of managed healthcare and the role of risk-sharing under capitation:

“As well as providing healthcare services at industry negotiated fee-for-service tariff rates for the medical aid and private patient, Medicross offer a range of unique, comprehensive managed healthcare plans on a capitated basis (a fixed monthly fee) to look after the patient's individual healthcare requirements. Managed Healthcare is a means of providing healthcare services within a defined network of service providers, who in turn assume the responsibility and therefore the risk of providing quality, cost-effective care, while ensuring that only appropriate services are delivered. Under this model, emphasis is placed on keeping the patient well, rather than treatingepisodes of illness. In this environment the primary healthcare practitioner is responsible for managing downstream utilisation of services and effectively becomes the custodian of the patient's healthcare funds.”(Our emphasis added)

6. Mr. Strauss’ outline of the workings of Discovery’s capitated primary care option, the Key Care plan, also pinpoints the essential features of capitation:

‘Adv Berger: What was then the arrangement between the scheme and Carecross?

Mr . Strauss: The arrangement was that Carecross would provide all the primary care benefits though a network that they would put together. There would be a capitated payment, a fixed payment per member per month from the scheme to Carecross in return for which they would provide a list of services according to specific medical codes and according to specific medial ferneries (should read ‘formularies’) and pathology tests and radiology tests.’

6. In concept capitated managed care is a species of managed care that is characterised by a ‘fixed payment per member per month from the scheme’ – with the inevitable consequence that there is a transfer of risk from the medical scheme to the managed care organisation. In its implementation, capitated primary care and other forms of risk-transferring managed care require that the managed care entity which contracts with the medical scheme undertakes the supervision or management of a network of primary healthcare providers who generally assume a part of the risk. If they in turn receive their remuneration by way of a capitation payment, there is risk transfer to their level or tier in the healthcare matrix. In other cases, the managed care entity may retain the whole or a part of the risk at its level by paying the service providers on a fee-for-service basis. The Commission’s expert, Mr Hodge, elaborated further on the concept of capitation and the concept of the passing of risk:

“So in terms of the third model, which is what we are talking about, the providers today with primary capitated managed care, that company takes on risk. So it offers a scheme for a fixed fee per member per month to manage and typically this involves unlimited day-to-day benefits. And they then established a doctor network or in some cases clinics and they will pay the doctors either on a capitation basis themselves and pass down the risk or on a discounted fee-for-service.

As I’ve documented there, they perform certain functions. So they overlap in terms of the administrator in terms of doing claims processing. But the key aspects, which Dr Nauta brought out is the ability to monitor, analyse and specifically manage utilisation. If you’re on risk, you need to manage the utilisation and especially if you’re paying your doctors on a fee-for-service basis to ensure that essentially the income you get in is not exceeded by the benefits you pay out. You’ve clearly got to implement trained doctors. We’ve heard more, let’s say intangible aspects such as getting their buy-in to manage the concept, and just manage the doctor relationship in general to ensure that the doctors provide cost-effective and quality health care.” ⁵¹(our emphasis added.)

6. Although some witnesses argued averred that there are primary managed care products for low-cost insurance options that do not rely on full capitation, in truth much of the evidence before us regards capitation as an essential element of a managed care product directed at providing health insurance for low-income consumers. This is not to deny Dr. Walter’s contention that full capitation lies at the end of a long journey that may begin with varying mechanisms for managing a fee-for-service arrangement and that ultimately ends with full risk transfer. But it is to insist that a high degree of risk transfer, (in the form of capitation) is required if healthcare provision is to be extended on a significant scale to low-income earners. Dr. Nauta contends that the transfer of risk”

“…is really critical to the success in this market. You’ve got to ultimately transfer risk from you as entity in the middle, that buys this from various options and various schemes, to the doctor.”⁵²

6. And for all Mr. Dorfling’s insistence on a range of alternative managed care products for the low-income market, it does not seem that the merging parties disagree with Nauta’s assessment of the non-substitutability of anything except risk transfer – in other words, capitation - in respect of the low-income market. Dr. Stillman, reports that:

“Medicross shares the common view that to offer a medical scheme option that covers prescribed minimum benefits at these price points, i.e. low price points, the managed care model, as opposed to the fee-for-service model, is the only practical alternative. Medicross believes moreover that to provide a private healthcare product at these price points, it will be necessary for managed care to be on a full risk basis, i.e. to offer a managed care plan that covers specialists, medicines, hospitals as well as primary care.”⁵³

6. Stillman sums up the merging parties’ view:

“In sum the parties believe that the only effective way to deliver low-cost medical scheme options at prices affordable to low-income consumers, is through a full-risk managed care product offering”.⁵⁴

6. Thus, by the merging parties own reckoning, full risk transfer is necessary if health care insurance is to be made available to low-income consumers. And it is this model that requires highly organised primary care provider networks and a sufficient number of lives to incentivise the doctors and other medical service providers to accept full risk transfer.

6. Mr. Dorfling contended that the extension of private healthcare to low-income consumers could be achieved by a range of managed care products. He lists what he believes are a number alternative managed care products adequate to the task of ensuring low-income health insurance option, although, as elucidated earlier, even he concedes that full-risk transfer is the ‘most effective’ mechanism.⁵⁵

6. Indeed it is clear that the demand-side of the market also recognises the non-substitutability of full-risk capitation. The GEMS tender for its Topaz and Sapphire options, from where the bulk of the predicted surge in demand for low-cost insurance cover is expected to emanate, clearly specifies that GEMS is calling for tenders for full-risk capitation.⁵⁶

6. We should, for the sake of completeness, comment on a distinction much relied upon in the parties’ initial filings and dealt with by the Commission in its report, but which now seems to have been abandoned by both. This is the distinction between the provision of capitated managed care products for low-income earners (where Prime Cure is focused), and capitated products for the middle and higher income markets. This latter is the segment where Medicross is focused and is often referred to as the ‘buy-down’ market. It is not clear to us that either the parties or the Commission ultimately attached much significance to this distinction. It is clear that capitation is a mechanism for offering low-cost medical insurance and it is the low-income segment of the population at whom it will be aimed. There is a prospect of part of the higher-income part of the market ‘buying-down’ and this is already occurring to some limited extent. But it will be limited because these options embody limitations imposed on the scheme member that higher income options do not, and, for that reason, these options are unlikely to attract significant support from higher income purchasers of medical insurance. Moreover these ‘buy-down’ options will not be actively marketed or facilitated. At all levels, the healthcare providers clearly attempt to maintain a separation between the high-income and low-income purchasers of medical insurance, precisely because of the prospect of high-income purchasers availing themselves of options that cost less than they are able to afford, thereby eroding revenues and profits. In the face of ever-rising healthcare costs, we conclude that while buy-down is a phenomenon that is unstoppable, on present evidence it is unlikely to proceed so far that it blurs or eliminates the boundaries set by capitation.

Geographic Market

6. The geographic market is in our view national. There is a limited market for regional primary managed care products and this market may be penetrated by regional providers utilising regional networks. However, it is our view that these will service a shrinking portion of the overall health insurance market, including the low-income market. We will, in our discussion of entry barriers, outline why we view the regional IPAs to be inadequate substitutes for well-organised national networks – indeed, although the evidence is not unanimous, credible evidence pointed to important weaknesses of the regional IPAs, weaknesses that militate against them providing the extent and character of network management that primary managed care for low-cost health insurance demands. Many of the medical aid schemes, large and small, submitted that a national footprint was one of the key criteria they would look for in selecting a managed care provider. Mr Strauss, of Discovery, was particularly emphatic in this regard:

“MR STRAUSS: From our perspective we’re always … one of the first criteria will be for a national footprint, Faranani, as they’ve produced their membership lists, have always dominated Gauteng rather than anyone else. We’ve been into their organisation and looked at their systems and their processes, many of which they outsource, and they just haven’t seemed to attract the lives to make them into a robust organisation.”⁵⁷

6. In short, there will be niche opportunities for regional providers of capitated primary managed care. But these are unlikely to constrain the competitive behaviour of the national providers. Accordingly, we conclude that the geographical market is national.

6. Activities in this market engage closely with related markets. In particular, interaction with the market for the provision of private hospital services and the market for the provision of medical scheme administration services will be selectively considered.

The Impact of the Merger on Competition

6. The relevant product market – the market for the provision of capitated primary managed healthcare products – is highly concentrated. The merging parties estimate that there are 342 000 lives covered by capitated managed care options. Of these, 10,2% are covered by Medicross, 33,6% by Prime Cure and 43,9% by Carecross. That is, 87,7% of the number of lives covered by capitated managed care options are accounted for by the three largest players. Faranani is estimated to enjoy a market share of 5%, with Metropolitan’s share standing at 1,5% while ‘other IPAs’ collectively account for 5,8%.⁵⁸

6. This is, by any reckoning, a highly concentrated market. However a merger cannot be judged on this fact alone. We proceed then to examine the impact of the merger on competition.

6. The Commission has argued that this transaction has both a horizontal and vertical dimension. The horizontal dimension arises from the merger of two firms involved in the same product and geographical market. The vertical dimension refers principally to the place of the acquiring firm in the Netcare hospital group. We will analyse each of these dimensions in turn.

6. Section 12A(2) provides a non-exhaustive list of factors that are to be considered in the assessment of the impact of a merger on competition. Those factors that are pertinent in the consideration of the impact of the horizontal dimensions of the merger are ‘the ease of entry into the market, including tariff and regulatory barriers’ (12A(2)(b)), ‘the level and trends of concentration, and history of collusion, in the market’ (2(c)), ‘the degree of countervailing power in the market’ (2(d)), ‘the dynamic characteristics of the market, including growth, innovation and product differentiation’ (2(e)), ‘the nature and extent of vertical integration in the market’ (2(f)) and ‘whether the merger will result in the removal of an effective competitor’ (2(h)).

The Horizontal Dimensions of the Merger

Price sensitivity

127. Before turning to a detailed consideration of the factors listed in Section 12(A)2, we examine a proposition that has, to a greater or lesser extent, received the endorsement of several of the witnesses who participated in these hearings. This concerns the question of price responsiveness. In essence the merging parties assert that this is an unusually price-sensitive product, and consequently that there is limited capacity for the exercise of market power.

128. Firstly, it is clear that the product which is assumed to be inordinately price sensitive is not the managed care product (in this case, capitated managed care) at all, but rather refers to the insurance product itself. It is then implicit in the assumption that because an increase in the price of the capitated managed care product will be passed through to the consumers of the insurance products their conjectured sensitivity to price increases will restrain an exercise of market power on the part of the managed care providers.

129. We should be clear that there is insufficient evidence to sustain the assumption – and that is all that it is – that low-income consumers will be particularly sensitive to movements in the price of health insurance. Dr. Stillman, the merging parties’ expert witness, concedes that because these low-income insurance products are ‘new development(s)’ there is insufficient empirical evidence to undertake the standard statistical and econometric tests that would be normally employed to resolve this disagreement.⁵⁹

6. It appears to us that many of the ready assumptions that are made regarding the price sensitivity of the insurance product confuse the entry-level price – what several witnesses refer to as the ‘price point’ - with responsiveness to changes in price.⁶⁰ It is common cause that a large class of consumers, so-called ‘low-income consumers’, has effectively been locked out of private health insurance because even the lowest price options remain out of their reach. Low-income consumers do not partake of health insurance for the same reason that they do not partake of first-class air travel: they cannot afford it. They are not at all sensitive to movements in the price of these products because they simply do not feature in the consumption baskets of low-income consumers.

6. Prodded by a combination of government interventions and their own commercial interest in tapping a potentially large new market, a range of players in the healthcare industry are only now actively exploring mechanisms for lowering the cost of private healthcare insurance to the point where it enters the consumption baskets of these low-income consumers. None – in the private sector at any rate - are more actively involved in this quest than the parties to this merger and their fellow participants in the relevant market. However once affordable products have been developed – and managed care products directed at the provision of low-income healthcare insurance will be key to achieving this – there is no a priori reason for assuming that those who purchase these options will be particularly sensitive to price increases.

6. Indeed because this is an insurance product – albeit a short-term insurance product – one could reasonably conjecture that a consumer who has already sunk a material part of her income into purchasing this product would be reluctant to forgo the possibility of recouping this in the shape of future payouts when these are required. We acknowledge that regulation has attempted to lower the costs of switching from one health insurance plan to another.⁶¹ But these efforts notwithstanding, there are cogent reasons why switching costs will remain particularly high. Not the least of these reasons is that this is a notoriously complex product making comparison between alternative options difficult. Moreover, many consumers will purchase their health insurance plan from agents who may not always have an interest in enhancing the consumer’s ability to make the necessary comparisons between the products on offer.

6. In any event there remains an unresolved disagreement between the parties and the Commission regarding the intensity of competition between medical schemes themselves. The Commission has taken the view that competition between medical schemes is muted and, therefore, that competition in this market will act as a poor indirect restraint on the primary managed care market. The merging parties assert a contrary view. There is not sufficient evidence for us to decide the intensity of competition in the medical schemes market here. However we do note Mr. Hodge’s observation that primary managed care is but one component of the contributions to the cost of a scheme option. Therefore a substantial increase in the primary care component may then not reflect as a significant increase in the end price of the overall option and this may enhance the ability of the provider of capitated managed primary care products to exercise market power.⁶²

6. We note too that Prime Cure has recently increased its premiums by some 25% and that Medicross’ predictions for the merger reflect significantly increased prices by Prime Cure and a simultaneous growth in membership.⁶³ Again this is not definitive. But it is not consistent with the notion of a highly price-sensitive market unable to absorb even modest price increases.

6. We turn now to an examination of those factors listed in Section 12(A)(2) of the Act that are pertinent to our consideration of the impact of this transaction on competition.

Barriers to Entry

6. The Commission has concluded from its investigations that entry barriers into the market for capitated managed care options are significant. The record evidences considerable support for this conclusion. The most important entry barriers that are identified include the need for significant financial backing, administrative capacity, the existence of significant economies of scale represented by the number of insured lives, and then finally, and in our view, decisively, to a range of elusive factors that we collectively refer to as ‘social capital’. These latter include the capacity to build relationships with those institutions – notably the trade unions - that hold considerable sway over the decisions of those most likely to opt for low-cost health insurance options, as well as relationships with doctors and other primary care providers, reflected in the ability to assemble and maintain well-organised networks of primary care providers.

6. The parties themselves have identified high entry barriers. Prime Cure, the target firm, is quite explicit in this regard. The ‘Limited Confidential Information Memorandum’ or ‘LCIM’, a report prepared by a firm of consultants, Sevillano, Houseman, which was commissioned by Prime Cure and whose conclusions appear to be based entirely on interviews with Prime Cure management and shareholders, makes several direct references to the high entry barriers. It identifies the necessity to build relationships with the trade unions as a particularly significant barrier.⁶⁴ It also argues that new entrants will have to rapidly secure a significant number of insured lives. The consultants clearly believe that Prime Cure has overcome these barriers and thus represents an attractive acquisition opportunity. Mr. Patterson, a witness representing the Prime Cure shareholders, attempted to represent this as a ‘selling document’ and thus predictably hyperbolic, but this does not strike us as credible. It was, after all, a document presented to a potential purchaser extremely well versed in the healthcare sector generally and one that had experience of attempting to develop and market capitated options. It seems unlikely that Medicross, or its controlling shareholder, Netcare, would have been persuaded by mere puffery. Indeed, Medicross, presents these factors – Prime Cure’s established relationships and its insured lives – as the principal reasons for undertaking the transaction. We are assured that Medicross/Netdirect will enter the market if the transaction does not take place but that it will, by its own admission, take it from 18-36 months to do so and this from the firm that is, as we shall elaborate, probably best placed for rapid entry.⁶⁵

6. Dr. Nauta, the managing director of Carecross, the largest provider of capitated managed care services, testified to the high entry barriers surrounding this market. He believes that there are two particularly significant barriers to entry, these being the construction and management of a primary care providers network, and the accumulation of the number of capitated lives necessary to cohere the network.