GROUP PURCHASING ORGANIZATIONS

      WHAT IS A GROUP PURCHASING ORGANIZATION ? 

   Most hospitals in the United States procure their supplies through Group Purchasing Organizations ( GPOs ). GPOs negotiate vendor contracts that are intended to save money for the hospitals and other health care providers, such as nursing homes. The genesis of GPOs can be found in the common and quite essential activity where a number of small organizations combine their purchasing power to gain buying leverage on their suppliers to negotiate for lower prices and other discounts for related services. Buying cooperatives, or collective buying initiatives, of this type can be found in a number of industries, especially when they are in the early stages of their growth. 
   The first known hospital GPO was the Hospital Bureau of New York, founded in 1910. The proliferation of the GPO industry had a humble beginning. They were generally established by groups of small hospitals. For about 50 years, the GPO concept grew slowly. By the early 1970s, with the establishment of Medicare and Medicaid, there were 40 hospital GPOs in the United States. (http://www.ftc,gov/ogc/healthcarehearings/docs/03092bloch.pdf)
   As companies in an industry grow, they become more complex and managing their supply chain function may take different paths along a continuum. At one end, companies may create their own purchasing departments, which manage all aspects of purchasing and other elements of the supply chain. At the other end, highly specialized middlemen may emerge to provide one or more of these services with greater efficiency in terms of product groups or concentrated geographical areas. Some hospital groups have chosen to locate these services within their own organizations or more recently through Integrated-Delivery Networks (IDNs). However, a great many others have opted to work with independent middlemen, that is, GPOs. A large majority of the hospitals procure their supplies through GPO-negotiated vendor contracts. 
   The modern-day GPOs could not be more different than their early predecessors. Rather than mere servants of their hospital masters, the new GPOs are giant behemoths in a very large industry. The GPO industry is a classic example of a highly concentrated oligopolistic structure, where a handful of companies control more than 80 percent of the hospital supplies purchased through GPOs. This oligopolistic market structure has allowed these, mostly privately owned and controlled entities, to extract excessive rates of return for their own benefit   and to the detriment of their member hospitals.  In an economic situation that has been characterized by drastic increases in healthcare costs and inefficiency, the GPO oligopoly is a major factor of heretofore unrecognized significance. 
   GPOs as middlemen present a set of unique opportunities, which makes their role as agents to be highly lucrative. As agents, they operate with rather limited obligations of due diligence and fiduciary duty to their clients. They have also received special protection from antitrust laws. And lastly, while a very large part of their income is derived ---directly or ---indirectly from government programs such as Medicare and Medicaid, the responsible government agencies have bee indifferent and inept in ensuring that government funds are prudently used. 
   An inevitable outcome of this state of affairs is that the system favors agency at the expense of stewardship. The GPOs' primary role is that of providing a service to their healthcare clients, for which they assess a service charge. However, as privately owned independent organizations, they also seek to maximize profits for their shareholders. Under normal conditions of competitive markets, these interests are balanced by market forces. This however, is not the case for the GPO industry. The enormous size of the industry, and the fact that it controls buying power of such magnitude, would raise anticompetitive concerns under the best of circumstances, that is, freely operating competitive markets. In the case of GPOs, the potential for abuse is even greater. As middlemen, they carry little risk or incur additional costs arising from normal business operations. The justification for their services ---and the cost of these services, that is, GPO revenues---must rest on the criterion of efficiency, that is, low unit transaction costs arising from economies of scale, which would yield greater benefits to their clients and masters, that is, hospitals, nursing homes, and other healthcare organizations. However, these efficiencies and cost savings are unlikely to occur, if the agencies' costs, that is, opportunities and incentives toward self-enrichment on the part of GPOs, are not controlled. 

                                  SOURCES OF REVENUE

   GPOs derive most of their revenue (more than 50 percent) from administrative fees paid by manufacturers and distributors, effectively capped at 3 percent of purchasing volume in tandem with Medicare Safety Harbor regulations. This was confirmed in the report prepared in May 2005 by the Office of Inspector General (OIG) , U. S. Department of Health and Human Services. This report indicated that "three GPOs collected $513 million in revenues for the period reviewed, mostly from administrative fees. 
   Notwithstanding, GPOs also derive a handsome portion of their revenue from other "fees" paid by suppliers in excess of the 3 percent cap stipulated under Federal safe harbor regulations to attract GPO business. Estimates by various sources indicate that these fees can range anywhere from 6 percent to 18 percent of purchasing volume. In addition, another source of revenue is derived by GPOs from distribution fees levied on suppliers. Health Industry Distributors Association estimates that GPOs charge Medical Products Distributors, particularly those serving acute care facilities , a distributor's fee in excess of 11 percent computed on a basis greater than the cost of the distribution service provided. In some cases, GPOs may also receive a patronage fee or patronage dividend from a supplier as a reward for the successful negotiation of a contract with a GPO. 

                        EXAMPLE OF A MAJOR GPO

   Based on the number of covered hospitals, Novation is by far the largest national purchasing organization. It is also the largest GPO in the United States based on the volume of purchases. In the last several years, the company has been experiencing a stable annual purchasing growth of 13 percent. In 2007, Veterans Health Administration, University HealthSystem Consortium, and Provista members used Novation and alliance contracts to purchase $33.1 billion in supplies and services. 
   Novation was established on January 1, 1998. It is an affiliate of healthcare alliances VHA and UHC and conducts supplies and services contract purchasing for VHA and UHC and conducts supplies and services contract purchasing for VHA, UHC, and Provista. Novation currently is one of Cardinal Health's biggest GPO customers. 
   The company procures medical equipment and supplies, pharmaceuticals, laboratory equipment, food, and other products needed to run healthcare facilities. 

   Many GPOs, including Novation are widely believed to demand excess fees from manufacturers. Novation extracts fees from manufacturers in a number of ways. It requires suppliers to sell through private label brand called NovaPlus, the largest comprehensive private label program in health care. The company also uses Marketplace@Novation and other incentive and performance-based programs such as OPPORTUNITY, the most active online exchange of its kind in the industry, to expand its presence in the market. In 2000, Novation got control over the electronic marketplace through the acquisition of e-commerce company Neoforma and partnering it with Premier's (another GPO) Global Healthcare Exchange (GHX), LLC.