Full opinion text
TABLE OF CONTENTS I. Proceedings................................960 II. Parties.....................................961 A. Plaintiffs...............................962 B. Defendant..............................963 C. Voluntary Hospitals of America .............963 III. The Hospital Supply Industry...................965 IV. The Purchasing Agreement....................972 V. Implementation of the Purchasing Agreement.....974 VI. Implied Antitrust Exemption...................977 VII. Market Analysis.............................979 A. The Relevant Market......................979 1. The Product Market....................980 (a) Medical-Surgical Supply Dimension____982 (b) The Distributor Dimension...........986 (c) The Hospital Customer Dimension .....988 2. The Geographic Market.................988 B. Market Volume and Defendant’s Market Share 993 1. The Martin Potential...................994 2. The Armbruster Potential............. 995 table of contents 3. The Hepp Potential...................996 4. Comparison.........................996 VIII. Attempt to Monopolize........................999 A. Anticompetitive Conduct and Specific Intent to Monopolize............................1001 B. Dangerous Probability of Success............1009 IX. Unreasonable Restraint of Trade................1013 X. Exclusive Dealing............................1026 XI. Boycott....................................1033 XII. Damages and Remedy.........................1036 A. Proof of Damage.........................1036 B. Amount of Damages......................1039 C. Injunctive Relief......................1044 XIII. Attorney Pees and Costs.......................1045 XIV. Conclusion..................................1045 OPINION DOUGLAS W. HILLMAN, District Judge. This antitrust action brought under the Sherman and Clayton Acts was filed by four regional distributors of medical-surgical supplies against the American Hospital Supply Corporation, the nation’s largest manufacturer and distributor of hospital supplies. The suit challenges (1) the legality of a Purchasing Agreement executed by defendant American Hospital Supply Corporation (“AHSC”) and the Voluntary Hospitals of America (“VHA”) on July 5, 1979, and (2) the legality of the joint AHSCVHA conduct implementing that Agreement. Federal jurisdiction exists under 28 U.S.C. §§ 1331 and 1337 and 15 U.S.C. §§ 15 and 26. Plaintiffs filed this action on October 31, 1979. Trial to the court commenced on November 3, 1980, and proceeded for approximately 80 trial days, concluding September 21, 1981. In the course of the proceedings the court heard 43 witnesses, including nine experts. The proceedings are recorded in the trial transcript which runs almost 15,000 pages; includes approximately 800 exhibits and several hundred pages of designated deposition testimony. Counsel have filed post-trial briefs and proposed findings of fact and conclusions of law that consume an additional 525 pages. The case was exceptionally well tried and briefed by able counsel. In synopsis, the following factual circumstances underly this case. American Hospital Supply Corporation (AHSC) is a national manufacturer and distributor of health care products and services. In 1979, AHSC entered into a Purchasing Agreement with a group of hospitals known as the Voluntary Hospitals of America (VHA). The Agreement contemplates that AHSC will sell a high volume and broad range of products to at least 29 VHA hospitals spread across 22 states. In return, the hospitals become eligible for volume discounts, price protection and certain vendor services. Plaintiffs are engaged in the business of distributing medical-surgical and other supplies to hospitals and compete with defendant for this distribution business in eight VHA hospitals. Plaintiffs claim that in executing and implementing the Purchasing Agreement defendant AHSC, the VHA and individual VHA hospitals have conspired to violate the antitrust laws. I. PROCEEDINGS The complaint alleges that defendant, AHSC, has violated Section 1 and 2 of the Sherman Act and Section 3 of the Clayton Act. Five antitrust violations are charged: (1) attempt to monopolize; (2) price fixing; (3) tying; (4) exclusive dealing and group boycott; and (5) price discrimination under the Robinson Patman Act. Counts II through V were framed in language alleging a conspiracy between the defendant AHSC and the VHA. The complaint prayed for treble damages and injunctive relief. In its answer, defendant denied any antitrust violation and raised as affirmative defenses a Robinson Patman immunity under the Nonprofit Institutions Act and a general, implied antitrust exemption under Section 2103 of the HCFA Provider Reimbursement Manual. After presenting an extensive case in chief, plaintiffs were permitted to amend the complaint to include a sixth count which alleges a conspiracy between AHSC, the VHA and the individual VHA hospitals to unreasonably restrain trade. At the close of plaintiffs’ case, defendant moved to exclude certain evidence conditionally admitted under Fed.R.Evid. 801(d)(2)(E) and moved to dismiss the amended complaint under Fed.R.Civ.P. 41(b). Defendant’s evidentiary motion attacked the admissibility of testimony concerning statements made by high-ranking VHA and VHA hospital personnel. Defendant objected to the admission of the evidence as hearsay. Plaintiffs contended the evidence was admissible under the co-conspirator exemption to the hearsay rule. In accordance with the procedure approved in United States v. Vinson, 606 F.2d 149 (6th Cir. 1979), the evidence was conditionally admitted pending a final determination by the court on the existence of a conspiracy sufficient to admit the evidence. By a memorandum opinion dated April 13, 1981, this court determined that sufficient evidence of joint or conspiratorial activity existed to admit the evidence under the co-conspirator hearsay exemption. The court then dismissed plaintiffs’ claims of price fixing, tying, and price discrimination. As a consequence of the dismissal of plaintiffs’ price discrimination claim, the court did not address defendant’s defense of immunity under the Nonprofit Institutions Act. As to plaintiffs’ remaining claims, the court held defendant’s motion to dismiss in abeyance. Accordingly, plaintiffs’ claims of attempt to monopolize, exclusive dealing and group boycott and unreasonable restraint of trade are now before the court. Pursuant to Fed.R.Civ.P. 52(a), this memorandum opinion constitutes the findings of fact and conclusions of law in this matter. In support of factual determinations, the court gives citations to designated deposition transcripts, trial record or exhibits where appropriate. These citations are not intended to represent the sole source of support for the fact determination involved. Similarly, those determinations of fact not accompanied by any specific reference to evidentiary material should be viewed as facts found by the court in light of its consideration of the record as a whole. II. PARTIES The parties are competitive distributors of hospital supplies. The term hospital supplies includes several broad product categories. Three product categories figure prominently in this case: medical-surgical supplies, parenteral solutions, and laboratory supplies. Other hospital product categories, such as office furniture, equipment, dietary or laundry products are of peripheral significance. For the purpose of this general introduction, medical-surgical supplies are disposable health care products, used in high volume by hospital personnel and generally used directly with the patient in the course of medical treatment. Parenteral solutions are intravenous nutritional fluids. Laboratory supplies are reagents and minor equipment items used by hospital laboratory personnel. Defendant is a national distributor of a complete line of hospital supplies. Plaintiffs are regional distributors of primarily medical-surgical supplies. The distribution function consists of purchasing products from manufacturers, warehousing then selling and delivering them in smaller quantities to health care institutions. The primary customers for this distribution service are hospitals. A. Plaintiffs. Plaintiff White and White Surgical Supply and Pharmacies, Inc. (White and White) is a Michigan corporation with headquarters in Grand Rapids. Eighty percent of White and White’s sales are of medical-surgical supply products. (T 730) An insignificant volume of sales consists of parenteral solutions and no sales are made of laboratory supplies. (Byington Dep. 12/12/79, at 65) Seventy percent of White and White’s sales are made to hospitals. (T 730) Other customers include physicians, nursing homes, retail pharmacies and industrial accounts. (T 852) White and White distributes from two warehouse facilities, one located in Grand Rapids and the other in Ann Arbor, Michigan. (T 679-680) The maximum sales area of the company includes the lower peninsula of Michigan, northwest Ohio and northeast Indiana. (T 862-863, DX 100) Corporate sales for fiscal 1980 were $18 million. (T 887) Plaintiff Bluefield Supply Co. is an industrial wholesale distributor with headquarters in Bluefield, West Virginia. (T 3880) Bluefield distributes hospital supply products through its subsidiary, Skyland Hospital Supply Division (Skyland). Seventy percent of Skyland’s sales are of medical-surgical supplies. (Rhodes Dep. 12/10/79, at 52) Ten percent of Skyland’s sales consist of parenteral solutions (Id. at 50) and no more than two percent of the sales relate to laboratory supplies. (Id. at 52) Sky-land’s primary customers are hospitals. (T 4007) Secondary customers include physicians and nursing homes. Skyland has two distribution facilities, one in Bluefield and the other in Riply, West Virginia. (T 3989-90) The maximum sales territory of the company includes West Virginia, Virginia and parts of Ohio, Tennessee, and Kentucky. (DX 201) Total sales for fiscal 1979 were $15 million. (T 4137) The Crocker-Fels Company (Crocker-Fels) is an Ohio corporation with headquarters in Cincinnati. Ninety percent of Crocker-Fels’ sales are of medical-surgical supplies. (T 376) Crocker-Fels makes insubstantial sales of parenteral solutions or laboratory supply products. (T 374, Smith Dep. 12/6/79 at 52, 57) Eighty percent of the company’s sales are made to hospitals and the remaining 20% are made to physicians and nursing homes. (T 377) Crocker-Fels maintains a principal distribution facility in Cincinnati, Ohio, and a secondary warehouse in Louisville, Kentucky. (T 372) Distribution is made to a maximum geographic area comprising a five-state region around Cincinnati, including parts of Illinois, Indiana, Ohio, West Virginia and Virginia. (DX 242-246) Total corporate sales in fiscal 1979 were $17.8 million. (T 608) The final plaintiff, Ransdell Surgical, Inc. (Ransdell) is a Kentucky corporation with headquarters in Louisville. Approximately 80% of Ransdell’s sales are of medical-surgical supplies. (T 94) Ten percent of sales consist of parenteral solutions and a small proportion of sales are of laboratory supplies. (Ransdell Dep. 12/4/79 at 49-50) Eighty percent of Ransdell’s sales are made to hospitals. The remaining business is done with physicians, nursing homes and in retail trade. Ransdell operates from a single warehouse located in Louisville. (T 98) The company’s maximum sales territory is the area around Louisville encompassing parts of Indiana and Kentucky. (DX 185) Ransdell’s sales for fiscal 1978 totaled $10.1 million. (T 209) B. Defendant. Defendant American Hospital Supply Corporation (AHSC), headquartered in Evanston, Illinois, is engaged in the manufacture and distribution of over 120,000 health care products and services. (PX 81) Organizationally, AHSC is subdivided into a series of divisions, each with a specialized manufacturing or distributing function. The following manufacturing divisions of AHSC are relevant to this case: the McGaw Laboratories Division, Pharmaseal Division, Convertors Division, Dade Division and V. Mueller Division. AHS McGaw Division manufactures and distributes irrigating and parenteral solutions and equipment for blood collection and storage. AHS Pharmaseal Division manufactures a wide range of disposable medical and surgical supplies such as needles, syringes, latex surgeon’s gloves, procedure trays and anesthesia products. AHS Convertors Division manufactures disposable products for use in hospital operating and obstetrical departments, such as surgical gowns, face masks, caps, shoe covers and towels. AHS Dade Division manufactures reagents and other scientific products. AHS V. Mueller Division manufactures surgical instruments, equipment and supplies. Other AHSC manufacturing units of lesser, but some, relevance include Hamilton Industries Division (office and laboratory furnishings), Edward Laboratories and Edward Pacemaker Divisions (biomedical devices for cardiovascular surgery), and Heyer-Schulte Division (implant products). (See generally PX 244, Appendix 1) AHSC distribution is carried out through the following divisions: McGaw Laboratory Division, Scientific Products Division, the American Hospital Supply Division, V. Mueller Division, Hospitex Division and the Dietary Products Division. McGaw Laboratory distributes its in-house manufactured parenteral solutions. Similarly, V. Mueller distributes its in-house manufactured surgical instruments and equipment. Scientific Products distributes reagent and scientific products manufactured by the Dade Division. The American Hospital Supply Division is the principal AHSC distribution unit for over 40,000 products which are primarily medical-surgical supplies. The Hospitex and Dietary Products Divisions distribute hospital textile and food products respectively. (See generally, PX 244, Appendix 1) AHSC is the largest distributor of hospital supplies in the world. Its national network of warehouses allows the corporation to distribute a complete range of hospital supply products to over 7,000 hospital customers. (PX 244, Appendix 1, at 26) In fiscal 1978, AHSC reported net sales of $1,741,709,000. (Defendant’s answer, ¶ 7) C. Voluntary Hospitals of America. The Voluntary Hospitals of America (VHA) is an association of hospitals which, though not a party, is alleged to be a co-conspirator of AHSC. It has appeared and filed a brief in this case as amicus curiae. The VHA is a for-profit corporation organized under the laws of Illinois and headquartered in Troy, Michigan. The shareholders of the VHA are 29 prestigious, nonprofit hospitals spread across 22 states. These institutions are acute care hospitals, with an average capacity of 650 beds. The VHA hospitals provide primary, secondary and tertiary medical care and in many cases are teaching facilities. The VHA was founded in 1977 to provide its member hospitals management services, research and development activities, economics of scale, cost containment mechanisms and political strength. (T 5018-19, DX 502) The VHA board members believe the voluntary, non-profit hospital system is more responsive to community needs than proprietary hospital chains. (Id.) The VHA also believes that large, prestigious non-profit hospitals have common goals, problems and needs which can be better understood and managed through a collective association. Another stated purpose of the VHA is to contain rising hospital costs. (T 4607, 4610, DX 502) Incident to this last purpose, VHA negotiates group purchasing agreements on behalf of the member hospitals. (T 4989, 5000, 8677) The Chief Executive Officer of the VHA is Robert Kitzman. The VHA is governed through a Board of Directors consisting of the chief executive officers of the shareholder VHA hospitals. Below the Board of Directors are subordinate committees which consider specialized problems. One such committee is the Materials Management Committee, which deals with product standardization among the VHA hospitals. Membership in the VHA is increasing under two expansion programs. Through a 1977 stockholder expansion program, a large (500 bed) hospital may pay $50,000 and become a voting shareholder member. Through a 1979 stockholder expansion program, a smaller hospital, sponsored by one of the pre-existing shareholders, may pay $1,000 and become a non-voting affiliate. (PX 164) The VHA has added several affiliates. A recent affiliate is the Affiliated Hospitals of Indiana which is a network of small and medium sized hospitals in central and southern Indiana. (T 4996) The VHA has had at least seven nominees for 1977 stockholder status and seven nominees for 1979 stockholder affiliate status. (PX 277, 331, 346) New members are expected to participate in all VHA programs. (PX 347, 331, 303) III. THE HOSPITAL SUPPLY INDUSTRY The focus of this antitrust inquiry is the hospital supply distribution industry. Distributors, by definition, purchase in bulk from manufacturers and sell a broader product mix in smaller quantities to their customers. Hospital supply distributors have developed certain practices for purchasing, inventorying, order processing and delivering supplies. A regional hospital supply distributor purchases a substantial portion of its inventory from approximately 15 to 20 major manufacturers. (DX 200) These suppliers are national manufacturers of a broad line of products which hospitals use in high volume. For example: Johnson and Johnson, a national manufacturer of adhesive and gauze bandages and, through its subsidiary, Ethicon, a major suture manufacturer (DX 301); Kendall Co., a major manufacturer of urological products; Sherwood Medical Co. and Becton-Dickinson, national manufacturers of disposable needles, syringes, vacutainers and blood collection equipment (T 4303, DX 302); and C. R. Bard, a major manufacturer of catheters, enemas, tubes, procedural kits and trays (DX 294). In addition to these major suppliers, distributors purchase a narrower range of supplies from many, more specialized manufacturers. A distributor may purchase supplies from 200 to 500 suppliers. (Rhodes Dep. 12/10/79 at 50; Ransdell Dep. 12/4/79 at 46) Distributors acquire inventory at discount prices by purchasing in bulk quantities from manufacturers. Manufacturers generally offer price discounts ranging from 5% to 15% on bulk purchases. A distributor normally must purchase goods in “truckload” quantities to be eligible for manufacturer price discounts. (T 742-744) Distributors, such as plaintiffs, generally earn a 10% to 15% gross profit margin. (T 742, 4015- 4016) Consequently, distributors regard the ability to purchase in bulk as essential. (T 742) A regional distributor, such as White and White, inventories as many as 10,000 products. (T 684) Plaintiffs maintain inventory in warehouses ranging from 7,000 to 88,000 square feet. (Smith Dep. 12/6/79 at 39, Rhodes Dep. 12/10/79 at 24) Hospital orders are solicited by distributors’ salesmen who make periodic visits to a hospital’s purchasing staff. An order is placed by the hospital with the distributor either manually with the salesman or by a computer order entry system that links the hospital to the vendor’s in-house computer. If manually received, the distributor enters the order into the in-house computer. The computer scrambles the purchase order and prints out a “picking ticket.” The picking ticket indicates a sequence in which an order can be filled by the warehouseman on a single trip through the warehouse. A copy of the picking order may also serve as the packing list or pre-invoice document for the customer. Once picked, the products are assembled in the shipping area and delivered to the hospital by truck, van or express mail. Emergency deliveries may also be made by cab or salesman’s car. If an order is entered into the computer for a product which is temporarily not in inventory, the computer records the item as “back ordered.” Back orders are filled as inventory is replenished. (See generally, Ransdell Dep. 4/8/80 at 86-92, DX 324, 327, 328) Hospitals generally purchase the bulk of their supplies from ten to fifteen primary suppliers. (DX 590, 363) Hospitals make remaining purchases of smaller volumes of products from thousands of suppliers. (PX 592) The volume and mix of supplies which a hospital purchases vary with the hospital’s function and size. Psychiatric and chronic care hospitals rarely perform surgery and consequently purchase a relatively small volume and narrow mix of hospital supplies. (T 3515) Acute care hospitals are the primary focus of this suit. Such hospitals buy a broad range and high volume of hospital supplies. Similarly, on a per-bed basis, larger hospitals purchase more hospital supplies than do smaller hospitals. This is because larger hospitals perform more surgery, perform more complex surgical operations, usually have large outpatient programs, and are often teaching facilities for the medical profession. The VHA hospitals are large, teaching hospitals and consume a large volume of hospital supplies. Purchasing for the hospital is done by a corps of buyers. The buyers are managed by a Materials Manager or Director of Purchasing. This supervisor is in turn managed by upper level hospital administrators who generally have little or remote purchasing experience and little involvement in the day-to-day purchasing function. Purchasing decisions are also influenced by the opinions of the hospital professional staff. Hospital supply products can be categorized into two classes: commodity products and user preference products. Commodity products are generic products selected by hospital purchasers without concern for brand name considerations. User preference products are manufacturer branded items, preferred because of product quality. Which particular products become user preference items will vary from hospital to hospital. Generally, products which are ingested, injected or physically applied to patients become user preference items. Product preferences are formed by the particular group of professionals who routinely use the product, typically, physicians or nurses. In some hospitals, professionals are organized into committees which test, evaluate and recommend products. The hospital purchasing department gives considerable weight to the preferences of its professional staff. Consequently, the staff or its committee is a key marketing contact for distributors’ salesmen. Hospital purchasing decisions are made in consideration of three factors: product quality, vendor service and price. The product quality factor pertains primarily to user preference items. Quality perceptions make a user preference item somewhat less price sensitive than commodity products. The possibility of a shift from one product to another product because of price fluctuation is minimized because of the brand allegiance of the hospital professional staff. However, interbrand competition does exist; manufacturers and dealers frequently request that their product be evaluated by the hospital staff. Intrabrand competition based on price and service also exists between competing dealers of the preferred product. Generally, the sale of user preference items yields a high profit margin; consequently, this business is highly desirable. In contrast, commodity products are high volume, fungible goods sold at lower profit margins. Commodity product profit margin is kept low by strong price and service competition. Vendor service is a second crucial consideration in a hospital’s purchasing policy. Distributors render several services to hospitals. Sales representatives are expected to call on large hospitals within their territory as frequently as two or three times a week. Salesmen explain new products, solicit and receive customer orders, arrange emergency deliveries and correct back order problems. Prompt, regular product delivery is expected and is essential to a hospital’s effort to minimize inventory costs. A distributor’s efficiency in product delivery is measured in terms of a vendor’s “lead time.” Lead time is the time that elapses between the hospital’s placement of an order with a vendor and the actual receipt of the products. Quick distribution, evidenced by a short lead time, allows a hospital to deplete its inventory to lower levels before reorder is necessary. Reliable distribution permits the hospital to set aside a smaller amount of inventory as a cushion against unexpected back order problems. In short, efficient distribution service allows the hospital to shift much of the inventory function onto the distributor and thereby maintain a smaller, less costly in-house inventory. Vendors cooperate in this process by estimating the requirements of important hospital clients and reserving a portion of their inventory for these hospitals. (DX 258, 360, 417) Incidental to rapid, reliable product delivery, many hospitals desire that their main suppliers have a computer order entry capability. A computer order entry system can create cost savings for distributors (T 5216-5217) but will not directly assist the hospital in reducing costs. (T 3627) Certain varieties of computer order entry systems which use computer cards may be keyed only to the sponsoring vendor. (Butschi Dep, 4/29/80 at 305) However, computer order entry systems which use a keyboard or teleprinter are capable of placing orders with any vendor having a complementary receiving terminal. (Butschi Dep. 4/29/80 at 370, T 723) The AHSC computer order entry system, acronymed ASAP, uses a Bell 43 printer as its basic entry hardware. (T 2954) This computer hardware can be used to gain access to other vendors. (T 723) In this period of rapidly escalating costs, hospitals are interested in minimizing the “total cost” of hospital supplies. This total cost includes both the cost of acquiring the product and the cost of managing the product within the hospital until its use in patient treatment. The internal material management cost associated with supplies is substantial. For every dollar spent to purchase a product, a second dollar is spent to manage that product to the point of end use. (T 3275, 3808-3810) Some distributors offer advice on hospital supply management. (PX1, ¶5, T7418, DX 567) Distributors also offer product consumption reports which summarize prior periodic and average purchases by the hospital from the reporting vendor. (DX 360 at 4, ¶ 12, PX 1) These reports and analyses are intended to aid the hospital in buying an economical product mix and minimizing internal handling costs. Opinions vary as to the value of these material management services. Some believe that the services are worthwhile. Others believe that the services are without value, either because they involve statistical analyses which the hospitals already can perform or because genuinely objective material management advice can best be obtained from an independent consultant and not from an interested supplier. (T 3713-3714) A final service expected of a major distributor is emergency delivery of products when the occasional need arises. Historically, price is the final and vital factor influencing a hospital’s purchasing decisions. Hospitals’ sensitivity to price has grown with government regulation limiting the third-party reimbursement system and proposed legislation to contain hospital costs. Vendors operate under various pricing policies. By a catalog or price list each vendor publishes a list price for each product. Prices may also be established by a vendor’s policy of “list-less” or “cost-plus” pricing. Under the list-less method, the hospital pays the list price appearing in a catalog less an agreed upon percentage discount. Under cost-plus pricing, the hospital pays the manufacturer’s cost on the product plus some additional percentage for the distribution charge. Prices established under these pricing policies are subject to change with any increase or decrease in the list price or the manufacturer’s cost. These basic pricing policies are often modified by special contract terms. Vendors frequently modify their pricing policies by offering a price cap or volume discount rebate. A price cap limits or “caps” any price increase of a product for the duration of a contract. Through a price cap term a distributor may agree to limit any price increase to a fixed percentage or agree to increase its price only in response to a price increase by the manufacturer. Under a volume discount provision, a vendor offers a price discount if the hospital purchases a stated high volume of product. The discount is often expressed as a percentage. The discount percentage rate is often graduated with progressively larger discount percentages matched to progressively larger purchase levels. Some volume discounts are cumulative meaning that if the hospital purchases enough to trigger the discount, the discount relates back to all of the hospital’s purchases from that vendor. Other volume discounts are incremental meaning that the discount applies to only those purchases beyond a stated volume. The discount is calculated at the close of the purchase period. Payment of the discount is made to the hospital in the form of a rebate check or a credit memo against any outstanding payment to the vendor. (PX 1, 472) Product quality, vendor service and price are factors which hospitals consider in making their purchasing decisions. However, hospitals use no uniform method to purchase supplies. 'Among the many methods used are formal competitive bidding, restrictive list bidding, negotiation, prime vendor contracts, standing orders, open orders, Z contracts, and manufacturer contracts with a choice of distributor clause. (DX 497,497a, T 7356-60, 7379-69, 9175-76, 9652-53 and 11916, DX 493, 494) In its most formal aspect, competitive bidding entails a hospital identifying a needed product, determining product specifications, soliciting written bids from vendors, evaluating the bids and selecting a vendor. (T 7357) Hospitals also use less formal variations of the competitive bidding process. Restrictive list bidding is much the same as general competitive bidding except that the hospital solicits bids from only selected distributors. (T 5206) Negotiation is merely price bargaining with a selected, usually the incumbent, distributor. (T 7358) Standing orders and open orders are types of agreements between a hospital and a vendor which are automatically renewed annually unless one party gives prior notice that the agreement is to be discontinued. (T 7368) An important type of purchasing arrangement often found between a hospital and a vendor is a prime vendor agreement. A prime vendor contract is a type of requirements contract in which the hospital relies on a specific seller to provide it with the bulk of a product line in return for the seller’s commitment to maintain adequate inventory, a high service level and lower prices. (T 3637) Large hospitals may have more than one prime vendor. (T 3647) Prime vendor contracts are usually for a short period of time or terminable on notice by the purchasing hospital. In addition to the above forms of purchasing arrangements between a hospital and a distributor, hospitals may on occasion bypass the distributor and arrange direct purchasing from the manufacturer. This is not customary because the hospital’s demand for flexible, rapid and reliable delivery of relatively small volumes of products is rarely compatible with a manufacturer’s bulk sales requirements and rigid delivery schedule. Two kinds of supplies are routinely purchased directly from manufacturers: (1) bulky or heavy products which hospitals use in high volumes such as parenteral solutions or bandages; and (2) expensive, high technology items which must be special ordered for a specific patient such as an artificial hip. (T 3571) Products in the first category are direct ordered because the heavy weight or bulk of the product, coupled with the hospital’s large demand for the good, makes truckload shipping efficient between the manufacturer and the hospital. The second category of products is sold directly because the product is an inherently individualized good which a distributor cannot efficiently inventory. Apart from these direct sales, the more common practice is for hospitals to deal directly with a manufacturer and then arrange for delivery for the product through a distributor. A hospital may deal directly with a national manufacturer, such as Johnson & Johnson, for a broad range of hospital supplies and have the agreement contain a clause specifying that the product shall be delivered to the hospital by a distributor of the hospital’s choice. (DX 218, 493, 494) A variant of this hospital-manufacturer agreement is the Z contract. Under a Z contract a hospital negotiates with a manufacturer for the purchase of hospital supplies. The contract contains a price term and gives the hospital the option of naming a distributor. The hospital names a distributor who delivers the product for the price specified in the manufacturer’s contract. The contract price may be above distributor’s cost, in which case the distributor obtains a share of the contract price, which represents part of the distributor’s profit. However, the Z contract price is invariably lower than the distributor’s sale price, and to obtain its normal profit, the distributor will look to the manufacturer for a contribution. (PX 244 at 15) Commerce in hospital supplies has been profoundly affected by spiraling health care costs. Health care is one of the most rapidly rising sectors of the American economy, currently costing $220-230 billion annually. (T 11874) ($247,000,000,000 according to a recent New York Times article.) Hospital costs account for 40% of all health care costs and have been one of the fastest escalating components in the general escalation of health care costs. (T 11875) Hospital costs rose at an average rate of 17.3% between 1974 and 1977. (T 11904) Currently, national spending on health is rising at about 15 percent a year. Increased hospital costs have had three major effects on the hospital supply industry. First, rising hospital costs have brought about a shift from reusable to disposable hospital supplies. Second, hospital cost increases have prompted a variety of government cost containment regulations. Third, the threat of more government cost containment regulation has prompted private cost containment efforts by the hospitals and hospital suppliers. As indicated above, hospitals in recent years have, to a large extent, shifted from reusable hospital supply products to disposable hospital supplies. Some experts believe this trend has now leveled off. In any event, the lasting effect of this trend has been to vastly expand the market for hospital supplies used in the course of patient care. Rising hospital costs have also triggered state and federal hospital cost containment regulations. Government cost control is the natural consequence of the fact that over half of all hospital expenditures are paid by some government reimbursement agency. At the federal level, the Social Security Amendments of 1972 limit Medicare reimbursement to prevent inefficient delivery of health services. Pub.L.No.92-603, Title II, §§ 223, 224. The statute influences hospital purchasing practices by admonishing the hospital to follow defined “prudent buyer provisions.” See Health Care Financing Administration, Provider Reimbursement Manual, § 2103. (T 11901-03) A second piece of complex federal legislation, The National Health Planning and Resources Development Act of 1974, 42 U.S.C. § 300k et seq. This Act requires regional planning in the development of health care facilities and encourages hospital shared services. At the state level, 27 states have regulatory systems which establish rate setting or rate review mechanisms over hospitals. (T 11887) Most state programs provide for “caps” which limit rates of increase for health care services. (T 11888) Some states also require prior state approval of hospital charges. (T 10881-84) Eighteen VHA hospitals are subject to some state rate review. (DX 630) All VHA hospitals are subject to federal laws limiting third-party reimbursement to health institutions. Apart from the existing government regulations noted above, federal legislation has been proposed to cap increases in hospital revenue. In 1977, President Carter proposed legislation which would impose a nine percent limit or “cap” on increases in hospital revenue. See, H.R. 6575, 95th Cong., 1st Sess., 123 Cong.Rec. 12085 (1977). Alternative legislation was proposed by Senator Herman Talmadge which would limit hospitals to reimbursement under rates to be established by HEW. See, S. 1470, 95th Cong., 1st Sess., 123 Cong.Rec. 13827 (1977). The private sector of the hospital industry, including AHSC (PX 280), has consistently opposed a system of mandatory government controls on hospital revenue. Such legislation has not been enacted. Instead, the hospital industry sought to establish a system of voluntary cost containment. (T 2532-33) In late 1977, the American Hospital Association, the Federation of American Hospitals, the Pharmaceutical Manufacturer Association, and the Health Industry Manufacturers Association established a private cost control program called the “Voluntary Effort.” (T 3218) The aim of the Voluntary Effort was to reduce the growth rate of hospital care expenditures from a level of 15.6% in 1977, to 2% annually- Rising costs and cost containment regulations have impacted the structure of the hospital industry. To achieve cost savings and maximize government reimbursements, many hospitals now engage in centralized planning, purchasing and management. Organizationally, two types of arrangements have come into use: (1) multi-hospital systems, and (2) shared services arrangements. (T 571-74, 3624-26, 3667-68, 3964-65, 5008, 5370-73 and 11925-27) Several forms of multi-hospital systems have developed in the United States. One such multi-hospital system is the proprietary (for profit) chain, such as Humana Hospital Corporation of America (HCA), and Hospital Affiliates International (HAI). (T 5177-78, DX 171 and DX 144) Several of the proprietary hospital chains are extremely large organizations. A recent proposed merger of two proprietary chains, HCA and HAI, would create a 40,000-bed chain, larger than any other investor-owned group and larger than most non-profit hospital groups. A second type of multi-hospital system is an association of non-profit hospitals structured along common religious affiliation, such as the Sisters of Mercy Hospital Group. Less formally organized are the shared services arrangements among independent, non-profit institutions. Generally such shared services arrangements are organized on a geographic basis. Typical of this kind of association is the Hospital Purchasing Services (HPS), which has 235 hospital members throughout Michigan, Ohio, Indiana and Wisconsin. (T 911, 13038) The VHA is structurally different from the above hospital associations. It is not an association based on common ownership, religious affiliation or regional ties. Instead, the common bond between VHA member hospitals is that each member is a large, prestigious, independent, non-profit hospital. This common status and a common financial and regulatory environment are believed to give rise to a set of common problems susceptible to group action. (DX 502) Some 100-200 hospital associations, referred to generally as purchasing groups, currently exist in the United States. (T 3625) A hospital may be a member of more than one group. (T 744, 918-19) Hospitals engage in group purchasing to obtain volume purchase price concessions. Some hospital associations, like the VHA, negotiate group purchasing agreements through their own for-profit corporation. Other hospitals retain a for-profit corporation to engage in group purchasing activities on behalf of the hospitals. An example of this latter practice is MedEcon Services, which for a fixed fee negotiates group purchases of hospital supplies for 81 client hospitals. (T 5181) Some purchase groups, such as MedEcon, require constituent hospitals to honor group contracts. These are “committed volume contracts.” Some hospital supply experts consider committed volume contracts to be the most effective group buying method for obtaining price concessions. (T 3620-21) Other purchasing agreements, such as the AHSC-VHA Agreement, do not expressly commit the hospitals to purchase the contracting vendor’s goods. (T 3739) The expert testimony presented to the court generally indicates that competition for hospital group business rarely proceeds on a single product basis. Usually, related products are organized into product lines and trade proceeds on this scale. The terms and conditions of hospital group purchasing agreements are similar to individual hospital purchasing agreements. Hospital group contracts commonly contain price cap provisions and volume discounts. (PX 1, DX 143, 149, 360) Deeper price discounts are usually accorded to hospital groups in recognition of their bulk purchasing. Group purchasing agreements which run as long as three years are not uncommon in the industry. (DX 360, 361, 414) Hospital associations employ a variety of competitive group buying techniques. One example is the practice of MedEcon Services. MedEcon obtains a double price discount by overlapping contracts with both the manufacturer and a distributor for a fairly narrowly-defined product line. (T 5196) Initially, bids are solicited from manufacturers. Normally, the preferred manufacturer must offer a price concession and price protection for the contract period in order to obtain the association’s bulk business. After negotiating a manufacturer’s price, MedEcon presents the business to various distributors and negotiates a further discount. Assured of manufacturer price stability and a committed volume of hospital business, distributors are willing to discount their services. A double price concession is thus obtained. (Id.) Hospital group purchasing has radically altered the service aspect of the supply distribution business. As noted earlier, hospital service requirements favor a vendor with local distribution facilities. Local distribution to members of a national hospital group is difficult for regional distributors. Some hospital associations, like MedEcon, divide national group purchase requirements among a series of regional prime vendors. (T 5210) Other hospital groups, such as the VHA, Humana, or Hospital Affiliates Incorporated (HAI), prefer to deal with national vendors who can service all members of the group. (Smith Dep. 12/6/79 at 177, 5/14/80 at 205) AHSC is the only vendor with complete national service capabilities. (Id.) The General Medical Corporation is the only other supplier capable of near national service. (DX 138, 292) Regional distributors have attempted to compete for large hospital group purchasing business by forming nationwide consortia of dealers which collectively negotiate and provide national service. One such effort is Abco. Abco is a collection of 35 dealers which contracts for the manufacture of a line of private brand products and seeks to market these products to hospitals and hospital purchasing groups. (Smith Dep. 12/6/81 at 181) Abco succeeded in contracting to several large hospital groups. (Id. at 182) Subsequently, Abco lost these contracts because constituent dealers were small and insufficient in number to service their large hospital customers. (Id. at 183) In 1979, sixteen regional dealers under the leadership of Crocker-Fels’ president, Rufus Smith, formed a second consortium, United Hospital Supply Co. (USHCo). USHCo was organized for the general purpose of selling hospital supplies to national and multi-state purchasing groups. Specifically, it intends to be an alternative competitor to AHSC as a national hospital supplier. UHSCo has already signed sales contracts with two multi-state purchasing groups, Hospital Affiliates International, Inc. and General Health Services. (DX 148-151) *>!<**** IV. THE PURCHASING AGREEMENT On July 5, 1979, AHSC and the VHA entered into the Purchasing Agreement which is at the heart of this antitrust action. The VHA is a signatory party on behalf of its member hospitals. The Purchasing Agreement expressly states that the member hospitals are third party beneficiaries to the Agreement and may enforce the Agreement against AHSC. (PX 1, ¶ 15) The Agreement has a life of 3V2 years beginning July 1, 1979. The Purchasing Agreement is unlike a traditional group purchasing contract. The VHA hospitals are not expressly obligated to purchase any AHSC product or service, nor is AHSC bound to sell any product to the hospitals at any stated group price. The product and price terms of any sale are to be negotiated between the individual VHA hospitals and AHSC. The Purchasing Agreement offers a series of financial benefits which will accrue to VHA hospitals if the hospitals, as a group, reach certain fixed purchase levels for AHSC goods and services. After reaching these group purchase levels, the hospitals become eligible for a volume discount and price cap. The price cap and volume discount provisions of the Purchasing Agreement apply to the sale of the following AHSC products: “medical/surgical, laboratory, dietary, laundry, housekeeping, parenteral therapy, surgical instruments and supplies, equipment and furnishings.” (PX 1, page 2, ¶ 3) These products must be distributed by AHSC. AHSC manufactured products which are distributed by other vendors are not included within the Purchasing Agreement. Paragraph 11 of the Purchasing Agreement provides for the volume discount to VHA hospitals on products purchased from AHSC after January 1, 1980. The discount is linked to the VHA group average, per-bed purchases of AHSC products within the calendar year. If the hospitals as a group fail to achieve an average purchase level of $2,000 per bed within the year, no volume discount is earned. Above this $2,000 threshold, the discount increases as the hospital group’s average per-bed purchases within the year increase. Below is a chart appearing in the Purchasing Agreement (PX 1) which indicates the necessary group purchase level to reach a corresponding incremental discount: AGGREGATE ANNUAL PER BED INCENTIVE PURCHASES PER BED DISCOUNT INCREMENTAL PER CALENDAR YEAR VOLUME $ 0 - $2,000 0.0% $2,001 - $2,500 1.0% $2,501 - $3,000 2.0% $3,001 - $3,500 3.0% $3,501 - $4,000 4.0% $4,001 - $4,500 5.0% $4,501 - 6.0% These volume discounts are a group-acquired benefit. The average purchases of the entire group determine the discount percentage. The Agreement does not require all or any VHA hospital to purchase at any threshold level to obtain the discount, nor can a single VHA hospital with a high per-bed purchase level alone qualify for the discount. The average purchase level necessary to earn the discount is measured by the hospitals’ purchases of AHSC products on a per-bed basis. The Purchasing Agreement notes that the VHA hospitals had a total of 20,501 beds as of July 1,1979. If the group purchases at the threshold level of $2,000 per bed, annual group purchases of $41,002,-000 must occur before any discount is earned. The volume discount percentage progressively increases as the hospital group purchases increase. The Purchasing Agreement provides the following hypothetical calculation of the discount which would accrue if the VHA group purchases reach $4,000.00 per bed. “If annual aggregate purchases by MEMBER HOSPITALS reach $4,000 per bed, the MEMBER HOSPITALS in the aggregate will earn: 1.0% of $500/bed (2,001-2,500) = $5.00/bed = $102,505 + 2.0% of $500/bed (2,501-3,000) = $10.00/bed = $205,010 + 3.0% of $500/bed ($3,001 - $3,500) = $15.00/bed = $307,515 + 4.0% of $500/bed (3,501 - 4,000) = $20.00/bed = $410,020 for a total of $1,025,050.” (PX 1, page 12) The discount is paid retroactive from the purchases in the form of a rebate. During the first quarter of the calendar year, AHSC will calculate the aggregate per-bed purchases for the preceding year to determine the rebate earned. Then AHSC will remit the rebate directly to the hospitals according to a distribution formula to be designed by the VHA. Paragraph 10 of the Purchasing Agreement provides for price cap protection. The price cap is also triggered when the hospital group’s average per-bed purchases reach a threshold level. The price cap provision divides the 3V2 year life of the contract into three price cap periods: an “initial period” from July 1, 1979, through December 31, 1980, and the two calendar year periods of 1981 and 1982. Price increases are limited to 9% within the initial period if the hospitals reach an average group purchasing level of $2,500 per bed. Price increases are limited to 6% in each of the two calendar year periods if the hospital group purchases average $3,400 per bed and $4,000 per bed respectively. The price cap operates through a dual pricing system involving a “base price” and a floating purchase price for each AHSC item. At the end of each price cap period, the base price plus the 9% or 6% growth factor permitted by the Agreement retroactively places a cap on the purchase price. Any difference between the purchase price paid and the inflated base price is refunded to the VHA hospitals as a rebate. During the initial period of the contract, AHSC and VHA will develop for each member hospital a list of “base products” each sold at a “base price.” The base products include (1) every AHSC product purchased by a particular hospital in June of 1979 at a base price equal to the purchase price of that product on July 1, 1979; and (2) every additional AHSC product purchased at any time during the initial period at a base price equal to the purchase price prevailing when the product is first bought. Throughout the life of the Agreement, each VHA hospital will negotiate with AHSC and pay the purchase price for any AHSC product it chooses to buy. The purchase price for a particular AHSC product may vary at different VHA hospitals. Also, at any VHA hospital the purchase price may increase or decrease during the price cap period. At the end of the price cap period, the aggregate purchase price for all AHSC products is calculated for each hospital. Similarly, the aggregate base price for all AHSC products is calculated for each hospital. The aggregate base price is inflated by 9% in the initial price cap period or by 6% in each of the two succeeding calendar years as stated in the Agreement. This inflated aggregate base price is the maximum amount due from each VHA hospital for the products it purchased during the price cap period. If the aggregate purchase price exceeds the inflated aggregate base price, the difference is returned to the hospital as a rebate. Between the three price cap periods established under the Agreement, the base price for each AHSC product is allowed to escalate. The average purchase price for the prior period becomes the new base price for the succeeding period. The following example, taken from the Purchasing Agreement, shows the process for calculating the cap prices and the amount of any rebate due: The Purchasing Agreement also offers to the hospitals, for a standard charge, use of the AHSC computer order entry system, known as ASAP. Also, AHSC offers each VHA hospital material management consulting services for a fee and offers, without charge, a customer purchase analysis report. (See, e.g., DX 567) V. IMPLEMENTATION OF THE PURCHASING AGREEMENT As noted earlier, the AHSC-VHA Purchasing Agreement is not a self-executing sales contract. VHA-member hospitals are not expressly obligated to buy any AHSC product or service. (PX 1, ¶ 8) Nor is AHSC obligated to provide the hospitals with any specific product or service at a definite price. Consequently, the Purchasing Agreement must be implemented by an underlying pattern of dealing between AHSC and the VHA member hospitals. The Purchasing Agreement contemplates this. It assigns the VHA the task of aiding AHSC in its presentation of various sales opportunities to the member hospitals. (PX 1, ¶ 8) The underlying course of dealing between AHSC and VHA does not conform to the arm’s length bargaining relationship traditionally found between buyer and seller. The VHA regards its major suppliers as “partners.” This partnership theory of business is evident in VHA group contracts with General Electric for the purchase of CAT scanners, with the Standard Register Company for the purchase of business forms, and with AHSC for the purchase of hospital supplies. (T 4986-4989, PX 85) AHSC fully concurs with this partnership theme. (PX 5, 8, 37) AHSC has used the partnership theme in its implementation of the Purchasing Agreement at individual VHA hospitals. (PX 8, 101, 104-112, 115, 118, 121) The Purchasing Agreement was introduced at each VHA hospital through a slide show presented by AHSC officials Robert Simmons or Terry Mulligan. (PX 149) VHA chief executive, Robert Kitzman, also participated in these presentations. (PX 6, 149) At the time of the slide show presentations, AHSC and the VHA anticipated that the VHA hospitals would increase their per-bed purchase levels from AHSC from $1,300 to $3,000 within the first year of the contract. (PX 3, 4) Implementation of the contract also involved the presence of AHSC official Robert Simmons at the VHA Board of Directors meetings even if the agenda did not pertain to the AHSC-VHA contract. (PX 132, 148) At some of these meetings, Mr. Simmons distributed a monthly progress report. The report ranked the VHA hospitals according to their per-bed purchases from AHSC and also showed the percentage of increase or decrease in each hospital’s purchasing level as compared to the prior period. (PX 146, 147, 148) These “scoreboarding” techniques were intended by AHSC to induce peer pressure among hospital chief administrators to support the Purchasing Agreement. AHSC expected the VHA hospitals would pressure each other to increase their purchases from AHSC so that the hospital group might qualify for the volume discount and price cap benefits. (PX 18, 138) Within each VHA hospital, AHSC also expected internal pressure to support the Purchasing Agreement. Hospital chief administrators were expected to require lower level hospital purchasing agents to purchase more AHSC products. (PX 45) VHA’s Robert Kitzman acted as an intermediary seeking to induce the VHA hospitals to convert their hospital supply business to AHSC. Kitzman worked with AHSC personnel to inhibit competitive bidding for hospital supplies at the VHA hospitals. (PX 38, 39, 40, 158) Kitzman and Peter Frechette of AHS Scientific Products Division agreed to work to “preclude formal bidding” by AHSC’s competitors. (PX 38) Kitzman’s notes dated September 18, 1979, taken during a planning meeting contain statements that AHSC divisions should be viewed as a “vendor of choice and that competitor bids should not be accepted.” (PX 39) Similarly, an AHSC memo dated August 14, 1979, states that Kitzman did not want the VHA hospitals to check out AHSC’s pricing via the bidding process. (PX 40) Mr. Kitzman viewed the volume discount and the price rebate provisions of the Purchasing Agreement as tradeoffs against any requirement that AHSC provide the lowest price on a product. In a letter to the purchasing agent for Baptist Medical Center, Kitzman noted that AHSC should not be expected to be the lowest bidder on hospital supplies in light of the price cap and volume discount incentives offered in the Purchasing Agreement. (PX 158) The VHA, through Robert Kitzman, also attempted to persuade VHA member hospitals to disclose to AHSC its competitor prices so that AHSC could “match” these prices if it so chose. (PX 3, 4, 12,14,15,17, 18, 19, 23, 31, 32, 35, 42, 47, 100, 170, 267) The Agreement to permit AHSC to review the hospital records about other vendors’ prices was made by the VHA Board of Directors, not by the individual hospital purchasing agents. (PX 3, 4, 12) AHSC sales representatives were told to confront hospital purchasing personnel diplomatically and draft a list of products convertible from other vendors to AHSC at an equal price. (PX 12) If permitted by the hospitals, AHSC sales representatives were to compile a price list of convertible products on a document entitled a product analysis form. (PX 11, 100, 24 at page 27304, 20) Some VHA hospitals disclosed competitors’ pricing information to AHSC personnel. (PX 17, 23, 32, 35, 42) At other hospitals, purchasing agents considered such disclosure to be illegal, unethical or unwise. (PX 12, Dietz Dep. 6/4/80 at 324, PX 33) AHSC also contacted hospital supply manufacturers and requested they provide pricing data on their VHA hospital clients. (PX 267, 70) The AHSC matching policy was not intended to apply on a product-by-product basis. Instead price matching was intended to establish an overall price equilibrium for the bulk of the converted products. (PX 14, 267, 15) A memo authored by AHSC official Bob Simmons explains the matching program. “Regarding your question on matching prices, we did agree to ‘be competitive’ with the broad range of products they will purchase from us. In other words if they will give us a majority of their products, we will be able to come up with overall pricing that will be equal to pricing they currently have. This does not necessarily mean that we will match every price but that where we are above some of their items we will compensate by being below their pricing in other areas.” (PX 14) The AHSC matching policy is limited by a “walk away privilege” by which AHSC could decline “unprofitable” business which the VHA hospital could obtain at an extremely low price from its usual vendor. (PX 45) A long-term implementation goal of the AHSC-VHA Agreement is to develop a series of standardized products to be used by all VHA hospitals. (PX 1, ¶ 6) The VHA Material Management Committee is responsible for product standardization. This committee requested that AHSC submit to it a list of potential standard products. No similar request was made of other vendors. (PX 36) The VHA Materials Management Committee toured AHSC’s California and Illinois facilities and later recommended to the VHA Executive Board standardization on four AHSC Pharmaseal products. (PX 52, 36) The four AHSC Pharmaseal products were subsequently standardized. AHSC expects increased standardization of its products. (PX 36) Implementation of the Purchasing Agreement at one particular VHA hospital, Charleston Area Medical Center (CAMC), in Charleston, West Virginia, involved the hiring away from Skyland of salesman Paul Bush by AHSC. Mr. Bush was Skyland’s highly successful sales representative at CAMC. His sales accounted for $5.8 million of Skyland’s hospital supply business. (T 4128) In 1978, Bush earned in excess of $100,000 in commission from Skyland for his sales in CAMC. (T 4103) Had he remained with Skyland during 1979, his annual income again would have exceeded $100,-000. Prior to his decision to leave Skyland for AHSC, Skyland had determined to lower his commission rate, thus lowering his earning potential. (T 4103) Bush was distressed by this commission rate change. (Bush Dep. 7/1/80 at 222-224) In July, 1979, Bush met with AHSC officials in Chicago. (Bush Dep. 6/18/80 at 157-170) During the visit, the AHSC-VHA Purchasing Agreement was discussed, as well as the future of small hospital supply firms. (Id. at 167-170, 178, 187-189) Later CAMC officials, Messrs. Dietz and Lowe, informed Bush that CAMC would support the Purchasing Agreement and that Skyland would lose much of its business at that hospital. (Bush Dep. 7/1/80 at 218-220; Lowe