Controversial Role of GPOs in Healthcare-Product Supply Chains

By Qiaohai Hu and Leroy B. Swarz Purdue Krannert School of Management

Group 1 : Babu John Parlin Marbun Petri Lahdekorpi

Contents
Facts of GPOs

GPOs Controversies
Flow chart of GPO GPOs Benefits and Criticism Research Model Hotelling Duopoly

Model Different Research Questions Research Results

Facts
Group Purchasing

Organizations are profit or non-profit organization owned typically by hospitals 7280% of every healthcare dollar is acquired through group purchasing GPOs account for over 85% of hospital purchases Largest GPO, Novation, contracted for over 2,400 hospitals with purchasing

Facts
Highest cost with lowest life expectancy?

The Research
Qiaohai and Leroy:
Build a highly style model

that include the contract administration fees. Address questions relevant to healthcareproduct supply chains. To view of the gaps between the simplicity of the model and the complexity of GPOs.

GPO Group Purchasing Organizations

Lower Prices through
product expertise over a wide range of products
buying power of their members

Non profit organizations which want to maximize

their owners/members surplus. GPO revenue sources

Contract administration fees charged to

Manufacturers. membership fees charged to provider-members

administrative fees charged to

distributors

Miscellaneous fees for services

GPOs Controversies
The fees GPOs charge to Manufacturers (3% of

contracted sales), forcing them to charge higher prices for products. The role they play in healthcare-product supply chains. The concentration of their purchasing power. Some of business practices they employ. GPOs promote or stifle competition ?

GPOs Controversies
Total annual revenue generated:

$5 Billion - $6 Billion which legitimately belongs to their member hospitals! GPO contract did not guarantee that hospital saved money: GPOs prices were often higher than prices paid by hospital negotiating with vendors directly. GPO contract blocks or slows the innovation or improvement of existing products.

GPOs Reaction to Criticisms

Arguing that GPOs

reduce prices and competitive in 2 ways:

Pool purchasing

leverage of hospitals buying products on nationwide contracts. Establishment of price ceilings beneath which hospitals negotiate on their own.

GPO Flow chart

Author: http://www.ccpharm.com/01_wholesaler.php 12th December 2011 4.19pm

Top 5 Areas in Hospitals Interest

The Research Model - The Hotelling Model - Example

The cost and choice of ice-cream is the same for each distributor. Buyers are evenly distributed along the beach. The first pattern of market share has the two salesmen positioned so that each is at the centre of his half of the beach and the market is split up evenly.

Author: http://www.answers.com/topic/hotelling-model 12th Dec 2011 2.39pm

The Hotelling Model - Example

If A now moves nearer to the middle of the beach, he will increase his market share.

Author: http://www.answers.com/topic/hotelling-model 12th Dec 2011 2.39pm

The Hotelling Model - Example

The logical outcome of this will have both salesmen back to back at the centre of the beach, as long as some customers are willing to walk nearly half a mile for an ice-cream, i.e. that the consumer provides the transport. This analogy indicates that locational decisions are not made independently but are influenced by the actions of others.

Author: http://www.answers.com/topic/hotelling-model 12th Dec 2011 2.39pm

Hotelling Model is to represent contracting costs:

Product-search cost

(what alternatives are available?) Product-assessment cost (which is best?) Contract-negotiation cost (what price for what quantity?) Transaction processing cost (buying or selling?)

Will GPO be formed?

Symmetric preference Two identical manufacturers Contracting costs are lower due to competition Contracting costs are moving up supply chain to manufacturers Asymmetric preference Two un-identical manufacturers due to:
Product Brand

GPO preferred charges lower CAFs, less profit

for manufacturer

Can off-contract price be lower from on-contract?

There is no obligation to buy on contract products Compliance is the ratio between on/off contract Higher compliance means higher market share

and bigger purchasing power and lower prices GPO results lower off-contract prices GPOs are not anticompetitive, instead it presents the equilibrium that maximizes manufacturers profits

Competition and Safe harbor provisions (CAF)

Should GPOs be allowed to charge CAFs? CAFs charged to manufacturers result less

investment on innovation or R/D However, there is no effect on any parties profit

Extensions
Monopoly If contracting through the GPO, it lowers the providers contracting cost The monopolist can charge a higher price Profit seeking GPO the safe-harbor provisions of the Social Security Act are limited to average 3%, reports are required providers equilibrium price is unaffected by the size of the CAF

Extensions
Profit seeking GPO Sources of revenue GPOs profits are extracted from the manufacturers profits, not the providers surplus GPOs is to charge their provider-members a fixed contracting fee GPOs offer a wide range of additional business services to their members that can be used either to generate profit or to offset contracting costs Given the 3% CAF, that for-profit GPOs have an incentive to reduce their own contracting costs Whether GPO operates on a profit or not-for-profit basis, the result for providers is the same.

Research Results
GPO increases competition between the manufacturers

and lowers costs, if there is no monopoly price competition, lowers the manufacturers incentive to introduce innovation off-contract price might be lower than the on-contract price so GPOs are not anticompetitive Lower off-contract prices are not evidence of anticompetitive behavior on the part of GPOs. Eliminating CAFs have no effect on any partys profit or cost Results are same whether GPO operates for profit or not for profit for-profit GPOs reduce manufacturers profits for-profit GPOs have an incentive to reduce contracting

Thank You
Questions and Answers?
Group 1 : Babu John, Parlin Marbun, Petri Lahdekorpi