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.