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GPOs’ Business Practices Questioned

06 September, 2012

Questioning the business practices of Hospital Group Purchasing Organizations (GPOs) tends to bring forth the ire of sector’s most ardent apologists. They are the organizations’ rapid response team, always at the ready to rebuke any and all criticism. Armed with well-tested statements alleging the groups’ magnanimity, efficiency and cost savings to hospitals, to hear them tell it, GPOs are saving the U.S. healthcare system tens of billions of dollars annually.

Despite the spin, there simply isn’t any solid evidence from any source that these organizations are saving hospitals and/or taxpayers any money. [1]  Due to the model’s complexity, the data cannot be evaluated with satisfactory statistical confidence. What we do know is that GPOs are at the root of an increasingly oligopolistic healthcare system that is stifling innovation, thwarting competition, jeopardizing the supply-chain and interfering with the autonomous purchasing choice of hospitals.

According to the Government Accountability Office,” in 2007 the six largest national GPOs by reported purchasing volume together accounted for almost 90 percent of all hospital purchases nationwide made through GPO contracts.” [2] Since that time, consolidation has resulted in just three firms, MedAssets, Premier and Novation controlling over 80% of purchasing volume. [3] These few firms can dictate which drugs, devices and supplies are used in hospitals and which manufacturers are permitted to gain entry into the healthcare supply-chain.

  “. . .some of these agreements. . . provide that a signing hospital cannot solicit rival bids, examine rival products, or even entertain rival proposals.” [4]
Einer Elhauge, Professor of Law, Harvard Law School

By way of background, GPOs were originally created as non-profit collectives to drive down purchasing costs for hospitals. By pooling resources, GPOs negotiated high volume, low margin contracts with pharmaceutical, medical supply and device companies on behalf of member hospitals. Originally, GPOs charged fees to hospitals to cover their overhead and worked diligently toward negotiating cost savings for their members. The model worked to the advantage of hospitals, manufacturers, patients and taxpayers – for awhile. Then, in 1986, Congress passed legislation that provided a statutory safe harbor for GPOs under the Anti-Kickback statute. As a result, GPOs now finance their organizations, not by membership fees, but through payments from manufacturers of between 3 – 9.9% of purchases. [5]

According to analysis from the Senate Judiciary Committee, by collecting fees from manufacturers, GPOs now have a greater incentive to sell more products at higher prices to hospitals.  The exemption has led to a pernicious ‘mission creep.’ GPOs are now increasing their capital base, not just through kick-backs from manufacturers, but also through schemes involving various ‘voluntary’ marketing fees, also charged to manufacturers. These ‘side-bets’ are used as leverage by manufacturers to win sole-source or preferred-source GPO contracts. More aptly called ‘monopoly concessions’, these fees favor large incumbents and drive out healthy competition. By no means cheap, these so-called ‘voluntary’ fees can run into the millions of dollars.

 ‘When suppliers finance buying groups’,  “you get the tail wagging the dog.”
- R. David Nelson, former director,  Institute for Supply Management

What has set in is a perverse kind of greed. Rather than fostering competition, the GPO model thwarts it. Rather than leveling the playing field, it decimates it. Rather than spurring innovation, it kills it.

”We have heard startling allegations of scandal and conflicts of interest that have infected these groups . . . these practices are appalling and cannot be tolerated.”
- Senator Herb Kohl

Not surprisingly, monopoly concessions can have dire consequences. Locking out competitors in the supply-chain has already led to critical drug shortages, sending hospitals scrambling to obtain medications for their patients. In addition, lifesaving new medical devices from entrepreneurial firms have been denied access into the healthcare supply-chain.  Unfortunately, the problems caused to the nation’s healthcare system by anti-competitive practices cannot be easily remedied. After a long campaign by large manufacturers to lock-out smaller competitors from GPO contracts, there simply aren’t many small competitors left. The damage done to entrepreneurs is incalculable. The affect on innovation in the U.S. healthcare system may be irreparable.

Venture capital needed to develop new drugs and devices has been drying up for years. According to Elizabeth H. Weatherman, managing director, Warburg Pincus, New York, private equity is reluctant to finance new medical technology because the “collusion” between GPOs and large manufacturers serves as a barrier to entrance, preventing smaller companies from gaining enough traction to become profitable.

What is most egregious is that this information has been in the public realm for at least a decade. Sworn testimonies before Congressional Committees have shown the need for regulatory action, specifically the reversal of the “safe-harbor” exemption. However, to do so just might bankrupt the GPOs, and no one in Congress seems to have the intestinal fortitude to deny this po­werful group its corporate welfare.

In recent years, we have seen far too much of ‘crony’ capitalism. The concept of fair competition has long been considered part of what makes the United States one of the best places in the world to conduct business. Given our nation’s ideals, including that of ‘equal’ opportunity, it is disappointing to see that a protected class has been permitted to leave the level playing field far behind.

For those that dedicate their lives to medicine, the inherent conflicts built into the hospital GPO system should be appalling. Fortunately, there are alternatives. Many in the hospital sector are leaving the GPO machine behind. Some are leaving merely out of conviction, while others simply see the logic of disintermediation (cutting out the middleman). Anecdotally, we know of many hospitals that have saved money by abandoning the GPO system all together.  For instance, after Virtua Health in New Jersey cut its ties with its GPO, the savings were enough to give its nurses significant raises, expand its emergency rooms and improve its operating rooms.

“As a Catholic nonprofit, we believe we have a responsibility to be good stewards of our resources.”
- Stephen Shivinsky, Trinity Health spokesman

In a healthcare environment of rapidly increasing costs and declining reimbursements, choice is unquestionably beneficial to all participants.

“Nothing should come between the company and our customers: that includes price, service, quality or third parties.”
- Mark E. Biehl, CEO, North Coast Medical, Inc.

[1] United States. Congress. Senate. Senate Finance Committee.  Empirical Data Lacking to Support Claims of Savings With Group Purchasing Organizations, 111th Congress. September 24, 2010
[2] ibid.
[3] ibid.
[4] .  Elhauge, Prof. Einer,  “The Exclusion of Competition for Hospital Sales through Group Purchasing Organizations.”  (June 25, 2002).
[5] United States. Congress. Senate. Senate Finance Committee.  Empirical Data  Lacking  to Support Claims of Savings With Group Purchasing Organizations, 111th Congress. September 24, 2010

Works Cited/ Links

1. Litan, Robert E.  & Singer, Hal J.  “Do Group Purchasing Organizations Achieve the Best Prices for Member Hospitals? An Empirical Analysis of Aftermarket Transactions,”   Navigant Economics, Oct. 2010
2. Qiaohai (Joice) Hu, Schwarz, Leroy B. and Uhan, Nelson A.. “The Impact of Group Purchasing Organizations on Healthcare-Product Supply Chains.” (2011)
3. United States. Cong. Senate. Senate Finance Committee.  Empirical Data  Lacking  to Support Claims of Savings With Group Purchasing Organizations, 111th Congress. September 24, 2010
4. Blake, Mariah.  “Dirty Medicine”, Washington Monthly (2010)
5. Bogdanich, Meier, Williams and Walsh.  “MEDICINE’S MIDDLEMEN; Questions Raised of Conflicts At 2 Hospital Buying Groups,”   The New York Times (2004)
6. DeLay, Daniel .  Watch Out For GPOs: Group purchasing organizations   may be driving your medical costs higher,” Forbes (2004)
7.  Elhauge, Prof. Einer,  “The Exclusion of Competition for Hospital Sales through Group Purchasing Organizations.”  (June 25, 2002).
8. Mundy, Alicia. “GPOs Back Under the Microscope” , The Wall Street  Journal (July 7, 2010)
9. Pitts, Peter, J. “Drug shortages? Look to the middleman”
Washington Examiner(April 21, 2012)
10. Sethi, Prakash, “Group Purchasing Organizations:
An Undisclosed Scandal in the U. S. Healthcare Industry
,” New York: Palgrave/Macmillan, 2009
11. Toscana, Nick. “ Making self-contract work in a contracting world.”
Healthcare Purchasing News
(January, 2003)
12. U.S. Government Accountability Office, Group Purchasing Organizations: Services Provided to Customers and Initiatives Regarding Their Business Practices, GAO-10-738, Aug. 2010.
13. Walsh, Mary Williams. “Senators Investigate Hospital Purchasing.” The New York Times. (August 14, 2009)
14.  Zweig, Phillip & Zellner, Wendy.“Locked Out Of The Hospital Businessweek, ( March 15, 1998)