The GPOs: Where do they go from here?

Want to know one question about the GPOs—Group Purchasing Organizations—that no one can really answer? Try asking how many of them are actually out there!

Even if you limit the GPO universe to those active in healthcare, not even the General Accounting Office tries to put an actual number on it, noting only that the industry trade group, HIGPA, says that hundreds exist in one form or another. In foodservice, perhaps only a dozen of these are highly visible. But if you consider the fragmented nature of long term care facility ownership, as well as the prevalence of regional co-ops, the picture gets muddier.

Such groups have existed for years, not only among operators but also for groups like independent distributors. Yet it has been in healthcare that the term "GPO" has risen to prominence and taken on an identity of its own.

Much of their growth has been in response to intense cost-containment pressures exerted by managed care plans and the government, via Medicare and Medicaid. As a result, group purchasing arrangements have become almost universal in acute care and have spread rapidly in the long term care segment.

For self-operated foodservice departments, GPOs are often seen as essential to efforts to remain independent in the face of aggressive sales efforts targeted at hospital administrations by foodservice contractors.

Consolidation, too, has raised the stakes. Today the seven largest GPOs account for more than 85 percent of all hospital purchases nationwide, with a combined volume of over $60 billion. And the two largest organizations—Novation and Premier— account for more than half of all GPO volume.

Mines in the safe harbor

GPO contracts cover everything from ballpoint pens to CAT scanners, carpeting to syringes. Foodservice, which typically represents less than six percent of an acute care facility's expenditures, is not considered a primary driver when hospitals determine the GPO to which they will belong.

Still, GPOs do seek to drive member compliance within the full portfolio of their programs, and in that way have become a major factor in foodservice. As they penetrate long term care, where food expenditures often represent 50 percent or more of a facility's total, they may prove even more significant.

Finally, the influence GPOs wield is not without controversy. Their business models have long raised antitrust questions (see sidebar, p. 64), especially since so-called "safe harbor" provisions in federal law exempt them from some anti-trust rules. And recent moves by some to carry healthcare foodservice programs into other segments have raised class-of-trade and other channel concerns for manufacturers.

In this article, we'll take a brief look at these issues and also profile some of the more significant groups active in foodservice. But first, it's worth reviewing how the GPOs grew into the major force they are today.

Looking back

Students of the industry trace the origin of GPOs to the turn of the century, when local hospitals occasionally banded together to demand better utility rates from steam or power suppliers. But "most of the GPOs we know today had their roots in large metropolitan-area hospital associations," says Tom Wessling, vice president of nutrition and facility services at St. Louis-based Amerinet.

"They came together for advocacy, to deal with Blue Cross and Blue Shield, and then looked at purchasing. In the 1970s, med/surg supplies, lab services and IV solutions represented the big dollars in purchasing budgets and that's where they focused initially."

Food was eventually added to the list. Many original programs were little more than "market basket" spreadsheets, circulated to local distributors for price bids, then turned over to member hospitals.

The formation of VHA (Volunteer Hospitals of America) in 1977 was an early milestone, representing an effort to bring big hospital purchasing "clout" to the many community hospitals in its membership. Other GPO consolidation followed.

Premier as we know it today was formed in 1996, a merger of Premier Health Alliance, Sun Health and American Health Systems (AMHS). Novation followed two years later, a joint venture of VHAand UHC (the University Health Consortium).

On the distribution side, a ground-breaking move occurred in 1989 when Kraft Foodservice (one of the predecessors of US Foodservice) allied itself with Baxter, a leading healthcare supply organization. That eventually gave the distributor a dedicated field sales organization, and clearly positioned it as a healthcare specialist. It became the basis for the division known as Dietary Products and eventually paved the way for US Foodservice's unique position today as sole-source provider to both Premier and Novation.

A big change came for operators in the 80s with the advent of DRGs (Diagnostic Related Groups) and the "flat fees" they entailed.

"Hospitals were no longer automatically reimbursed for their costs," Wessling says. "Cost management began to receive much more attention. At the same time, outsourcing became a buzzword. If you weren't doing a good job managing your costs, your job could go away. That idea brought a lot of focus to the issue."

The Shift in Power

As GPOs grew larger, another change began to take place. Until then, most purchasing contracts were cost-plus arrangements with distributors, often hard to audit, with distributors negotiating their own pricing and allowances separately with manufacturers.

When GPOs only obtained rebates from manufacturers, they were tracked and redeemed separately. But as they grew more powerful, they began negotiating directly with manufacturers for the delivered price of goods, giving them a stronger basis for cost-plus distribution contracts with the distributors. That was a major shift in the power balance.

Despite such changes, all parties gained in many respects. While manufacturers had to make pricing concessions, they found in GPOs a reliable way to sell a difficult segment and a tool to drive regional distribution. Also, the GPOs gave them data on product movement that distributors had been reluctant to provide.

Distributors were forced to share the marketing allowance pie with GPOs, but they also got a long sought goal. As GPOs began to require prime distributor agreements, they gained the larger drops and committed customer relationships they wanted.

Finally, operators were big gainers with benefits that went beyond pricing. Many no longer had to worry about complex bids. Participating in a hospital's GPO was prima facie evidence you were "buying smart." The groups also provided new clinical programs and support services and helped fund muchneeded education programs.

Follow the money

GPOs' revenue and cost savings largely accrue in three ways. The first is from so-called "administrative fees" charged to distributors and vendors as a prerequisite for participating in the programs. These are usually capped at three percent of program volume and in foodservice usually average less than that. Typically, after a group pays overhead costs, the remainder is returned to members as patronage income.

A second type of member revenue is representedby back-end marketing allowances or rebates, typically a set amount per case, that are claimed after the sale and often structured as an incentive to help grow volume. Historically, these were tracked first by operators, then by servicing distributors, and finally by GPOs that grew very efficient at managing the purchasing and distribution data needed to redeem them. One of their advantages was visibility: when rebate checks came in, it was clear evidence of savings that could be reported to an administration. Another advantage of this approach is that discounts can sometimes fall outside of state bidding requirements.

A third and increasingly important source of GPO revenue is represented by deviated pricing. It appears in the form of off-invoice credits applied by a distributor at the time of invoicing, and which the distributor then "bills back" to the manufacturer for credit.

Most GPOs are technically registered as forprofit organizations even if their owners are non-profits. Some are shareholder owned; othersare owned privately. Each has its own culture and operating philosophy (see sidebars).

How much pricing power can be attributed directly to a GPO's relative size? Quite a bit, the largest groups argue. But evidence also exists to the contrary. For example, a GAO pilot study of the groups in 2002 found that in the purchases of items like needles and pacemakers, large GPOs did not always obtain better pricing for members than smaller groups.

Yet another view holds that GPOs should be evaluated like mutual funds, assuming that those with the least overhead provide members with the greatest benefit. GPO overhead varies widely and this has become a matter of significant interest to both oversight organizations and members.The significant growth of newcomer GPOs like MedAssets is apparently due to their streamlined business models which eliminate much of the overhead of traditional shareholder organizations in favor of a simple fee-for-service structure.

The distributor connection

One issue facing the largest GPOs is that it has become more and more difficult to separate a GPO's program from its distribution arrangements. US Foodservice, for example, has had a series of exclusive distribution contracts with Premier over the past eight years. In 2004, after Novation put its distribution contract up for bid, it made the decision to abandon its former multi-source contract and also go exclusively with US Foodservice.

Much to the consternation of rival Sysco, that has technically given USF a sole-source relationship with facilities controlling as many as two-thirds of all acute hospital beds. Meanwhile, Sysco has aggressively sought to retain as much of the Novation business as it can. Look for more contention—and controversy—in this area in the coming year.

More questions than answers

There are a variety of other issues that GPOs face, including those raised by an ongoing Senate investigation (see sidebar on p. 64). While many of the questions raised there mostly deal with product categories like medical devices, foodservice programs have issues of their own, including the following: Multiple memberships. Many groups seek program compliance by prohibiting members from belonging to more than one GPO. Still, multiple membership is common. If a member seeks to claim benefits from two programs in the same category, even inadvertently, it can create significant reconciliation issues—and overhead costs—for the GPOs, distributors and manufacturers who must sort out competing demands for purchase credits.

Double dipping. So-called "double dipping" issues have come to haunt manufacturers over the past decade as the increasing number of regional and national purchasing programs have begun to overlap in ways manufacturers did not intend. Some say the challenge of matching up data from multiple programs has grown into a reconciliation nightmare that is impossible to manage. Back-end allowances are particularly prone to this problem,-one reason the industry is moving towards deviated pricing that can be directly monitored in the invoicing process.

Bundling. Bundling—requiring a member to participate in two or more unrelated programs in order to participate in either of them— has been a hot button for regulators. In the past, it has been an issue in foodservice as well, with some groups requiring a member to use all of its committed manufacturer agreements if it wanted to take advantage of any of them.

Sole sourcing. So-called "sole sourcing" agreements are also a regulatory focus. Some argue they are anti-competitive since they lock members into a single provider for products or services.But even GPOs that seek to offer members multiple choices tend to be skeptical of such claims. They point out that sole source awards result from fairly intense open bidding and that plenty of opportunity for competition exists at that stage of the process.

"The U.S. government is the biggest purchaser in the country, and it sole-sources all the time," notes one GPO executive, wryly.

Operators have come to appreciate the buying opportunities so-called product " standardization" can provide, but most can also cite sole source arrangements they feel put them at a disadvantage if a contract forces a product choice that is clearly of a lower grade than alternatives.

"My view is that the group sometimes lets 'value engineering' override obvious quality assurance issues," says one high-visibility operator. "Money seals the deal. Our administrations see the savings, but we see the impact it can have on customer satisfaction."

Extendability. Perhaps the most controversial foodservice issue in the GPO community today has been the move by Premier and US Foodservice to extend Premier's healthcare program into other segments. This has been most visible in college dining, where Premier has signed about a dozen new members, but is reportedly also occurring in other segments.

Many manufacturers take strong exception to such "extendability," saying foodservice programs and pricing are based on "class of trade" factors, such as the costs they entail in servicing particular segments, the mix of product those segments consume, the "not for profit" status of most GPO members and other factors. They also argue there has always been an implicit understanding that healthcare programs are not automatically extendable without-approval. While the size and strength of GPOs as major customers makes this issue highly sensitive, confrontation is inevitable.

Contractor program overlaps. Another form of channel conflict arises when GPO members have foodservice departments that are contract-operated. In such cases, management companies are quick to compare GPO programs to their own manufacturer agreements and demand "equal treatment" when they believe unfair discrepancies exist.

All of these situations mirror classic trade issues that have existed for years between manufacturers, distributors and large chain restaurant operators. As in the past, reconciliation will likely be uneasy and driven by market pressures. Stay tuned.

Is growth necessary?

One aspect of the extendability issue can be summed up in a simple question: "Will the largest GPOs and their members benefit from still more volume?" In foodservice, many apparently think so. But with acute care largely saturated, the only growth most can reasonably expect must come either by convincing individual members or IDNs to switch allegiances, or by moving into other segments.

GPO membership has been fairly consistent for years (one distributor executive compares it to a college fraternity "rush" system, saying "It is a comfort level choice, and many times you are in it 'for life.'"). Still, there have been some significant membershift changes recently—Catholic Healthcare East recently left Premier and took its $500 million in purchases to Consorta. And upstart MedAssets says that 17 multi-facility IDNs have left larger groups to join it in the last two years.

"The GPOs have become much more aggressive in the marketing they do to prospective members," says one observer. "Today it is almost bare-knuckle fighting. Also, hospitals themselves are taking a hard look at GPO overhead and asking if all the activities they is paying for are really necessary. And as an older generation of hospital executives approaches retirement, GPO allegiances are being broken. That's another reason for more turnover."

Many GPOs see long-term care as their best opportunity for future growth. These facilities are typically smaller and more fragmented than those in acute care, with smaller drops that make them less profitable to distributors. Such factors are among those that make them a market that is increasingly receptive to GPO membership opportunities. As a result, longterm care will be a GPO membership battleground for the next decade.

The advent of e-commerce

What's ahead? More sophisticated data management, for one thing. It has always been at the core of a GPO's services; no matter how deals are structured, they involve a convoluted process in which individual purchases are tracked, incentives, allowances and rebates are calculated and claimed, and billbacks are reconciled between distributors and manufacturers. The sheer complexity of this job gave a competitive advantage early on to those organizations which invested in specialized systems to manage these data streams.

Those systems have evolved into the e-commerce and e-exchange web sites most major GPOs espouse today. In fact, without them, it would be virtually impossible to bring meaningful order to the GPO pricing landscape. Longer term, they could also potentially address some of the industry's more contentious trade issues, such as double dipping.

With the greater emphasis some groups are now putting on the revenue-enhancement side of operations, another next step could be for GPOs to tap member point-of-sale data to provide new services on that basis.

Still, these systems require very significant investments from the GPO and distributor organizations involved, cumulative investments that are clearly separating organizations into technology camps of "haves" and "have nots." They are also tending to shift more administration costs to distributors, requiring them to document that pricing arrangements are executed properly, that constantly changing program extensions, terminations and renewals are implemented on a timely basis, and so on.

The upshot? In the future, healthcare institutions will become more dependent on GPOs and their data management systems and partners to make far-reaching decisions about not only purchasing but also many other aspects of their operations. The GPOs in turn will become more dependent on sophisticated data-exchange relationships with distributors, manufacturers and their members. Mutual, data sharing inter-dependence will clearly drive the future of the industry.