Research

Group purchasing organizations encounter troubled waters in the 'safe harbor'

A controversial regulation creates a "safe harbor" from antitrust laws for certain aspects of the relationship between suppliers and group purchasing organizations (GPOs) in the healthcare industry. The scenario: Hospitals join the GPOs, which negotiate group contracts with manufacturers for supplies ranging from syringes to operating tables. The manufacturers pay "administrative fees" to the GPOs — the very organizations responsible for evaluating and selecting products from competing manufacturers. Is it a kickback, or a discount rewarding the efficiency of group contracting?

2008-01-16

Six years after conflict-of-interest allegations prompted ongoing reforms among group purchasing organizations (GPOs) in the health care industry, Congress still hasn't closed a controversial loophole, critics say. At issue is a regulation that creates a "safe harbor" from antitrust laws permitting what would otherwise be considered illegal kickbacks between suppliers and buyers.

The "kickback" occurs during this scenario: Hospitals join the GPOs, which negotiate group contracts with manufacturers for supplies ranging from syringes to operating tables. The manufacturers pay "administrative fees" to the GPOs — the very organizations responsible for evaluating and selecting products from competing manufacturers. A kickback, or a discount rewarding the efficiency of group contracting?

Point of disagreement

Until the safe harbor is eliminated and the loophole is closed, government and consumers will continue to pay more than is necessary for health care, according to Mark Leahey, executive director for the Medical Device Manufacturers Association, a nonprofit group based in Washington, D.C.

Given the astonishing growth in U.S. health care costs, it's hard to name another industry where GPOs would seem to make more sense. Health care costs doubled from 1993 to 2004, according to the Centers for Medicare and Medicaid. More recently, during a 12-month period in 2006–2007, the cost of living grew 3.3 percent, while the national medical bill jumped 8.4 percent. "There is no business justification for this model — it's not efficient," Leahey said, referring to the middleman system.

In addition, GPOs have little motivation to squeeze contract prices, as they collect a percentage of the total contract value, he continued. "Congressional intervention created this dynamic, which has harmed competition and innovation and inflated the cost of health care," Leahey noted.

While the current system may not be ideal, writing more laws to impose heavier regulation on GPOs isn't the answer, said Eugene Schneller, a prominent healthcare researcher and a professor at the W. P. Carey School of Business' health management and policy program. He authored a 2000 study titled "The Value of Group Purchasing in the Health Care Supply Chain."

"We don't need further legislation, because the GPOs are apparently doing a very good job at self-policing. They've put together a code of conduct that has changed a good number of contracting behaviors," Schneller explained. They are very committed to acting on their charge to increase diversity in suppliers."

Studies indicate that almost all American hospitals belong to at least one GPO, indicating members endorse the GPO system, he added. "I'm not trying to be Pollyanna-ish, but even when hospitals don't use a GPO to buy certain types of things, such as prosthetic knee and hip joints, they often use the GPO price as a reference for their own negotiating purposes. This creates some needed tension in the market and provides value to members," Schneller said.

He points out that some hospitals are dealing directly with vendors, partly or altogether, bypassing traditional GPOs in favor of negotiating their own purchasing contracts, even for mundane, high-volume items such as gloves and syringes. Others, including the 19-hospital Sisters of Mercy Health System, based in Chesterfield, Missouri, actually are GPOs representing a relatively smaller set of organizations.

GPOs still evolving

That doesn't mean the healthcare GPO is dying out, though. For one thing, banding together to negotiate for better prices still makes excellent sense, especially since many hospitals continue to struggle financially. Add to that the well-known financial stresses hospitals face: pricey equipment and technology cost increases; the ongoing drain of government-required IT improvements; decreased profits due to Medicare, Medicaid and insurance discounts; and the ubiquity of un-reimbursed patient care.

Instead, Schneller predicts that the GPO model will change — but not in terms of being more closely regulated. He describes a system of organizations "with core competencies such as negotiating contracts and strategic sourcing, and new, added services."

What kind of services? Assisting hospitals with process improvement strategies, asset management, or various consulting specialties such as product standardization. Looking forward, we'll likely see more services offered that help hospitals improve the revenue cycle, like drug-cost or inventory management.

Like Leahey, distributor Alan Grogan insists he isn't anti-GPO, just anti-safe harbor — a provision that allows GPOs to recover as much as 3 percent from suppliers as a result of their efforts to reduce the transaction costs through national contracting.

As the owner of Grogan's Healthcare Supply in Lexington, Ken., and spokesperson for the non-profit group, Competitive Access in Healthcare Distribution (CAHD), he particularly objects to being shut out of rebates that GPO members get when they buy from the manufacturers rather than through distributors. Organizations endorsing CAHD's position paper include Associated Medical Products of Indianapolis, Ind., Schryver Medical in Denver, Colo., and Pharmed Corp., in Westlake, Ohio.

"Legislators don't understand the problem, because it's complicated," Grogan continued. Most GPO contracts involve the manufacturer selling it to the entity that uses it, he said. "But the vast majority of hospital commodities like syringes, sutures and gloves tend to be negotiated by manufacturers but sold through distributors like me."

Example: A company that makes a popular line of syringes contracts with all GPOs, but close to 100 percent of its products are sold to distributors, who in turn sell to GPO as well as non-GPO clients. "The difficulty is the mechanism by which the syringe maker gives discounts. The discount to GPO members is funneled through companies like mine, which take title to the product. We want access to the same rebate situation," he explained.

A more even playing field

On its Web site, CAHD lists a number of demands, including access to manufacturers' eligibility lists to identify "all end-user customers in the distributor's geographic market and their GPO affiliation." Another demand: enable distributors to see product contracts with rebated costs for every GPO with a member in the company's geographic market. Finally, they call for manufacturers to honor all rebates without asking the GPO's permission first.

"Contrary to what some people think, I agree that GPOs have saved a lot of money for the healthcare system. But removing the safe harbor won't eliminate their mission, just remove the potential problems it causes," Grogan said. In contrast, Curtis Rooney is convinced that fiddling with the existing safe harbor would be a mistake.

Rooney is president of the Health Industry Group Purchasing Association (HIGPA). Based in Washington, D.C., the trade association represents more than 20 GPOs. Rooney concedes there once were "perceived conflicts of interest" in the GPO environment, but that the four Congressional hearings held since 2002 prompted organizations to revamp contracting practices, among other things.

For instance, HIGPA members are asked to comply with an annual survey and follow ethical guidelines set out in its "Health Group Purchasing Initiative," which includes sharing information publicly about their business practices. Because GPOs now police themselves, and sufficient legislation governing contracting already exists, HIGPA would "prefer not to have any further Senate hearings in 2008."

Led by Sen. Herb Kohl (D-Wisconsin), legislators were rumored to be planning another run at GPO regulation in late 2007, but nothing emerged by year-end, despite a high-profile whistle-blower lawsuit. In fact, the subcommittee hasn't held hearings on the subject since 2006, Rooney said — perhaps an indication that government concern has faded as GPO self-regulation progressed. "We think we've done a remarkable job at turning the industry around and creating our own ethics initiative," Rooney said.

Rooney's group is considering backing a bill co-sponsored by Sen. Kohl that would require pharmacy and medical device manufacturers to disclose any gifts provided by physicians. "We are looking at this now. Due to our own efforts at being transparent, we would like their business practices to be transparent, too," he continued. "We're holding a meeting next week and members of Congress and their staff are invited."

Future?

U.S. hospitals utilizing group purchasing organizations have high expectations for satisfaction in their GPO membership, Schneller says. He heads the W. P. Carey School's Health Sector Supply Chain Research Consortium, which has membership representing major hospitals across the U.S., GPOs, and health sector information technology companies.

The consortium continues to assess the ways that supply chain innovation and organizations affect the performance of the health care system. One of its member organizations, Catholic Health Initiatives in Denver, is working closely with its 30 hospitals to bring increased savings, through collaborative practices, to its $1.3 billion health care supply spend. Schneller believes that GPOs will continue to be an important force in a very complex and frequently fragmented health care system.

Bottom Line:

• Health care costs doubled from 1993 to 2004, according to the Centers for Medicare and Medicaid. From 2003 through 2007, healthcare costs rose an average of 9.3 percent each year (note: the increase slowed from 2006 to 2007, to 8.4 percent). The role of GPOs will become increasingly crucial because the cost of medical supplies in the hospital environment is predicted to "equal if not exceed" labor costs, traditionally a facility's biggest expense. Why? "The hospital is becoming a place for more acute care. Less costly types of healthcare are being taken outside of its walls; what is left is turning into a more material-intensive environment," Schneller explains.
• Strategic sourcing and contracting, Schneller adds, are not always core competencies for hospitals. Indeed, this is an area where increased "outsourcing" of these activities to GPOs, with high expectations for significant price reduction and increased services from suppliers, makes great sense,
• According to a 2007 Verispan list, the three largest GPOs, defined by number of hospitals and beds, are Novation, with 2,541 hospital members and 480,224 staffed beds; Amerinet, with 1,817 hospital members and 213,823 staffed beds and MedAssets Supply Chain Systems, with 1,717 hospital members and 246,330 staffed beds.
• SCMetrix, a collaborative venture between the W. P. Carey School of Business and the Association for Health Care Materials Management will be collecting information from a wide range of America's hospitals on how their relationships with GPOs affects their own performance.

Health Finance Faculty