oversight

Group Purchasing Organizations: Use of Contracting Processes and Strategies to Award Contracts for Medical-Surgical Products

Published by the Government Accountability Office on 2003-07-16.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                           United States General Accounting Office

GAO                        Testimony
                           Before the Subcommittee on Antitrust,
                           Competition Policy and Consumer Rights,
                           Committee on the Judiciary, U.S. Senate

For Release on Delivery
Expected at 2:30 p.m.
Wednesday, July 16, 2003   GROUP PURCHASING
                           ORGANIZATIONS
                           Use of Contracting
                           Processes and Strategies to
                           Award Contracts for
                           Medical-Surgical Products
                           Statement for the Record by Marjorie Kanof
                           Director, Health Care—Clinical
                            and Military Health Care Issues




GAO-03-998T
                                                July 16, 2003


                                                GROUP PURCHASING ORGANIZATIONS

                                                Use of Contracting Processes and
Highlights of GAO-03-998T, a statement          Strategies to Award Contracts for
for the record for the Subcommittee on
Antitrust, Competition Policy and               Medical-Surgical Products
Consumer Rights, Committee on the
Judiciary, U.S. Senate




Hospitals have increasingly relied              The seven GPOs we studied varied in how they carried out their contracting
on purchasing intermediaries—                   processes. The GPOs were able to expedite their processes for selecting
GPOs—to keep the cost of medical-               products to place on contract, particularly when they considered these
surgical products in check. By                  products to be innovative. The GPOs also reported receiving from
pooling purchases for their hospital            manufacturers administrative fees in 2002 that were generally consistent
customers, GPOs—in awarding
contracts to medical-surgical
                                                with the 3-percent-of-purchase-price threshold in regulations established by
product manufacturers—may                       the Department of Health and Human Services. However, for certain
negotiate lower prices for these                products, they reported receiving higher fees—in one case, nearly 18
products.                                       percent.

Some manufacturers contend that                 The seven GPOs also varied in the extent to which they used certain
GPOs are slow to select products                contracting strategies as leverage to obtain better prices. For example, some
to place on contract and establish              GPOs, including one of the two largest, used sole-source contracting (giving
high administrative fees that make              one of several manufacturers of comparable products an exclusive right to
it difficult for some firms to obtain           sell a particular product through the GPO) extensively, whereas others used
a GPO contract. The                             it on a more limited basis. Most GPOs used some form of product bundling
manufacturers also express
concern that certain contracting
                                                (linking price discounts to purchases of a specified group of products), and
strategies to obtain better prices              the two largest GPOs used bundling for a notable portion of their business.
have the potential to limit
competition when practiced by                   In response to congressional concerns raised in 2002 about GPOs'
GPOs with a large share of the                  potentially anticompetitive business practices, the Health Industry Group
market.                                         Purchasing Association (HIGPA) and GPOs individually established codes of
                                                conduct. (See figure.) The conduct codes are not uniform in how they
GAO was asked to examine certain                address GPO business practices. In addition, some GPOs’ conduct codes
GPO business practices. It focused              include exceptions and qualified language that could limit their potential to
on seven large GPOs serving                     effect change.
hospitals nationwide regarding
(1) their processes to select
manufacturers’ products for their               Figure: Business Practices Addressed in Codes of Conduct
                                                                                                          HIGPA members                        Non-HIGPA members
hospital customers and the level of              Business
                                                 practice                                GPO A        GPO B   GPO C GPO D             GPO E      GPO F    GPO G
administrative fees they receive                 Product selection contracting
from manufacturers, (2) their use                processes
of contracting strategies to obtain              Contract administrative fees
favorable prices from                            Sole-source contracting
manufacturers, and (3) recent
                                                 Bundling
initiatives taken to respond to
concerns about GPO business                      Commitment level requirements
practices.                                       Contract durations

                                                         Identified in HIGPA code of conduct                      Identified in both HIGPA and individual GPO code of
                                                                                                                  conduct
                                                         Identified in individual GPO code of conduct             Not identified in code of conduct
                                                Source: Codes of conduct provided by HIGPA and the seven GPOs in our study.




www.gao.gov/cgi-bin/getrpt?GAO-03-998T.         Note: A code of conduct was determined to identify a business practice if it was mentioned in the
                                                code’s text.
To view the full product, including the scope
and methodology, click on the link above.
For more information, contact Marjorie Kanof
at (202) 512-7114.
Mr. Chairman and Members of the Subcommittee:

We are pleased to have the opportunity to comment on the role of group
purchasing organizations (GPO) in the marketplace for medical-surgical
products. Faced with persistent pressures to cut rising costs, hospitals
over the past two decades have increasingly relied on purchasing
intermediaries—GPOs—to keep the cost of medical-surgical products in
check. Hospitals buy everything from commodities—for example, cotton
balls and bandages—to high-technology medical devices, such as
pacemakers and stents,1 through GPO-negotiated contracts. By pooling the
purchases of these products for their hospital customers, GPOs may
negotiate lower prices from vendors (manufacturers, distributors, and
other suppliers), which can benefit hospitals and, ultimately, consumers
and payers of hospital care (such as insurers and employers).

Some manufacturers—especially small manufacturers of medical
devices—have contended that GPOs employ a slow process for selecting
products to place on contract and establish high administrative fees that
have made it difficult for some firms to obtain a GPO contract. They have
also expressed concerns about certain contracting strategies that GPOs
use as leverage to obtain better prices. They contend that these strategies
have the potential to limit competition when practiced by GPOs with a
large share of the market.

At the request of the subcommittee, we examined certain GPO business
practices that critics contend have the potential to create an uneven
playing field for manufacturers. This statement focuses on seven large
GPOs serving hospitals nationwide regarding (1) their processes to select
manufacturers’ medical-surgical products for their hospital customers and
the level of administrative fees they receive from manufacturers, (2) their
use of contracting strategies to obtain favorable prices from
manufacturers, and (3) recent initiatives taken to respond to concerns
about GPO business practices. In a subsequent report for this
subcommittee, we will expand our earlier work and examine the extent to
which hospitals benefit from participation in GPOs. In April 2002, we




1
 A stent is a device used to provide support for tubular structures like blood vessels. It can
be made of rigid wire mesh or may be a metal wire or tube.




Page 1                                                                          GAO-03-998T
                   reported that for two products in one local market, a hospital’s use of a
                   GPO contract did not guarantee that the hospital paid a lower price. 2

                   We focused our current work on purchases made by acute care hospitals
                   for medical-surgical products, including commodities, such as cotton balls
                   and bandages, and medical devices, such as pacemakers and stents.3 We
                   did not investigate GPOs’ business practices with regard to other products
                   that hospitals purchase, such as pharmaceutical products, capital
                   equipment, and food supplies. Our findings are based on structured
                   interviews with representatives of seven major national GPOs. We also
                   interviewed representatives of 13 medical-surgical product manufacturers
                   of various sizes and representatives of trade associations from the
                   following industries: group purchasing, medical-surgical product
                   manufacturing, supply distribution, and venture capital. We also consulted
                   with experts, including representatives from two hospitals, three venture
                   capital firms, two industry consultants, and one technology assessment
                   company. In addition, we reviewed literature on group purchasing and
                   antitrust law. We did not independently verify the information we
                   obtained. The information GPOs provided was self-reported. We
                   conducted our work from May 2002 through July 2003 in accordance with
                   generally accepted government auditing standards.


                   The GPOs we studied were able to alter the duration of their process for
Results in Brief   selecting products to place on contract, particularly when they considered
                   these products to be innovative. GPOs’ product selection processes
                   generally took 6 months, and ranged from as short as 1 month to as long as
                   18 months. One GPO specifically reported expediting or modifying its
                   formal selection process when it considered a product to be innovative
                   and wanted to award a contract quickly. The seven GPOs also reported
                   receiving from manufacturers administrative fees in 2002 that were
                   generally consistent with the 3-percent-of-purchase-price threshold in
                   regulations established by the Department of Health and Human Services
                   (HHS). However, for certain products, they reported higher fees—in one
                   case, nearly 18 percent.



                   2
                    U.S. General Accounting Office, Group Purchasing Organizations: Pilot Study Suggests
                   Large Buying Groups Do Not Always Offer Hospitals Lower Prices, GAO-02-690T
                   (Washington, D.C.: Apr. 30, 2002).
                   3
                   We did not include government hospitals, such as those of the Department of Veterans
                   Affairs, in our study.




                   Page 2                                                                    GAO-03-998T
                            The seven GPOs we studied, including two with the largest market shares,
                            used sole-source contracting (giving one of several manufacturers of
                            comparable products an exclusive right to sell a particular product
                            through a GPO), product bundling (linking price discounts to purchases of
                            a specified group of products), and other contracting strategies to varying
                            degrees to obtain favorable prices. For example, while all seven GPOs
                            reported using sole-source contracts, some GPOs, including one of the two
                            largest, used them extensively, whereas others used them on a more
                            limited basis. Most GPOs used some form of bundling, and the two largest
                            GPOs used either contracts or programs that bundle multiple products for
                            a notable portion of their business.

                            In response to congressional concerns raised in 2002 about GPOs’
                            potentially anticompetitive business practices, the group purchasing
                            industry’s trade association established a code of conduct that directs
                            member GPOs to, among other things, address their contracting processes.
                            The conduct code also includes reporting and education responsibilities
                            for the trade association. The seven GPOs we studied drafted or revised
                            their own codes of conduct, but the conduct codes are not uniform in how
                            they address GPO business practices. Moreover, some GPOs’ conduct
                            codes include exceptions and qualified language that could limit the
                            potential of the conduct codes to effect change. It is too soon to evaluate
                            the effectiveness of these codes of conduct in addressing concerns about
                            potentially anticompetitive practices, as many conduct codes are recently
                            adopted and sufficient time has not elapsed for GPOs to demonstrate
                            results.


                            In seeking to provide their hospital customers with medical-surgical
Background                  products at favorable prices, GPOs engage with manufacturers in certain
                            contracting processes and sometimes use certain strategies to obtain price
                            discounts. Many manufacturers bid for GPO contracts because hospital
                            purchases with these contracts may increase manufacturers’ market share.
                            GPOs are subject to federal antitrust laws. A statement developed by
                            enforcement agencies helps GPOs determine whether their business
                            practices are likely to be challenged under the antitrust laws.


Manufacturers Contract      Many manufacturers use GPO contracts to sell their medical-surgical
with GPOs to Sell Their     products. These products include two types—commodities and medical
Medical-Surgical Products   devices. Commodities such as cotton balls and bandages are examples of
                            items for which physicians and other clinicians generally do not have
                            strong preferences. Manufacturers commonly use GPO contracts to sell


                            Page 3                                                         GAO-03-998T
                          hospitals these non-preference products because hospitals purchase these
                          items in large quantities. In contrast, medical devices can be “clinical
                          preference” items—that is, those for which physicians and other
                          practitioners are likely to express a preference. High-technology medical
                          devices such as pacemakers and stents are examples of clinical preference
                          items. Some manufacturers prefer to sell these items directly to hospitals.


A Few GPOs Dominate the   The GPO industry that purchases products for hospitals is large and
Market for Medical-       moderately concentrated. Experts have not determined a precise number
Surgical Products Sold    of GPOs currently in business, but some estimate that there are hundreds
                          of GPOs. While some GPOs operate regionally, this study focused on seven
through Contracts         national GPOs with purchasing volumes over $1 billion that account for
                          more than 85 percent of all hospital purchases nationwide made through
                          GPO contracts. In 2002, the combined purchasing volume of these GPOs
                          totaled about $43 billion, excluding distribution dollars. (See table 1.)

                          Table 1: Seven GPOs’ Purchasing Volumes for Total Customer Purchases Made
                          through Contracts, 2002

                           GPO                                                Purchasing volume (dollars in millions)
                           GPO 1                                                                             $14,330
                           GPO 2                                                                              14,413
                           GPO 3                                                                                4,400
                           GPO 4                                                                                3,233
                           GPO 5                                                                                2,837
                           GPO 6                                                                                2,564
                           GPO 7                                                                                1,466
                           Total                                                                             $43,243

                          Source: GPO-reported data.

                          Note: These purchasing volumes exclude distribution dollars.


                          Among the GPOs in our study, the two largest GPOs account for about 66
                          percent of total GPO purchasing volume for all medical products
                          (including, among other things, medical-surgical products,
                          pharmaceuticals, capital equipment, and food). These two GPOs also
                          account for 70 percent of the seven GPOs’ total medical-surgical product
                          volume. One of the two largest GPOs has as members 1,569 of the nation’s




                          Page 4                                                                        GAO-03-998T
                               approximately 6,900 hospitals; the other has 1,469 hospital members.4 One
                               of the two largest GPOs permits its members to belong to other national
                               GPOs, whereas the other largest GPO does not.


GPOs’ Business Practices       A GPO’s contracting process for manufacturers’ medical-surgical products
Encompass Contracting          generally includes several phases—namely, product identification and
Processes and Strategies       selection, requests for proposals or invitations to bid, review of submitted
                               proposals and applications, assessment of product quality, contract
                               negotiation, and contract award. The contract negotiation phase may
                               include the negotiation of a contract administrative fee. This fee is
                               designed to cover a GPO’s operating expenses and serves as its main
                               source of revenue.5 Contract administrative fees are calculated as a
                               percentage of each customer’s purchases of the particular product
                               included in a GPO contract.

                               In negotiating contracts, GPOs use certain contracting strategies as
                               incentives for manufacturers to provide deeper discounts and for hospital
                               members to concentrate purchasing volume to obtain better prices. These
                               strategies are not limited to use by GPOs, as some manufacturers also use
                               them in negotiating contracts with GPOs to increase market share. Key
                               contracting strategies include the following:

                           •   Sole-source contracts give one of several manufacturers of comparable
                               products an exclusive right to sell a particular product through a GPO.

                           •   Commitment refers to a specified percentage of purchasing volume that,
                               when met by the GPO’s customer (such as a hospital), will result in a
                               deeper price discount. Commitment levels can be set either by the GPO or
                               the manufacturer. For example, a manufacturer might offer greater
                               discounts to GPO customers that purchase at least 80 percent of a certain
                               group of products from that manufacturer. Commitment requirements can
                               also be tiered, resulting in the opportunity for the customer to commit to
                               different percentages of purchasing volume: the higher the percentage, the
                               lower the price.



                               4
                                The approximately 6,900 hospitals include government hospitals such as those of the
                               Department of Veterans Affairs and county hospitals.
                               5
                                In addition to using these fees to cover their operating expenses, GPOs often distribute
                               surplus fees to member hospitals. They may also use administrative fees to finance new
                               ventures, such as electronic commerce, that are outside their core business.




                               Page 5                                                                        GAO-03-998T
                          •   Bundling links price discounts to purchases of a specified group of
                              products. GPOs award several types of bundling arrangements. One type
                              bundles combinations of products from one manufacturer. A manufacturer
                              may find this arrangement advantageous because it allows increased sales
                              of products in the bundle that may not fare well as stand-alone products.
                              Another type bundles products from two or more manufacturers. Also,
                              contracts can be bundled for complementary products, such as protective
                              hats and shoe coverings used in hospital operating rooms, while others
                              bundle unrelated products such as patient gowns and intravenous
                              solutions. Hospitals that purchase bundles of unrelated products receive a
                              price discount on all products included in the bundle.

                          •   Contracts of long duration—those in effect for 5 years or more—can
                              direct business to manufacturers for an extended period.

                              When used by GPOs with a large market share, these contracting
                              strategies have the potential to reduce competition. For example, if a large
                              GPO negotiates a sole-source contract with a manufacturer, the contract
                              could cause an efficient, competing manufacturer to lose business and exit
                              from the market and could discourage other manufacturers from entering
                              the market.


Federal Safe Harbor and       Certain aspects of GPOs’ operations are specifically addressed by federal
Antitrust Safety Zone Exist   statute, regulation, and policy. While “anti-kickback” provisions of the
for GPOs                      Social Security Act prohibit payments in return for orders or purchases of
                              items for which payment may be made under a federal health care
                              program, the act also contains an exception for amounts paid by vendors
                              of goods or services to a GPO.6 Therefore, GPOs are allowed to collect
                              contract administrative fees from manufacturers and other vendors that
                              could otherwise be considered unlawful. In addition, regulations issued by
                              the Department of Health and Human Services establishing “safe harbors”
                              for purposes of the “anti-kickback” provisions provide that GPOs are to
                              have written agreements with their customers either stating that fees are
                              to be 3 percent or less of the purchase price, or specifying the amount or
                              maximum amount that each vendor will pay.7 The GPOs must also disclose
                              in writing to each customer, at least annually, the amount received from
                              each vendor with respect to purchases made by or on behalf of the


                              6
                              See 42 U.S.C. § 1320a-7b(b) (2000).
                              7
                              See 42 C.F.R. § 1001.952(j) (2002).




                              Page 6                                                          GAO-03-998T
                        customer. The Office of Inspector General in the Department of Health
                        and Human Services is responsible for enforcing these regulations.

                        Recognizing that GPO arrangements may promote competition among
                        manufacturers and yield lower prices in some cases and may reduce
                        competition in other cases, the U.S. Department of Justice and the Federal
                        Trade Commission issued a statement in 1993 for joint purchasing
                        arrangements. This statement sets forth an “antitrust safety zone”8 for
                        GPOs that meet a two-part test, under which the agencies will not
                        generally challenge GPO business practices under the antitrust laws.
                        Essentially, the two-part test in the context of medical-surgical products is
                        as follows: (1) purchases through the GPO account for less than 35
                        percent of the total sales of the product in the relevant market,9 and (2) the
                        cost of the products purchased through the GPO accounts for less than 20
                        percent of the total revenues from all products sold by each GPO member.


                        In recent years, some manufacturers of medical-surgical products have
GPOs Reported           contended that GPOs employ a slow product selection process and set
Modifying Contracting   high administrative fees that have made it difficult for some firms to obtain
                        GPO contracts. These firms tend to be small manufacturers that may have
Processes When          fewer financial resources available to successfully complete GPOs’
Desirable and           contracting processes than large manufacturers. The GPOs we studied
                        reported generally having contracting processes that can be modified for
Receiving               certain types of products. They also reported receiving from
Administrative Fees     manufacturers administrative fees that were generally consistent with
That Were Generally     federal regulations established by HHS.

Consistent with
Federal Regulations




                        8
                        Statements of Antitrust Enforcement Policy in Health Care, Statement 7, p. 23.
                        9
                         Although the GPOs in this study each has less than 35 percent of total GPO purchasing
                        volume for all medical products, it is possible, for example, that a GPO could have greater
                        than 35 percent of the total sales of one or more particular products.




                        Page 7                                                                        GAO-03-998T
GPOs Reported Expediting      In discussing GPOs’ selection of products and negotiation of fees, several
Reviews and Using a           manufacturers we contacted pointed to the paperwork and duration of
Public Solicitation Process   these processes as burdensome. Not all manufacturers shared the same
                              perspective. One small manufacturer commented that the process could
for Certain Products          sometimes be relatively easy but that the selection process can be more
                              difficult if the manufacturer is selling only one product.

                              The GPOs we studied were able to alter the duration of their process for
                              selecting products to place on contract, particularly when they considered
                              these products to be innovative. Based on their reported information,
                              GPOs’ product selection processes generally took 6 months, and ranged
                              from as short as 1 month to as long as 18 months. One GPO specifically
                              reported expediting or modifying its formal selection process when it
                              considered a product to be innovative and wanted to award a contract
                              quickly. Most GPOs did not have a distinctly separate process for selecting
                              innovative technology but reported that these products were generally
                              selected in a shorter amount of time compared with other products.

                              Figure 1 shows, across the seven GPOs, the average minimum, most
                              frequent, and maximum times taken for product selection.




                              Page 8                                                         GAO-03-998T
Figure 1: Duration of the GPO Product Selection Process

 14 Months


 12


 10


 8


 6


 4


 2


 0
        Average                 Average                    Average
       minimum               most frequent                maximum
         length                  length                     length
      of selection            of selection               of selection
        process                 process                    process

               Innovative products

               Other medicial-surgical products
Source: Interviews with representatives of seven GPOs.

Note: Averages weighted by GPO-reported dollar purchasing volume, excluding distribution dollars.




The GPOs in our study reported consulting various sources before making
a decision, including the GPO’s customers requesting the product;
published studies about the product; internal and external technology
assessments; and different manufacturers of the product, both with and
without a GPO contract. In all cases, the GPOs cited customer requests for
products as the most important factor in identifying which products to
place on contract.

In selecting a manufacturer, six of the seven GPOs, including the two
largest, solicit proposals publiclyeither through requests for proposals
or requests for bids through their Web sites. The extent to which these
processes are open to all manufacturers varies by GPO and by product.
For example, one of the GPOs solicits proposals publicly for clinical
preference products, but not for commodities.



Page 9                                                                             GAO-03-998T
                           GPO-reported information on new contracts awarded in 2002 suggest that
                           GPOs’ solicitations were not limited to manufacturers already on contract.
                           Nearly one-third of all the newly negotiated contracts awarded by the
                           seven GPOs in 2002 were awarded to manufacturers with which the GPO
                           had not previously contracted. The percentage of such contracts ranged
                           from 16 percent to 55 percent for the GPOs in our study. For the two
                           largest GPOs, this share was 29 percent and 55 percent. We could not
                           determine, from the information provided, whether these first-time
                           contract awardees were, for example, small manufacturers or companies
                           new to the industry or whether the products purchased through these
                           contracts were clinical preference items or commodities.


GPO-Reported Information   Manufacturers have expressed concerns that contract administrative fees,
Indicates That Contract    which are typically calculated as a percentage of each customer’s
Administrative Fees        purchase of products under contract, can be too high for some
                           manufacturers. These fees, combined with lower prices negotiated by the
Received Were Generally    GPO, may decrease revenue for manufacturers and may make it more
Consistent with Federal    difficult to obtain a GPO contract for newer and smaller manufacturers
Regulations                with fewer financial resources than for larger, more established
                           companies.

                           Five out of seven GPOs reported that the maximum contract
                           administrative fee received from manufacturers in 2002 did not exceed the
                           3-percent-of-purchase-price threshold contained in federal regulations
                           established by HHS. The most frequent administrative fee level that 4 out
                           of 7 GPOs received from manufacturers in 2002 was 2 percent; the lowest
                           fee level received by each GPO was 1 percent or less. Except for one of the
                           two largest GPOs, the GPOs reported that they have not negotiated any
                           new or renewed contracts in 2003 that include administrative fees from
                           medical-surgical product manufacturers that exceed 3 percent.

                           In 2002, fee levels for private label products —products sold under a
                           GPO’s brand name—were an exception: The typical contract
                           administrative fee paid by private label manufacturers was 5 percent. For
                           one of the two GPOs in our study with private label products, the
                           maximum administrative fee was nearly 18 percent. In addition to an




                           Page 10                                                        GAO-03-998T
                             administrative fee, the other GPO charged a separate “licensing” fee for
                             private-label products.10

                             GPOs use certain contracting strategies—which include sole-source
Seven National GPOs          contracts, product bundling, and extended contract duration—to obtain
Varied in the Extent         discounts from manufacturers in exchange for providing the manufacturer
                             with increased sales from an established customer base. Manufacturers
to Which They Used           and other industry observers have expressed concerns that use of these
Certain Contracting          strategies by the two largest GPOs can reduce competition. For example,
                             when GPOs with substantial market shares award long-term sole-source
Strategies                   contracts to large, well-established manufacturers, some newer, single-
                             product manufacturers—left to compete with other manufacturers for a
                             significantly reduced share of the market—may lose business and be
                             forced to exit the market altogether.

                             The seven GPOs we studied, including two with the largest market shares,
                             used these contracting strategies to varying degrees. For example, while
                             all study GPOs reported using sole-source contracts, some GPOs,
                             including one of the two largest GPOs, used it extensively, whereas others
                             used it on a more limited basis. GPOs also varied in their approach to
                             requiring commitment levels from their customers. With respect to
                             bundling, most GPOs used some form of bundling, and the two largest
                             GPOs used either contracts or programs that bundled multiple products
                             for a notable portion of their business. With respect to contract duration,
                             the two largest GPOs typically negotiated longer contract terms than the
                             other five GPOs.


For Some of the GPOs,        The use of sole-source contracting by the study GPOs varied widely with
Sole-Source Contracts        respect to the relative amount of sole source contracting they did and the
Accounted for a              types of products included in the contracts. For five of the GPOs, sole-
                             source contracts accounted for between 2 percent and 46 percent of their
Substantial Portion of the   medical-surgical product dollar purchasing volume.11 For the rest—the two
Purchasing Volume            largest GPOs—the shares of dollar purchasing volume accounted for by
                             sole-source contracts were 19 percent and 42 percent. Such levels of sole-




                             10
                              Some manufacturers pay this GPO licensing fees in exchange for using the GPO’s brand
                             name.
                             11
                              One GPO did not provide us information on purchasing volume for medical-surgical
                             products through sole-source contracts.




                             Page 11                                                                  GAO-03-998T
                         sourcing are worth noting, given the sizeable market shares of these two
                         GPOs.

                         GPOs also varied in their use of sole-source contracts for commodity
                         products as compared to medical devices for which providers may desire a
                         choice of products. Six of the seven GPOs in our study reported their use
                         of sole-source contracts for commodity products as compared to clinical
                         preference product. For one of the two largest GPOs, clinical preference
                         products accounted for the bulk—82 percent—of its sole-source dollar
                         purchasing volume.12 Two GPOs reported cases in which manufacturers
                         refused to contract with the GPO unless they were awarded a sole-source
                         contract. In contrast, commodities accounted for the bulk—between 62
                         percent and 91 percent—of the dollar purchasing volume that the smaller
                         of the seven GPOs purchased through sole-source contracts. GPO-
                         reported data indicate that the proportion of contracts that were sole
                         source, as a share of all contracts for medical-surgical products for the
                         past 3 years, remained relatively consistent for GPOs.


GPOs Considered          The seven GPOs in our study reported that hospital customers’
Customer Commitment to   commitment to purchase a certain percentage of their products through
Be Important, but        GPO contracts was an important factor in obtaining favorable prices with
                         manufacturers, and all reported establishing commitment level
Commitment               requirements to some degree. Most of the smaller of the seven GPOs
Requirements Varied      reported that customer adherence to commitment levels and contracts
                         were the most important factor in obtaining favorable pricing with
                         manufacturers. In principle, for GPOs with a smaller customer base, the
                         assurance of customer commitment to purchasing helps enable them to
                         achieve the higher volumes needed to leverage favorable prices from
                         manufacturers. The two largest GPOs reported that volume was the most
                         important factor for obtaining favorable prices and that customer
                         compliance with commitment level and contracts was next in importance.
                         For the two largest GPOs, a sizable customer base may provide the volume
                         levels needed to obtain favorable prices.

                         GPOs varied in their approach to requiring purchasing commitment levels.
                         One GPO requires customers to commit to an overall average dollar
                         purchasing level of 80 percent for those products available through the



                         12
                          One of the two largest GPOs in our study did not provide us information on sole-source
                         purchases represented by the two product types.




                         Page 12                                                                    GAO-03-998T
                            GPO, although the percentage could vary for individual products. The GPO
                            reported terminating the membership of at least one customer that did not
                            meet this target. Other GPOs reported establishing customer commitment
                            levels in certain contracts in order to obtain a certain price level, but
                            customers were not required to buy under the contract or buy at the
                            commitment level in order to retain GPO membership. Some GPOs’
                            contracts include multiple, or tiered commitment levels so that customers
                            can choose from a range of commitment levels and obtain price discounts
                            accordingly.


Most GPOs Use Some          All but one of the GPOs in our study reported using some form of
Form of Bundling, and the   bundling, including the bundling of complementary products, bundling
Two Largest GPOs Use It     several unrelated products from one manufacturer, and bundling several
                            products for which there are commitment-level requirements. One
for a Notable Portion of    bundling arrangement that GPOs reported using gave customers a
Their Business              discount when they purchased a bundle of complementary products, such
                            as protective hats and shoe coverings. Four GPOs reported bundling
                            complementary products. These bundles were included in a small
                            percentage of the GPOs’ contracts; each of the four GPOs reported having
                            no more than three contracts that bundle complementary products. One
                            GPO reported awarding only one bundling arrangement for two
                            complementary products—the only bundling arrangement the GPO had in
                            effect at the time it reported to us.

                            A second type of bundling reported by three GPOs, including the two
                            largest, gave customers a discount if they purchased a group of unrelated
                            products from one manufacturer. We define this type of bundling as a
                            corporate agreement. One of the two largest GPOs reported that corporate
                            agreements for medical-surgical products accounted for about 40 percent
                            of its dollar purchasing volume for medical-surgical products under
                            contracts in effect on January 1, 2003.

                            Four GPOs, including one of the two largest, used a third type of
                            arrangement that typically bundled products from different manufacturers
                            and required customers that chose this arrangement to purchase a certain
                            minimum percentage from the product categories specified in the bundle
                            in order to obtain the discount. We defined this type of bundling as a
                            structured commitment program. A structured commitment program
                            available through one GPO bundled brand name and GPO private label
                            items for 12 product categories and had a 95 percent commitment-level
                            requirement. In 2002, one of the two largest GPOs reported receiving



                            Page 13                                                      GAO-03-998T
                            about 20 percent of its medical-surgical dollar purchasing volume from its
                            structured commitment programs.

                            The use of bundling arrangements may be declining. For example, data
                            reported by one GPO showed a decline in the percent of its contracts that
                            were corporate agreements from 2001 to 2003.13 This trend was consistent
                            with comments made by one manufacturer and two medical-surgical
                            product distributors. The manufacturer told us that GPOs are less
                            interested in bundling different manufacturers together. Two distributors’
                            representatives told us that since the summer of 2002, GPOs have fewer
                            bundling arrangements and that some bundles were “pulled apart.”


The Two Largest GPOs        Our analysis of data reported by the study GPOs showed that, in 2002, the
Typically Award Contracts   two largest GPOs typically awarded 5-year contracts, whereas the other
with Longer Terms Than      five GPOs typically awarded 3-year contracts. For some of these contracts,
                            potential renewal periods constitute a portion of the contract duration.
the Other Five              Those contract terms remained fairly consistent between 2001 and 2003,
                            although two of the five GPOs reported that their most frequent contract
                            term declined by about 1 year. Some GPOs reported implementing policies
                            that may lead to a future reduction in contract terms. One of the two
                            largest GPOs began in the first quarter of 2003 to exclude from new
                            contracts the option for two 1-year contract extensions, so that when a
                            contract expires, this GPO will solicit proposals for a new contract.


                            In response to congressional concerns raised in 2002 about GPOs’
GPOs Have Taken             potentially anticompetitive business practices, the group purchasing
Initiatives to Address      industry’s trade association established a code of conduct that directs
                            member GPOs to, among other things, address their contracting processes.
Concerns about              The conduct code also includes reporting and education responsibilities
Business Practices,         for the trade association. The seven GPOs we studied drafted or revised
                            their own codes of conduct, but the conduct codes are not uniform in how
but It Is Too Early to      they address GPO business practices. Moreover, some GPOs’ conduct
Evaluate Their Efforts      codes include exceptions and qualified language that can limit the
                            potential of the conduct codes to effect change. It is too soon to evaluate
                            the effectiveness of these codes of conduct in addressing concerns about
                            potentially anticompetitive practices, as many conduct codes are recently



                            13
                             This period reflects contracts in effect on three dates—January 1, 2001, January 1, 2002,
                            and January 1, 2003.




                            Page 14                                                                      GAO-03-998T
                            adopted and sufficient time has not elapsed for GPOs to demonstrate
                            results.


Trade Association Code of   On July 24, 2002, the Health Industry Group Purchasing Association
Conduct Laid Groundwork     (HIGPA) adopted a code of conduct providing principles for GPO business
for Industry Self-          practices. HIGPA represents 28 U.S.-based GPOs—including five of the
                            seven major GPOs that we studied. HIGPA members also include health
Regulation                  care systems and alliances, manufacturers, and other vendors. The HIGPA
                            code of conduct principles address GPO business practices and actual,
                            potential, or perceived conflicts of interest. Among other things, the
                            HIGPA code of conduct provides that GPOs

                        •   allow hospital and other provider members to purchase clinical preference
                            items directly from all vendors, regardless of whether the vendors have a
                            GPO contract;

                        •   implement an open contract solicitation process that allows any interested
                            vendor to seek contracts with the GPO;

                        •   participate in processes to evaluate and make available innovative
                            products;

                        •   address conflicts of interest, such as disallowing staff in positions of
                            influence over contracting to hold equity interest in, or accept gifts or
                            entertainment from, “participating vendors”;14 and

                        •   establish accountability measures, such as appointing a compliance officer
                            and certifying annually that the GPO is in compliance with the HIGPA
                            code.

                            The HIGPA code also includes several provisions regarding the trade
                            association’s education and reporting responsibilities, including

                        •   assessing and updating the code of conduct to be consistent with new
                            developments and best business practices;




                            14
                             Participating vendors are those that have a contract or submit a bid or offer to contract
                            with a GPO.




                            Page 15                                                                       GAO-03-998T
                            •   implementing industry wide educational programs on clinical innovations,
                                contracting strategies, patient safety, public policy, legal requirements, and
                                best practices;

                            •   making available a Web-based directory that posts manufacturers’ and
                                other vendors’ product information; and

                            •   publishing an annual report listing GPOs that have certified their
                                compliance for the year with the HIGPA code of conduct.

                                As of May 19, 2003, HIGPA’s 28 U.S.-based GPO members certified that
                                they are in compliance with the HIGPA code of conduct principles.


Variations Exist in GPOs’       Although the HIGPA code of conduct laid the groundwork for many GPOs
Efforts to Address              to change their business practices, its guidelines do not comprehensively
Business Practices              address certain business practices. Specifically, the HIGPA code of
                                conduct requires GPOs to address business practices associated with
                                contracting, conflicts of interest, and accountability, and it grants GPOs
                                discretion in using contracting strategies. It recommends that GPOs
                                consider factors such as vendor market share, GPO size, and product
                                innovation when using multiple contracting strategies. However, the
                                HIGPA code of conduct does not directly address levels of contract
                                administrative fees or the offering of private label products.

                                Since August 2002, the seven GPOs we studied, even those that were not
                                HIGPA members, drafted and adopted their own codes of conduct or
                                revised their existing conduct codes. One GPO stated that its revised code,
                                while consistent with the HIGPA code, was more specific than HIGPA’s
                                principles, particularly in the GPO’s rules on stock ownership, travel, and
                                entertainment. Another GPO reported expanding on HIGPA’s code by
                                including provisions to cap administrative fees and prohibit bundling.
                                Similarly, GPOs who were not HIGPA members said they had revised their
                                existing codes of conduct and that their conduct codes were in some
                                respects stronger than HIGPA’s.

                                Nevertheless, GPOs’ individual codes of conduct varied in the extent to
                                which they addressed GPOs’ business practices, such as contracting
                                processes and strategies. Figure 2 provides an overview of the seven
                                GPOs’ conduct codes with respect to their business practices. The table
                                indicates whether a business practice was identified in a code of conduct,
                                but not how the practice was to be addressed.




                                Page 16                                                          GAO-03-998T
Figure 2: Business Practices Identified in GPOs’ Codes of Conduct

                                                           HIGPA                        Non-HIGPA
 Business                                                 members                        members
 practice                     GPO A         GPO B         GPO C   GPO D       GPO E   GPO F   GPO G
 Product selection
 contracting
 processes
 Innovative
 product
 selection
 Contract
 administrative
 fees

 Sole-
 source
 contracting


 Bundling


 Commitment
 level
 requirements

 Contract
 durations


 Private
 labeling

 Conflicts of
 interest-
 equity

 Conflicts of
 interest-
 other

 Internal
 accountability

 External
 accountability

         Identified in HIGPA code of conduct

         Identified in both HIGPA and individual GPO code of conduct

         Identified in individual GPO code of conduct

         Not identified in code of conduct
Source: Codes of conduct provided by HIGPA and the seven GPOs in our study.

Note: A code of conduct was determined to identify a business practice if it was mentioned in the
conduct code’s text.




Page 17                                                                                  GAO-03-998T
    As figure 2 shows, the conduct codes of all the study GPOs explicitly
    mentioned conflict of interest issues such as those dealing with equity
    holdings and other conflicts such as receipt of gifts and entertainment and
    the need for internal accountability. In addition, the conduct codes of most
    GPOs, including the two largest, included provisions dealing with the
    contracting strategies, such as sole-source contracting and bundling. For
    GPOs that are HIGPA members, the lack of additional provisions in their
    individual conduct codes for certain business practices such as
    contracting processes may not be significant, as provisions covering these
    areas are included in the HIGPA code. However, for one of our study
    GPOs that is not a HIGPA member, the conduct code lacked any
    provisions pertaining to contracting processes, product selection,
    administrative fees, sole-source contracting, commitment level
    requirements, contract duration, and private labeling.

    The code of conduct provisions for the GPOs in our study were not
    uniform in how they addressed business practices. For example:

•   Four GPOs, including one of the two largest, had unqualified provisions
    for capping administrative fees at the 3-percent threshold contained in
    federal regulations established by HHS. The other largest GPO had a
    provision for capping administrative fees at 3 percent only for clinical
    preference items and only for contracts awarded after the establishment of
    the GPO’s conduct code.

•   Four conduct codes had provisions limiting the use of sole-source
    contracts for clinical preference items specifically. Another conduct code
    limited the use of sole-sourcing to contracts meeting certain criteria, such
    as approval for use by a 75-percent majority of the GPO’s contracting
    committee. The language of one of the remaining GPO’s conduct codes
    was vague with respect to sole-sourcing, stating that the GPO will provide
    customers with choices for each product or service, without explicitly
    mentioning the use of sole-source contracts.

•   In their conduct codes, two GPOs had provisions prohibiting the practice
    of bundling of unrelated products, two GPOs prohibited and two limited
    bundling for clinical preference items, and three GPOs prohibited the
    practice of bundling products from different manufacturers. One GPO’s
    conduct code stated that the GPO would not obligate its customers to
    purchase bundles of unrelated products, allowing the possibility for
    bundles to be available to customers on a voluntary basis.




    Page 18                                                          GAO-03-998T
                                                            Exceptions and qualified language in the provisions have the potential to
                                                            weaken the codes of conduct. Table 2 shows examples of exceptions and
                                                            qualified language that can limit the potential of the individual GPOs’
                                                            conduct codes to effect change.

Table 2: Examples of Exceptions and Qualifications in Code of Conduct Provisions for the GPOs in Our Study

                                             Specific provision including exceptions and
 Business practice                           qualifiers (in italics)                                     Potential implications
 Product selection                           Will use public request for proposal process for clinical   Contract bids for most commodities will not go
 contracting processes                       preference products but not for most commodities.           through public solicitation process.
 Contract administrative                     Will reduce contract administrative fees that are           For clinical preference products, contract
 fees                                        greater than 3 percent to 3 percent for clinical            administrative fees negotiated prior to adoption
                                             preference products on a prospective basis.                 of conduct code are not subject to provision; in
                                                                                                         future contracts, administrative fee for all other
                                                                                                         items may continue to exceed 3 percent.
 Sole-source contracting                     No sole-source contracts for clinical preference            Manufacturers have incentives to link price
                                             products unless there is no other means by which the        discounts in return for exclusive contract
                                             GPO can obtain access to the product for customers.         awards.
 Bundling                                    No bundling of clinical preference products on a            For clinical preference products, bundled
                                             prospective basis, and no bundling of products across       contracts awarded prior to adoption of conduct
                                             different vendors.                                          code are not subject to provision; contracts for
                                                                                                         bundles of unrelated, non-clinical preference
                                                                                                         products with one manufacturer are not subject
                                                                                                         to the provision.
 Commitment level                            No commitment level requirements for clinical               For clinical preference products, commitment
 requirements                                preference products, on a prospective basis.                levels negotiated prior to adoption of conduct
                                                                                                         code are not subject to provision; all other
                                                                                                         products could have commitment requirements.
                                             Commitment level requirements not to exceed 80              Commitment-level requirements for clinical
                                             percent of purchasing volume for clinical preference        preference products have potential to remain as
                                             products, unless relevant committee approves                high as 80 percent of purchasing volume and,
                                             otherwise.                                                  under certain circumstances, may be higher.
 Conflicts of interest-equity                No equity interests may be held by GPO management           Other GPO staff may hold equity interest in
                                             and other staff with influence over contracting in any      participating vendors, that is, those on contract
                                             participating vendors.                                      or bidding for a contract.
                                                                                                         GPO staff with influence over contracting may
                                                                                                         hold equity interest in nonparticipating vendors.

Source: Individual GPOs’ codes of conduct.




Too Soon to Evaluate                                        Given the individual GPOs’ relatively recent adoption of codes of
Impact of GPOs’ Codes of                                    conduct—since August 2002—sufficient time has not yet elapsed for GPOs
Conduct                                                     to develop a history of compliance with certain conduct code provisions.
                                                            Two of the manufacturers and two distributors we interviewed reported
                                                            noticing improvements, stating that some GPOs are no longer using
                                                            certain contracting strategies. This observation is consistent with the
                                                            suggestion that the use of bundling may be declining. One manufacturer



                                                            Page 19                                                                         GAO-03-998T
                  that had difficulty in obtaining a contract with a large national GPO prior
                  to 2002 said it has since been awarded a contract for a clinical preference
                  item. The manufacturer also noted that, since September 2002, it has been
                  awarded several new contracts. However, two other manufacturers told us
                  they are skeptical that improvements have been made with regard to
                  business practices. Notwithstanding such anecdotal evidence, because of
                  the recency of GPOs’ actions taken, the ability to assess the impact of the
                  conduct codes systematically remains limited. One year is not sufficient
                  time for the codes of conduct to produce measurable trends that could
                  demonstrate an impact on the industry.


                  For more information regarding this statement, please contact Marjorie
Contact and       Kanof at (202) 512-7101. Hannah Fein, Mary Giffin, Kelly Klemstine, Emily
Acknowledgments   Rowe, and Merrile Sing made key contributions to this statement.




(290198)
                  Page 20                                                        GAO-03-998T
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