Five things to know about the role of GPOs in the healthcare supply chain

The debate over how to stem the rising costs of healthcare has assumed a central role in the public policy conversation. Because healthcare group purchasing organizations (GPOs) play an integral role in the medical supply chain, questions about whether GPOs operate competitively and whether they reduce healthcare costs have greater urgency.

In the 1980s, Congress endorsed GPOs as a powerful force offering competition and lowered prices in the medical supply market, finding that GPOs “can help reduce healthcare costs for the government and private sector alike.” In more recent years, the cost-savings benefits long attributed to GPOs have been the subject of some debate, typically centered on whether GPOs truly obtain the lowest prices for their members and whether GPO contracting practices shut out some suppliers. Some have suggested that the GPO funding model-vendor-paid administrative fees-may hamper GPOs from providing competitive benefits.

In light of these questions, we examined the role of GPOs and the vendor-funding model by evaluating empirical evidence and applying economic analysis. Based on our analysis, the following are 5 things to know about GPOs, their business model and role in the supply chain, and their impact on healthcare costs and competition:

1.   GPOs source and negotiate prices for products and services. GPOs help source and negotiate prices for drugs, medical devices, and other products and services on behalf of healthcare providers, including hospitals, nursing homes, ambulatory care facilities, physician practices, and home health agencies. Often, GPOs are owned by their provider members. They do not take title to or possession of product. Rather, the central purpose of GPOs is to improve efficiency. GPOs have also increasingly sought to differentiate themselves by offering a range of additional services to healthcare providers-for example, data analytics-that may further lower costs or improve operations.

2.   GPOs save money for healthcare providers and patients. GPOs reduce costs primarily through two mechanisms: lower transaction costs and lower prices through joint negotiation.

The healthcare supply acquisition process is complex, involving thousands of suppliers selling many more thousands of pharmaceuticals, devices, products, and services to thousands of healthcare providers. Because prices are frequently negotiated and negotiations can be complicated, the scope for transaction costs savings from reducing the number of negotiations is large. For perspective, imagine that 1,000 vendors each sell 10 products to each of 2,000 hospitals. If each vendor bargains separately with each hospital, there are 2 million negotiations to determine as many as 20 million prices. If the GPO negotiates one price for each product on behalf of its members, then the number of negotiations falls from 2 million to 1,000, and the number of prices negotiated falls from 20 million to 10,000.

Economic literature identifies several ways by which joint purchasing can yield lower prices than buyers can obtain on their own, including increasing a buyer’s bargaining strength, increased volume and other discounts, and more intense supplier competition. Evidence indicates that providers realize cost savings of 10% to 18% by using GPOs, relative to the costs providers would have incurred if they negotiated prices on their own. Importantly, providers are likely to pass some of these cost savings on to patients.

Next: The third thing

3.   GPOs operate in a vigorously competitive procurement market. Our research and analysis indicate that the GPO market is performing as a highly competitive, unconcentrated market. Several factors are consistent with this conclusion. First, healthcare providers can choose from multiple GPOs and can, and commonly do, simultaneously use multiple GPOs. Second, providers often own and control their GPOs, giving the GPOs strong incentives to seek lower prices. Third, providers can, and do, procure medical supplies directly from vendors, rather than through the group purchasing model. Fourth, given the relative price insensitivity of consumers of healthcare services, GPO margins are consistent with highly competitive behavior.

The market for procurement services offered by GPOs is fragmented, with at least five national GPOs, many smaller players that operate at the regional or local level, as well as some provider self-supply with supplementary GPO services. The recent rise of regional GPOs has further enhanced competition, while also suggesting relatively low barriers to entry or expansion by GPOs, as well as relatively low switching costs between GPOs enjoyed by healthcare providers.

4.   The current GPO vendor funding model is consistent with competition and savings. Most GPOs are funded by vendor-paid administrative fees calculated as a percentage of the sales made pursuant to GPO contracts. While some have suggested that a funding model based on vendor fees contributes to higher healthcare costs and should be altered (presumably in favor of provider funding), our analysis suggests otherwise. Vendor funding, a practice common in other industries, is likely to be more efficient than alternative models.

Concerns expressed by commentators regarding vendor funding typically focus on whether this funding model causes incentive distortions (by discouraging GPOs from negotiating lower prices), excludes some vendors from competing (by raising vendors’ costs), or leads to fraud (if providers fail to report “sharebacks” of administrative fees they receive from GPOs, potentially leading to excess Medicare reimbursements). However, our analysis exposes logical flaws with each of these arguments. Basic economic theory implies that the source of GPO funding, whether from vendors or providers, is unlikely to affect GPOs’ incentives on pricing, exclusion, or fraud. The source of funding could affect transaction costs, but both providers and vendors have incentives to choose a funding model with lower transaction costs. Ultimately, we have seen nothing that alters the economic conclusion that the current vendor funding model for GPOs likely reduces healthcare costs by lowering transaction costs incurred during procurement.

5.   Changing the current GPO vendor funding model would likely result in increased costs.

As healthcare costs continue to rise, institutions like GPOs that compete to improve efficiency and reduce supply chain costs are particularly important. The GPO vendor funding model, authorized by Congress more than three decades ago, likely contributes to these reduced costs. Altering that vendor funding model structure would likely result in increased costs, reducing savings for healthcare providers and patients. We find no empirical or economic basis to change the existing model.

Jon Leibowitz is the former chairman of the Federal Trade Commission (FTC) and partner at Davis Polk.

Dan O’Brien is the former FTC deputy director of the Bureau of Economics and partner at Bates White.

Russell Anello is an associate at Davis Polk.