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The High Cost of GPOs: American Dollars and American Lives

September 3, 2012

This is the story of how our healthcare costs are being driven up by huge medical manufacturing companies with a vested interest in preventing the expansion and distribution of potentially life-saving medical innovations. This is a systemic problem that shows how things can go wrong when you give people the wrong incentives.

Today, approximately 98 percent of our nations hospitals currently manage their medical equipment procurement through massive entities called Group Purchasing Organizations, or GPOs, and, according to the Government Accountability Office, roughly 73 percent of all non-labor purchases made by hospitals in 2009 were through these entities.

Originally formed in the 1960s, GPOs were non-profit organizations, funded by dues from member hospitals, established to give large groups of hospitals bargaining power when purchasing medical equipment from large medical manufacturing companies, allowing them to push down the price of certain items that their hospitals understandably required in bulk. By the 1970’s, many hospitals began forming for-profit GPOs, and the for-profit business model started taking over the industry.

In 1986, a federal policy change (that was originally designed to save hospitals money on their GPO dues) shifted sources of GPOs’ revenue streams by allowing them to receive their funding through agreements with the large medical equipment manufacturers. These agreements allowed GPOs to receive fees from the manufacturers that were based on percentages of manufacturers’ profits from the goods sold to member hospitals.

For those of you paying attention, that means that the vast majority of US hospitals are buying their medical equipment through profit-seeking GPOs that are financially invested in the hospitals themselves spending MORE money on medical products, because the more money the hospitals spend, the more the for-profit GPOs get in kickbacks from the manufacturers. Smart, right?

It gets worse.

In 1996, the FTC and the Justice Dept. gave for-profit GPOs a categorical exemption from antitrust legislation. The theory behind the move seems sound: the larger the GPO, the better prices they could negotiate for member hospitals. This resulted in a flurry of mergers between the different GPOs, and, as of 2008, 6 GPOs controlled 90% of GPO-related purchases by US hospitals.

Now this means that not one, but two thoroughly counterintuitive, and arguably moronic, systems are now in place:

First off, there is the incredibly perverse system of financial incentives for GPOs: GPOs are supposedly in charge of bartering on behalf of their member hospitals in order to get the best possible deals on medical equipment, but meanwhile, the GPOs’ profits are largely dependent on those Hospitals spending more money than is necessary on the equipment they purchase; in some instances, GPOs have received as much as 94 percent of manufacturers’ profits from products sold to GPOs’ member hospitals. So now you have GPOs and manufacturers supposedly bartering over the price of these goods, yet both the GPOs and the manufacturers have a financial incentive for the prices not to go too low. Which is profoundly stupid, no matter how you look at it.

Second, you also have huge numbers of hospitals that are tied into supply agreements THROUGH these GPOs. What this means is that GPOs are allowed to use their supply contracts with big medical manufacturing conglomerates to restrict their own member hospitals’ ability to procure medical equipment from any outside sources, regardless of whether or not those other sources provide equipment that is superior in either quality or design to the equipment that the GPOs provide.

So not only are GPOs likely responsible for inflating the cost of equipment for which we, healthcare consumers, end up footing the bill, but they are also capable of decreasing the quality of the care we receive by preventing smaller medical manufacturing companies from gaining any share of the market, regardless of whether or not the products of those smaller companies are superior to the competing products that hospitals are already carrying.

By restricting hospitals’ ability to procure medical equipment from suppliers other than those in possession of GPO contracts, the GPO’s have actually stifled innovation in the medical field; any medical innovation that is patented, but not by a large medical equipment manufacturer, sees its manufacturer immediately incapable of selling their product in any serious quantity to the vast majority of US hospitals, because those hospitals are bound by GPO contracts with huge medical manufacturing conglomerates that sell competing, if inferior, equipment.

I don’t want to give the impression that I am making any brazen accusations of explicitly illegal conduct in the GPO industry. While I am positive that much of the GPOs’ conduct is certainly ethically dubious, it was the government that arranged the counterintuitive and inefficient system in which they operate. I am simply making the point that GPOs would almost certainly save their member hospitals more money than they do if their own profit margins were not implicitly tied to the profits of their suppliers, and if those suppliers were not frequently paying them off to continue their contracts.

Adding to the worrisome mess is the fact that some huge GPOs, such as MedAssets (ranked between largest and 4th largest GPO in the country, depending on the website you use), are publicly traded, which means that they have an organizational obligation to provide their stockholders with profits. This is where we should start to get worried; MedAssets has necessarily conflicting interests in concurrently pursuing the best prices for member hospitals and the best return for shareholders.

As it stands, the shareholders are the better off of the two: a Texas-based company named MEMdata that helps hospitals and other health service companies process and compare bids for different products has found that GPO’s consistently overcharge their member hospitals by an average of 22%. The CEO of MEMdata, Bob Yancy, revealed in a 2010 Washington Monthly article that he had received two quotes for the same equipment on the same day from the same vendor. One quote, labelled “aggresive pricing,” was priced at $83,000, and the other, for the exact same equipment, was priced at $131,000. The quote for $131,000 was through a GPO.

Furthermore, a recent study performed by the Medical Device Manufacturer’s Association found that GPOs are responsible for overcharging US hospitals by approximately $37.5 billion dollars annually for equipment. Beyond this, there are numerous accounts of hospitals and other healthcare providers dropping the GPO procurement system entirely and immediately saving anywhere from hundreds of thousands of dollars to millions of dollars annually.

It should be obvious, at this point, that our healthcare prices should be lower, and our equipment should be better, but GPOs are standing in the way of both. Every dollar paid to a GPO by a supplier is a dollar that some patient has to pay to a hospital. And while they’re counting their money, there is a constant flow of medical innovations that are written off as collateral damage.

The truly sad part is that those innovations’ inability to get a foothold in our healthcare market isn’t just costing American money, it’s costing American lives.

http://www.gao.gov/assets/310/308830.pdf

http://www.washingtonmonthly.com/features/2010/1007.blake.html

http://www.medicaldevices.org/sites/default/files/GPO_pricing_litan_singer_distribution_oct%202010.pdf

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From → Economics, Healthcare

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