Group Purchasing Organizations: Funding Structure Has Potential Implications for Medicare Costs
Published: 2014-10-24T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: GPOs are purchasing intermediaries that negotiate contracts for medical products and services. GPOs contract with vendors and receive a fee from them when providers purchase from the vendor. These fees are a source of operating revenue for GPOs, and they are allowed to collect them if they meet the requirements of a safe harbor to the “anti-kickback” provision of the Social Security Act—known as the Anti-Kickback statute—which would otherwise prohibit such fees.
You raised questions about GPOs' contracting practices and about the impact of the GPO funding structure. This report examines (1) GPO contracting practices and the reported effects of these practices; (2) how GPOs are funded and the reported effects of this funding structure. To do this work, GAO sent a questionnaire to representatives of the 5 largest national GPOs about their contracting practices and sources of revenue; reviewed the literature on the effects of the GPO funding structure; reviewed laws, regulations, and guidance on the GPO safe harbor; interviewed representatives from HHS, FTC, the Department of Justice (DOJ), vendors, hospitals, trade associations, and economic and health care experts.
section_title: What GAO Found
paragraphs: According to representatives from the 5 large group purchasing organizations (GPO) in GAO's review, GPO contracting generally involves three phases: (1) issue requests for proposals or invitations for vendors to competitively bid for a contract, (2) review proposals, and (3) negotiate and award contracts. GPOs reported negotiating and awarding different types of contracts to vendors in different situations. All 5 GPOs reported that the majority of the contracts they negotiate are either dual-source or multi-source, meaning that the majority of the products sold through their contracts have more than one vendor available on the GPOs' contracts. In addition, all GPOs reported that they did not bundle unrelated products and awarded mostly contracts with 3-year terms in 2012. The views of experts and others GAO interviewed on the effects of GPO contracting practices varied on issues such as whether the practices affect product innovation. In addition, while officials from the Federal Trade Commission (FTC) stated that they continue to receive and review complaints each year about GPO contracting practices, in the last 10 years, the FTC has not initiated any enforcement actions directed at GPO conduct.
The 5 GPOs in GAO's review reported being predominately funded by administrative fees collected from vendors, which were almost always based on a percentage of the purchase price of products obtained through GPO contracts. The 5 GPOs reported that these fees totaled about $2.3 billion in 2012, and nearly 70 percent of these fees were passed on to GPO customers or owners. The literature and the views of experts varied widely on the effects of this funding structure. Some suggested it creates misaligned incentives for GPOs to negotiate higher prices for medical products in order to increase the amount of vendor fees that they receive. Others suggested that competition between GPOs incentivizes them to negotiate the lowest possible prices, and mitigates these concerns. There is little empirical evidence available to either support or refute these concerns. However, to the extent that the vendor fee-based funding structure affects prices for medical products and services, Medicare payment rates may be affected over time through the annual update to hospital payment rates, which relies, in part, on information that hospitals report to the Centers for Medicare & Medicaid Services (CMS)—an agency in the Department of Health and Human Services (HHS). Moreover, Medicare payments also could be affected if hospitals do not account for revenue they receive from GPOs, which they are required to report as a reduction in costs on their cost reports. However, the extent to which hospitals are reporting this revenue is not known because this has not been reviewed by HHS since 2005, and CMS officials stated that the agency has not specifically identified this as information that should be routinely audited. Repealing the safe harbor—which allows administrative fees—could eliminate the potential effects of the GPO funding structure on Medicare payment rates, but experts and others stated that this could be disruptive to the health care supply chain at least in the near term. Over the longer term, GPOs and hospital systems are likely to adapt to the new market environment. While a repeal of the safe harbor provision would require a clearer understanding of the impact of the GPO funding structure, hospitals' potential underreporting of administrative fee revenue presents an immediate risk that can be addressed within the current GPO funding structure.
section_title: What GAO Recommends
paragraphs: GAO recommends that the Secretary of HHS determine whether hospitals are appropriately reporting administrative fee revenues on their Medicare cost reports and take steps to address any under-reporting that may be found. HHS agreed with the recommendation. GAO also incorporated technical comments from HHS, FTC, DOJ, and GPOs.

section_title: Letter
paragraphs: Increases in health care expenditures in recent years have intensified  congressional scrutiny of the costs of medical care. Federal spending for  health care services provided through Medicare and Medicaid in fiscal  year 2013 totaled $850.7 billion—an increase from $557.4 billion in  2006—and spending is expected to continue to increase. The increase in  federal spending for health care services can be attributed, in part, to the  growth in health care costs, and an important component of those costs is  the cost of products that hospitals and other health care providers  purchase to provide care. Providers often use purchasing intermediaries  known as group purchasing organizations (GPO) to negotiate contracts  for products and services with vendors such as manufacturers,  distributors, and other suppliers. Providers can then purchase products  and services from the vendors for the prices negotiated by the GPOs.
When a provider purchases a product or service from a vendor that has a  contract with a GPO, the vendor pays the GPO an administrative fee,  generally based on the purchase price paid by the provider. These fees  are a source of operating revenue for GPOs, and they are allowed to  collect them if they meet the requirements of a safe harbor to the “anti- kickback” provision of the Social Security Act—known as the Anti- Kickback statute—which would otherwise prohibit such fees.harbor” provision was enacted in 1986 to allow these payments, which   This “safe  had constituted a violation of the Anti-Kickback statute. According to a  House of Representatives Committee report, the Committee believed that  GPOs could help reduce health care costs by enabling hospitals to obtain  volume discounts from vendors and that a safe harbor should be  established to ensure that GPOs and the vendors with which they  contract do not risk prosecution as a result of the payment and collection  of administrative fees.under this safe harbor has raised questions about whether GPOs are in  fact negotiating the lowest possible prices for their customers because of  an inherent conflict: while GPOs represent the interests of health care  providers to obtain needed products and services at a lower price, they  are funded based on a percentage of the costs of products purchased  from the vendors they negotiate with on behalf of providers.
However, the GPO funding structure protected  Over more than a decade, members of Congress and others have raised  questions about certain GPO contracting practices and the funding  structure that includes vendor-paid fees. For example, questions have  been raised about sole-source contracting, in which GPOs may contract  with only one vendor for a given product when multiple vendors of  comparable products are available; product bundling, in which price  discounts are linked to purchases of a specified group of products; and  long-term contracts of 5 years or more. Members of Congress have also  raised questions about the oversight of GPOs by the Federal Trade  Commission (FTC), the Department of Justice (DOJ), and the Department  of Health and Human Services (HHS), as well as GPO self-regulation  through the Healthcare Group Purchasing Industry Initiative (HGPII). We  issued five reports between 2002 and 2012 related to these issues.
You raised questions about GPOs’ contracting practices and about the  effects of the GPO funding structure. This report examines 1.  GPO contracting practices and the reported effects of these practices;  2.  how GPOs are funded and the reported effects of this funding  structure.
To address these objectives, we sent a questionnaire to representatives  of the five largest national GPOs by purchasing volume about their  contracting practices and sources of revenue, including administrative  fees collected from vendors. We also conducted a review of the literature  regarding the effects of the GPO funding structure. In addition, we  reviewed documentary evidence of the factors that GPOs consider when  contracting for products and services, and reviewed published articles in  economic and law journals, as well as analyses of the healthcare market.  We also reviewed laws, legislative history, regulations, and guidance  related to the GPO safe harbor. We interviewed FTC, DOJ, and HHS  officials about their oversight of GPOs. To obtain contextual information  about their experiences with GPOs, we interviewed representatives from  five hospitals and eight vendors of medical products. We selected  hospitals based on variation in the number of hospital beds, the extent to  which the hospital had an ownership interest in a GPO, and which GPOs  they used. We selected vendors based on variation in the types of  products manufactured. To determine the reported effects of the GPO  funding structure, we interviewed 13 experts in economics, the healthcare  market, and purchasing cooperatives. We identified these experts through  our search of the relevant literature on GPOs, healthcare markets,  purchasing cooperatives, and economics. We also interviewed trade  associations representing GPOs and vendors of medical products.  Information obtained from interviews is not generalizable. A more  extensive discussion of our scope and methodology appears in   appendix 1.
We conducted this performance audit from June 2013 through October  2014 in accordance with generally accepted government auditing  standards. Those standards require that we plan and perform the audit to  obtain sufficient, appropriate evidence to provide a reasonable basis for  our findings and conclusions based on our audit objectives. We believe  that the evidence obtained provides a reasonable basis for our findings  and conclusions based on our audit objectives.
subsections: section_title: Background
paragraphs: GPOs are organizations that act as purchasing intermediaries that  negotiate contracts between health care providers and vendors of  medical products and services, including manufacturers, distributors, and  other suppliers. The intent of GPOs is to save their customers money by  pooling their purchases in order to obtain lower prices and by taking on  the administrative burden of negotiating contracts with vendors. Through  GPO-negotiated contracts, health care providers can purchase products  from vendors, including medical devices, commodities, branded drugs,  and generic drugs, as well as services, such as laundry and food  services. The Healthcare Supply Chain Association (HSCA)—a trade  association representing 14 healthcare GPOs—estimates that U.S.  hospitals use, on average, 2 to 4 GPOs per facility, and nearly every  hospital in the United States—approximately 96 percent to 98 percent— purchases through GPO contracts.
According to HSCA, the first GPO was established in 1910 by the  Hospital Bureau of New York, and by the 1980s, there were more than  100 GPOs. While over 600 GPOs in various markets are currently active  in the United States, a relatively small number of GPOs dominate the  healthcare market for products and services sold through GPO contracts.  According to HSCA, GPOs vary in size, type of ownership, and the  contracting services they offer their customers. For example, some GPOs are owned by hospitals, while others are not. operate nationally, while others operate regionally to negotiate  contracts with local vendors.  serve not-for-profit hospitals, others serve for-profit hospitals, and  some serve both. offer a broad portfolio of products and services, while others focus on  specific product categories or certain types of health care, such as  long-term care.
In recent years, the GPO market has become more consolidated as some  large GPOs have merged. The five largest national GPOs have reported  contracting for a similar, broad portfolio of products, including, for  example, commodities such as cotton balls and bandages, devices such  as pacemakers and stents, and branded and generic drugs. During fiscal  year 2012, the 5 largest GPOs by purchasing volume reported a total  purchasing volume of $130.7 billion.
subsections: section_title: Administrative Fees
paragraphs: During the contracting process for products and services, GPOs negotiate  the payment of administrative fees by the vendor to the GPO. In addition  to using these administrative fees to cover operating expenses, GPOs  may distribute a portion of the fees to their health care provider customers  or use them to finance other ventures, such as investing in other  companies. GPOs may also use administrative fees to fund additional  services outside of group purchasing for their customers, which can  include custom contracting; services related to product evaluation, such  as clinical evaluation and standardization of products; assessments of  new technology; benchmarking data services; and marketing and  insurance services. (See fig. 1.)
section_title: Federal Oversight of GPOs
paragraphs: HHS’s Office of the Inspector General (HHS-OIG) is responsible for  enforcing the Anti-Kickback statute. The Anti-Kickback statute, originally  enacted in 1972 and amended over the years, generally prohibits the  knowing or willful receipt or payment of fees to induce or reward the  purchase of an item or service for which payment may be made under a  federal health care program. According to HHS-OIG, the main purpose  of the Anti-Kickback statute is to protect patients and federal health care  programs, including Medicare, from fraud and abuse by curtailing the  corrupting influence of money on health care decisions. In 1986  Congress added a “safe harbor” provision to the Anti-Kickback statute to  allow for fees paid by vendors to a GPO.issued a regulation establishing the requirements that GPOs must meet in   In addition, in 1991, HHS-OIG  order to qualify for safe harbor protection under the Anti-Kickback  statute. Under the regulation, a GPO must have a written agreement with its customers either stating that the  contract administrative fees are to be 3 percent or less of the  purchase price, or specifying the amount or maximum amount that  each vendor will pay; and disclose in writing to each customer, at least annually, and to the  Secretary of HHS upon request, the amount of contract administrative  fees received from each vendor with respect to purchases made by or  on behalf of the customer.
The GPO safe harbor statutory provision and regulation do not require  HHS-OIG to routinely review or monitor GPO written agreements and  disclosures. However, HHS-OIG has the authority to investigate potential  violations of the Anti-Kickback statute. HHS-OIG also has the authority to  impose administrative penalties, including civil money penalties, and  exclusion from federal health care programs on GPOs that violate the  statute. HHS-OIG also may refer such violations to DOJ, which in turn  may bring criminal and civil actions against GPOs that it determines to  have violated the Anti-Kickback statute. HHS-OIG does not have  general oversight authority over GPOs because GPOs do not directly  participate in Medicare and, therefore, do not enter provider agreements  with the Centers for Medicare & Medicaid Services (CMS)—a component  of HHS.
In 2012, we found that, according to officials from HHS-OIG, the office  had not routinely exercised its authority to request and review disclosures  related to GPOs’ administrative fees, but it had collected information on  GPOs’ administrative fees while conducting audits of hospitals’ cost  reports. The provision and receipt of discounts, rebates, and net  revenue distributions by GPOs to hospitals is protected from prosecution  under the Anti-Kickback statute by another provision—known as the  “discount safe harbor.” Specifically, a discount or other reduction in price  obtained by a Medicare or Medicaid provider is protected from  prosecution if the reduction in price is properly disclosed and  appropriately reflected in the provider’s Medicare, or applicable state  Medicaid, cost report.
HHS-OIG conducted two audits in 2005 in which it reviewed the  administrative fees that six national GPOs received from vendors and  how selected customers of the GPOs accounted for revenue distributions  from the GPOs on their Medicare cost reports. The cost reports are used, in part, to set hospital payment rates for Medicare. HHS-OIG found  that some of the GPO customers did not fully account for revenue  distributions from the GPOs on their Medicare cost reports.recommended that CMS provide specific guidance on the proper  treatment of revenue distributions received from GPOs on Medicare cost  reports. In December 2011, CMS issued an update to its provider manual  specifying that these distributions must be properly accounted for on the  cost reports.
DOJ and FTC are responsible for enforcing federal antitrust laws, which  GPOs are required to follow. investigate a GPO’s potential violation of federal antitrust laws, identified  either through a complaint filed with the agencies, through notification of a  merger, or through information obtained through the agencies’ own  efforts. The agencies have the authority to resolve violations in a number  of ways ranging from compliance under a consent order, to an  administrative complaint, to filing a criminal or civil suit. In addition to its  antitrust enforcement authority, DOJ also has the authority to bring  criminal and civil actions against GPOs that it determines to have violated  the Anti-Kickback statute.
The Sherman Act is enforced by DOJ and prohibits restraints of trade and  monopolization. See 15 U.S.C. §§ 1-7. The Federal Trade Commission Act, enforced by  FTC, bans unfair methods of competition and unfair or deceptive acts or practices. See   15 U.S.C. §§ 41-58. The Clayton Act, jointly enforced by DOJ and FTC, regulates mergers  and acquisitions, among other things, and gives DOJ and FTC, under the Hart-Scott- Rodino Amendments to the Clayton Act, the authority to review certain proposed mergers  before they occur. See 15 U.S.C. §§ 12-27.
In 2012, we found that DOJ and FTC had investigated complaints against  GPOs. We identified one lawsuit filed by DOJ against a GPO, while FTC  officials told us the agency had not taken any enforcement action against  a GPO since 2004. Officials said that while FTC has investigated GPOs  to determine whether their behavior was anticompetitive, the agency has  not brought any cases to court or issued any consent orders. An FTC  official told us that in order to take enforcement action against a GPO,  FTC would need to determine that a GPO violated the law and an  enforcement action was in the public interest.
section_title: GPOs Reported Generally Utilizing a Three-Phased Approach to Competitively Negotiate Contracts with Vendors
paragraphs: According to the GPOs in our review, GPO contracting generally involves  three phases: (1) issue requests for proposals (RFP) or invitations for  vendors to competitively bid for a contract, (2) review proposals, and   (3) negotiate and award contracts. (See fig. 2.)
Issue RFPs. Representatives from all five GPOs in our review reported  generally issuing RFPs as part of an open bidding process for products  and services to place on contract. Issuing RFPs includes notifying  vendors, and publicly posting information such as bid calendars, minimum  requirements for vendors, and criteria that the GPOs will weigh when  considering competing proposals. All five GPOs in our review have  posted on their websites information about the minimum requirements  that vendors must meet. For example, one GPO’s website states that  vendors must be the original equipment manufacturer or demonstrate an  exclusive marketing relationship for the products included in the RFP,  among other things. Another GPO specifies meeting minimum levels of  product quality, durability, and cost-effectiveness, as well as requirements  for the financial stability and long-term viability of the vendor. A sample  RFP provided by a GPO states that during the competitive bidding  process, it will consider a vendor’s product capabilities, maintenance, and  ability to upgrade, as well as pricing and other financial factors.
Four of the five GPOs in our review reported that under certain limited  circumstances, they may award contracts to vendors without issuing  RFPs. For example, these “non-bid” contracts may be awarded to  vendors that present a proprietary, patented, or innovative product; if a  small group of customers request a local or regional vendor contract; or if  a product supply shortage or other unique circumstances arise. The fifth  GPO reported that all contracts are awarded through a competitive  bidding process, even if there is only one bidder. A representative from  one generic drug manufacturer stated that, while there is not much  opportunity for innovation in the generic drug market, GPOs will award  contracts outside of the three-phased competitive bidding process to  vendors that have innovative packaging—such as flip-top vials versus a  pre-mixed bag—if it benefits their customers. A representative from this  manufacturer stated that GPO contracts with vendors generally contain  provisions that the GPOs have the right to add additional vendors of the  same product if the other vendor has innovative packaging.
Review proposals. All five GPOs in our review reported considering  multiple aspects of a vendor and product when reviewing proposals,  including weighing financial and nonfinancial criteria, and then scoring  competing vendors in order to inform their contracting decisions.example, one GPO reported reviewing aspects such as a vendor’s ability  to provide sufficient product to its customers, any documentation of  concerns raised by Food and Drug Administration (FDA) inspections,  quality and safety of the products, the source of raw materials, and bar  code readability. A representative from another GPO said that the GPO  considers the “total value” of a product or service for their customers, not  necessarily solely the price. The total value includes, for example, product  quality, upfront price, discounts, rebates, and anticipated administrative  fee revenue. This representative said that in certain situations, such as  with multiple possible suppliers of a product, a GPO customer would not  necessarily want to purchase the product with the lowest price.
Negotiate and award contracts. GPOs reported negotiating and  awarding different types of contracts to vendors in different situations. All  five of the GPOs in our review reported that the majority of the contracts  they negotiate are either dual-source or multi-source, meaning that the  majority of the products sold through their contracts have more than one  vendor available on the GPOs’ contracts. In addition, all five GPOs  reported that they did not bundle unrelated products, and awarded mostly  contracts with 3-year terms in 2012. All five GPOs also reported including  provisions in some contracts—referred to as commitment provisions—in  which customers that purchase a certain percent of product volume  receive a rebate or reduced price. For example, a vendor 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 a  customer to commit to different percentages of purchasing volume: the  higher the percentage, the lower the price.
Representatives from all five GPOs also reported that, in certain  situations, they negotiated sole-source contracts, contracts that bundled  related products, and long-term contracts of 5 years or more. All five  GPOs in our review reported that their contracting practices have not  changed much over time.
Sole-source contracts: All five GPOs reported that they do negotiate  sole-source contracts when it is advantageous to their customers,  though some GPOs reported negotiating a higher proportion of sole- source contracts than others. One GPO said that about 18 percent of  its customers’ spending through the GPO is through sole-source  contracts. Three GPOs reported sole-source contracting for branded  drugs and commodities, and four GPOs reported sole-source  contracting for generic drugs, including generic injectable drugs. For  example, one GPO reported that in 2012 it had sole-source contracts  in effect for generic drugs including an oncology drug—oxaliplatin,  and an antiviral—acyclovir. Representatives from this GPO reported  taking a vendor’s performance and supply capacity into consideration  when determining whether to sole-source contract with a vendor. For  example, the representatives stated that the GPO no longer sole- source contracts with a vendor that had failed to comply with FDA  standards. Representatives from one vendor stated that, as a result of  recent drug shortages, some GPOs have developed a philosophy to  contract with as many vendors as possible to ensure a continuous  supply for their customers, but that other GPOs choose to contract  with a limited number of vendors and hold those vendors accountable  for supplying their customers.
Contracts that bundle related products: Representatives from all five  GPOs in our review reported negotiating contracts that offer discounts  based on the purchase of bundled products, but restricting bundling to  products that are used together or are otherwise related in order to  create efficiencies and help standardize products for their customers.  Several GPOs reported bundling related commodities, and one GPO  reported bundling related branded pharmaceuticals. Representatives  from one GPO stated that the GPO bundles related products in the  same product category, such as intravenous (IV) sets and solutions,  diapers and underpads for incontinence care, and mobility aids such  as walkers, crutches, and canes. Representatives from another GPO  stated, for example, that it negotiates bundled contracts for  interventional coronary products including stents, balloons, catheters,  and guide wires. In addition, another GPO reported that, in 2013, it  implemented a program through which participating customers can  standardize their purchases for up to 40 commodity categories for  additional discounts.
Long-term contracts: Representatives from all five GPOs reported  awarding longer terms for certain types of products, such as IV  systems and laboratory products. One GPO reported that its  customers requested long-term contracts for IV systems because they  found it difficult to switch IVs and pumps every 3 years, and one  manufacturer we interviewed stated that the investment in time and  money needed to train clinicians in how to use a brand of IV products  makes it inconvenient and disruptive for hospitals to change these  products. A representative from another GPO stated that they often  negotiate longer-term contracts for chemistry analyzers and the  specific reagents that are used with them, and had recently negotiated  a 7-year contract for both the analyzers and reagents together.
Finally, all 5 GPOs in our review provide a grievance process for vendors  who are not awarded contracts. A representative of one GPO stated that,  when vendors are not awarded a contract and want to know why, GPO  staff debrief the vendor on how to make changes to increase their  chances of being awarded a contract during the next RFP cycle. After this  debrief, a representative of the GPO stated that vendors can file a formal  grievance with the GPO. Another GPO posted on its website that any  vendor may file a grievance within 30 days of the announcement of the  contract award. The website states that the GPO will acknowledge receipt  of the grievance immediately, and provide a detailed response within   90 days, including the GPO’s rationale for the final decision. In addition to  each GPO’s separate grievance processes, HGPII—which GPOs formed  in 2005 in order to promote best practices and public accountability  among member GPOs—also has a formal grievance process that  vendors may use to lodge complaints against GPOs. However, HGPII  representatives told us that no complaints have been formally submitted.  They explained that, while it is possible that there are no vendor  complaints, they believe it is more likely that not enough vendors know  about the grievance process. HGPII representatives stated that they have  brought on board an in-house ethicist to review HGPII’s grievance  process.
The views of experts and others we interviewed on the effects of GPO  contracting practices varied. For example, some experts and other  stakeholders contend that GPOs’ contracting practices may result in a  reduction in product innovation. Specifically, one expert said that if  manufacturers believe that it is impossible to get onto a GPO contract, but  that such a contract is necessary for market success, then manufacturers  will not innovate and create new products. However, others we  interviewed told us that GPO contracting practices do not block access to  innovative products. For example, all 5 of the largest GPOs reported  using a competitive bidding process as well as contract clauses that allow  for innovative products to be placed on existing contracts. The GPOs in  our review also reported participating in forums to help identify new,  potentially innovative, products in the marketplace. However, they said  vendors of products that are essentially the same as other products  already on GPO contracts need to compete through the competitive  bidding process for the opportunity to be awarded a contract. While  officials from the FTC told us that they continue to receive complaints  each year about the potential anticompetitive effects of GPO contracting  practices—including complaints that GPOs have contributed to recent  shortages of generic injectable drugs—in the last ten years, the FTC has  not initiated any enforcement actions directed at GPO conduct. FTC staff  explained that they have faced significant challenges in investigating  allegations of anticompetitive behavior of GPOs due to a lack of data.  They stated that there are a number of significant methodological  challenges related to conducting a rigorous economic analysis of the  GPO industry. In addition, a DOJ official told us that the agency has not   He  brought any actions or issued any guidance on GPOs since 2007.also stated that the DOJ has received one GPO-related complaint since  2012 when our most recent prior report was issued.
section_title: While Experts’ Views on the Effects of Vendor Funding of GPOs Varied, the Funding Structure May Affect Medicare Payment
paragraphs: The five GPOs in our review reported being predominately funded by  administrative fees collected from vendors, and the experts’ views of the  effects of this funding structure varied widely. In addition, the GPO  funding structure may affect Medicare payments over time.
subsections: section_title: GPOs Reported Being Predominately Funded by Vendors
paragraphs: The five GPOs in our review reported being predominately funded by  administrative fees collected from vendors, which were almost always  based on a percentage of the purchase price for products obtained  through GPO contracts. GPOs use these fees to fund their operating  expenses, including expenses related to contracting with vendors and  providing additional services to their customers outside of group  purchasing. On average, the five GPOs in our review reported that  administrative fees collected from vendors accounted for about   92 percent of their revenue in 2012, ranging from a low of 83 percent to a  high of 98 percent.average, 3.3 percent of their revenue from member fees, ranging from   0.2 percent to 12.1 percent. Member fees included, for example, fees that  a GPO charged hospitals in exchange for membership in the GPO. The  five GPOs also reported that revenue from outside investments  accounted for, on average, 2.2 percent of their revenue in 2012.  However, only two GPOs reported receiving this type of revenue, which  accounted for 8.1 percent and 2.7 percent of their total revenue in 2012,  respectively. This revenue included, for example, equity income from an  ownership interest in another GPO. Finally, the GPOs reported receiving,  on average, 0.6 percent of their revenue from other sources, ranging from  0 percent to 1.5 percent. This other revenue included, for example,   In addition, these GPOs reported receiving, on  vendor exhibit fees and conference fees. In addition to these sources of  revenue, two of the five GPOs in our review offered private label  programs to their hospital customers in 2012. Under these programs,  vendors may pay the GPOs licensing fees—which are also based on a  percentage of the purchase price of products—to market their products  using the GPO’s brand name. On average, the 5 GPOs reported that  licensing fees accounted for 2.2 percent of their revenue, though only two  of the GPOs in our review collected licensing fees through private labeling  programs in 2012. (See fig. 3)
The GPOs in our review generally reported receiving more fees from  vendors in 2012 than they did in 2008. Together, all five GPOs reported  collecting a total of $2.3 billion in administrative and licensing fees from  vendors in 2012.amount of fees collected from vendors in 2008, when adjusted for   This represents a 20 percent increase in the total  inflation. One GPO reported no change in the total amount of vendor fees  collected between 2008 and 2012, but did report a 15 percent increase in  its percentage of revenue from outside investments. The other four GPOs  reported increases in the total amount of vendor fees collected between  2008 and 2012, ranging from 13 percent to 53 percent, when adjusted for  inflation. GPO representatives told us there were many reasons for the  growth in volume of fees collected, including increases in purchasing  volume by customers and additional products being added to contracts.  Although we requested this information for years prior to 2008, two of the  five GPOs in our review reported that they were unable to provide it  because they do not retain records for that long.
All five GPOs in our review reported most frequently receiving  administrative fees from vendors that were at or below 3 percent,  although the two GPOs with private-label programs reported also  receiving licensing fees from vendors of products sold under the GPOs’  brand names in addition to administrative fees. All five GPOs in our  review reported that the most frequent vendor fee they received in 2012  was 3 percent. In addition, all five GPOs reported average fees received  in 2012, weighted by purchasing volume, of around 1 to 2 percent. This  average includes fees from distributors and manufacturers. Because fees  from distributors are often less than 1 percent, average fees from  manufacturers are likely to be higher than the 1 to 2 percent overall  average. In addition, the three GPOs without private-label programs in  2012 reported that the highest vendor fee they received that year was   3 percent. The administrative fee percentages that GPOs reported  receiving in 2012 are consistent with the levels that the GPOs reported for  2008.
The two GPOs with private-label programs in 2012 reported that their  highest fees—9.9 and 11.12 percent—were for products sold through  their private-label programs and included both an administrative fee as  well as a licensing fee for the GPO to market the products to their  customers. Representatives from the GPO that reported the fee of   9.9 percent stated that this was for a brand name drug with a variable fee  based on the vendor’s sales volume—the vendor was willing to pay a  higher fee in exchange for the GPO’s customers pre-ordering the drug.
Representatives from the GPO that reported the 11.12 percent fee stated  that the fee was negotiated with a vendor that supplied five generic drugs  through the GPO’s private-label program.
Average fee percentages, weighted by purchasing volume, that GPOs  reported receiving in 2012 were generally consistent across different  categories of products, but there were some small differences. For  example, fees for branded drugs were generally lower than for generic  drugs—average fees for branded drugs ranged from 0.86 percent to   2.08 percent, while average fees for generic drugs ranged from   1.31 percent to 3.62 percent. Four of the 5 GPOs reported that, of the  total amount of vendor fees they received in 2012, on average,   25 percent were for commodities, 15 percent were for devices, 12 percent  were for brand name drugs, and 8 percent were for generic drugs. The  remaining 41 percent were for other products and services, such as  capital equipment and food service. The fifth GPO in our review was  unable to report information separately for devices and commodities.
section_title: Experts’ Views on the Effects of the GPO Funding Structure Varied Widely, Though Empirical Data on the Effects Are Limited
paragraphs: The literature we reviewed and the views of experts we interviewed varied  widely on the effects of the GPO funding structure, specifically the  reliance on vendor fees. Some of the literature we reviewed and experts  we interviewed asserted that the vendor fee-based funding structure of  GPOs creates misaligned incentives for them to negotiate higher prices  for medical products in order to increase the amount of vendor fees that  that they receive. Several experts that we interviewed stated that, based  on economic theory, the GPO funding structure creates a principal-agent  problem, in which the GPOs are motivated to act in their own best  interests, rather than the best interests of their customers. These experts  argued that because the GPOs’ compensation increases as prices  increase, the GPOs have little incentive to negotiate lower prices, even  though their customers would benefit from lower prices. Therefore, GPOs  may place greater weight on the administrative and other fees than the  prices of products and services for their customers. According to these  experts, this funding structure—which allows vendors to pay  administrative fees to GPOs—distorts the bidding process and results in  inflated prices for hospitals relative to a funding structure where these  administrative fees are not allowed.
Other people we interviewed—including some experts and  representatives of the GPOs—stated that competition between GPOs to  retain their customers incentivizes them to negotiate the lowest possible  prices, and mitigates any theoretical principal-agent problem. They  explained that hospitals can switch GPOs anytime if they are not satisfied  with the prices that a GPO is negotiating. Representatives from one  hospital said that hospitals switch GPOs when they merge with larger  systems, but that there are significant costs related to the conversion.  Several experts reported that not only are the largest national GPOs in  intense competition with each other, they are in competition for purchases  made directly from manufacturers, as well as through regional GPOs, and  hospital and health system alliances. Specifically, one expert we  interviewed stated that GPO customers often obtain pricing information  from all possible sources and then selectively choose products and  services they can obtain for the best prices. Another expert told us that  the percentage-based administrative fee structure works well because  GPOs are only compensated for the sales that are made.
Although some experts have reported potential effects of the GPO  funding structure, empirical data on the effects are limited. We identified  one study that presented empirical data on the effects of the vendor-fee- based GPO funding structure. The authors of this study concluded that,  if the GPO safe harbor provision were eliminated, then GPOs “would  likely structure their procurement process in a way that elicited more  competitive bidding, resulting in lower prices and greater competition.” In  addition, the authors concluded that altering the GPO funding structure  would not eliminate any efficiencies that GPOs currently offer, such as  reduced transaction costs or consolidated buying power. We also found  other studies that presented empirical data focused more broadly on the  value of GPOs, such as studies that focused on whether GPOs save their  customers money. However, these studies did not include empirical  evidence that directly addressed the effects of the GPO funding structure.
section_title: The GPO Funding Structure May Affect Medicare Payments over Time
paragraphs: The GPO funding structure may affect Medicare payments over time. To  the extent that the vendor-fee-based funding structure affects prices for  medical products and services—either by reducing or inflating the costs of  the products and services—Medicare payment rates may be affected  over time through the annual update to the Prospective Payment System  hospital payment rates. According to HHS, these updates rely, in part, on  information reported by hospitals on their Medicare cost reports, which  reflect the hospitals’ costs of medical supplies, including those purchased  through GPOs.
Moreover, Medicare payments could be affected if hospitals do not  appropriately account for any revenues they receive from GPOs. These  revenues are required to be reported as a reduction in costs on hospitals’  costs reports. All five GPOs in our review reported passing a percentage  of the administrative fees—in some cases, the majority of fees collected  from vendors—on to their customers or owners in 2012. All five GPOs  reported sharing with their customers or owners between 37.6 percent  and 100 percent of the total administrative fees they received in 2012—a  total of $1.6 billion. This represents 70 percent of the $2.3 billion in administrative fees collected in 2012. The amount distributed to  customers and owners ranged from $54 million to $472 million per GPO.  To the extent that administrative fee revenue is not reflected on cost  reports, Medicare could be overpaying hospitals. The extent to which  hospitals are reporting this additional revenue is not known because  HHS-OIG has not reviewed cost reports for this information since 2005.  In addition, CMS officials told us that the agency has not specifically  identified this as information that should be routinely audited by Medicare  Audit Contractors.
Some experts that we interviewed stated that the potential effects of the  GPO funding structure on Medicare payment rates could be eliminated if  the GPO safe harbor were repealed and GPOs were no longer permitted  to collect fees from vendors. However, experts and representatives from  vendors, GPOs, and hospitals we interviewed stated that there would be  a disruption to hospitals and vendors while they transitioned to a new  supply chain model. Others we interviewed—including GPO  representatives—told us that if the safe harbor were repealed, GPOs  would eventually cease to exist because hospitals would not be able to  afford to pay the fees. However, some hospitals already pay directly for  access to contracts to supplement their existing contracting arrangements  with their GPOs. For example, a wholly-owned subsidiary of one large,  national GPO charges its customers a $50,000 a year subscription fee for  access to a web-based system for viewing hospital supply prices,  negotiating contracts with vendors directly, and tracking their purchases  and contracts online. The company has reported more than $10 billion in  purchasing power from a user base of 600 hospitals in its first year.  Finally, others stated that, if the safe harbor were repealed, smaller  hospitals might have more difficulty adjusting and may be more likely to  merge with larger hospital systems.
section_title: Conclusions
paragraphs: Congress passed the GPO safe harbor provision because it believed that  GPOs could help reduce health care costs by enabling hospitals to obtain  volume discounts from vendors. However, the GPO funding structure  protected under the safe harbor—specifically, the payment of  administrative fees by vendors based on a percentage of the cost of the  products or services—raises questions about whether GPOs are actually  negotiating the lowest prices. Some experts believe there is an incentive  for GPOs to negotiate higher prices for products and services because  GPO compensation increases as prices increase. However, other  experts, as well as GPOs, stated that there is sufficient competition  between them to mitigate any potential conflicts of interest. Almost   30 years after its passage, there is little empirical evidence to definitively  assess the impact of the vendor-fee-based funding structure protected  under the safe harbor. While repealing the safe harbor could eliminate  misaligned incentives, most agree there would be a disruption while  hospitals and vendors transitioned to new arrangements. Over the longer  term, if the current trend of hospital consolidation continues, the concerns  about these disruptions may be diminished to the extent that large  hospital systems may be in a better position to pay GPOs directly for their  services or negotiate contracts with vendors on their own. Furthermore,  given that some hospitals are already paying a subsidiary of one GPO  directly for access to vendor contracts, alternative approaches are  possible.
Despite the limited evidence on the impact of the vendor-fee-based  funding structure protected under the safe harbor, there is a potential  impact on the Medicare program. To the extent that the funding structure  has the potential to affect the costs of products and services, periodic  updates of Medicare’s payment rates will incorporate these costs over  time. Additionally, GPOs distribute to their owners and customers— mostly hospitals—a percentage of the administrative fees they collect  from vendors, in some cases the majority of such fees. Hospitals are  required by federal law to account for this revenue in reports to Medicare,  but that has not always occurred. In 2005, HHS-OIG found that some  GPO customers did not fully account for GPO revenue distributions on  their Medicare cost reports. Subsequently, CMS issued updated guidance  specifying that these distributions must be properly reported, but HHS has  not reviewed cost reports for this information since then. While a repeal of  the safe harbor provision would require a clearer understanding of the  impact of the GPO funding structure, hospitals’ potential underreporting of  administrative fee revenue presents an immediate risk that can be  addressed within the current GPO funding structure.
section_title: Recommendation for Executive Action
paragraphs: To help ensure the accuracy of Medicare’s payments to hospitals, we  recommend that the Secretary of the Department of Health and Human  Services determine whether hospitals are appropriately reporting  administrative fee revenues on their Medicare cost reports and take steps  to address any under-reporting that may be found.
section_title: Agency and Third- Party Comments and Our Evaluation
paragraphs: We provided a draft of this report to HHS, FTC, and DOJ for comment. In  its written response, reproduced in appendix II, HHS agreed with our  recommendation, and stated that it will add steps to its process for  auditing hospitals’ cost reports so that contractors may review  administrative fee revenues that hospitals receive from GPOs. We  received technical comments from HHS, FTC, and DOJ which we  incorporated as appropriate.
We also received comments on a draft of this report from the 5 GPOs in  our review and from HSCA. Many of the comments we received were  similar and include the following:
Some of the GPOs and HSCA noted that they were concerned that  the draft title was not consistent with the content of the report. We  reconsidered this title in light of their concerns and believe the revised  title—Group Purchasing Organizations: Funding Structure Has  Potential Implications for Medicare Costs—addresses their concerns,  but is still consistent with the findings of the report.
Some of the GPOs and HSCA disagreed with the draft report’s  characterization that repeal of the safe harbor would have potential  short-term disruption on the supply chain, stating that there would be  significant market disruption that could result in higher healthcare  costs. The draft report included statements we obtained from the  GPOs—as well as experts and others—on the potential impact of  eliminating the safe harbor. However, the draft report did not include a  recommendation to repeal the safe harbor, noting that there is limited  empirical evidence to definitively assess the impact of the vendor fee- based funding structure protected under the safe harbor.
Some of the GPOs commented that the example about a subsidiary of  a GPO with an alternative funding structure does not indicate that a  model like this could support the entire industry if the safe harbor were  repealed. The draft report only describes this as one possible  example, and we added additional context to the report to clarify this  point.
Some of the GPOs and HSCA noted that there is currently no  evidence that hospitals are not appropriately accounting for revenue  received from GPOs on their cost reports and that GAO did not  consider the findings of the 2005 HHS-OIG audit reports. However,  we did consider the 2005 audit findings, and we added additional  detail on them to the report. As noted in the draft report, the HHS-OIG  recommended in 2005 that CMS provide specific guidance on the  proper treatment of revenue distributions and, in 2011, CMS issued  updated guidance on this issue. Since that updated guidance, HHS  has not assessed whether revenues from GPOs are being  appropriately accounted for.
Some of the GPOs and HSCA noted that our draft report did not  explain the reasons for the 20 percent increase in GPO administrative  fees between 2008 and 2012. We added a statement to the report to  describe the reasons why the total volume of fees may have  increased, such as increased customer purchasing volume. In  addition, the draft report examined changes in the percentage of fees  collected, noting that these were generally consistent over this 4-year  period.
Some of the GPOs and HSCA stated that the draft report did not  explain the full set of benefits of the GPO industry. We added some  additional information to the report to more fully describe the activities  and reported benefits of GPOs and how they serve hospitals or other  providers. However, the scope of this report is focused on GPO  contracting practices and funding structure. In a prior report, we  described the services offered by GPOs and that work is referenced in  this report. (See GAO-10-738).
Some of the GPOs and HSCA commented that in describing the  literature on the GPO funding structure, we do not include a  discussion of any of the independent and industry funded studies on  the impact of GPOs. As we state in the report, while we identified  other studies that presented empirical data focused more broadly on  the value of GPOs, these studies did not include evidence that directly  addressed the effects of the GPO funding structure. In addition, some  GPOs and HSCA noted that the study described in our report was  funded by the Medical Device Manufacturers Association (MDMA).  We added a note to the report that explains that MDMA provided  funding for the author to purchase the data used in this study.
Some of the GPOs raised concerns about the sample size and  selection of vendors and hospitals we interviewed and stated that a  broader sample of vendors and hospitals is necessary to maintain a  more meaningful representation of their points of view. The  information we obtained from hospitals and vendors was used to  provide context and examples. We added a statement to the report to  note that this information was not generalizable.
Some of the GPOs commented that the description of FTC complaints  is incomplete. We report FTC’s comments on this matter and this  report has been reviewed by FTC.
Some GPOs commented that the draft report did not include a  description of the GPO governance process or advisory board  decision making. We added this information to the report.
We also received technical comments from the GPOs and HSCA which  we incorporated as appropriate.
As agreed with your offices, unless you announce the contents of this  report earlier, we plan no further distribution of it until 30 days from the  report date. At that time, we will send copies of this report to the  Secretary of the Department of Health and Human Services, the Attorney  General, the Chairman of the Federal Trade Commission, and  appropriate congressional committees. The report will be available at no  charge on the GAO website at http://www.gao.gov.
If you or your staff have any questions concerning this report, please  contact Linda T. Kohn at (202) 512-7114 or KohnL@gao.gov. Contact  points for our Offices of Congressional Relations and Public Affairs may  be found on the last page of this report. Other major contributors to this  report are listed in appendix III.
section_title: Appendix I: Scope and Methodology
paragraphs: Our objectives were to describe (1) Group Purchasing Organization  (GPO) contracting practices and the reported effects of these practices;  (2) how GPOs are funded and the reported effects of this funding  structure.
To address these objectives, we sent a questionnaire to the five largest  national GPOs by purchasing volume: Amerinet, HealthTrust Purchasing  Group, MedAssets, Novation, and Premier. We asked about their  contracting practices and sources of revenue, including administrative  fees collected from vendors. We fielded the questionnaire from December  2013 through March 2014. One GPO did not provide answers through our  web-based questionnaire. Rather, the GPO provided a separate  document with answers to some of the questions, and sometimes in a  different format than was requested. We clarified this GPO’s responses  through follow-up questions. Through our questionnaire, we asked about  each GPO’s purchasing volume by fiscal year, from 2000-2012; purchasing volume by category of medical product for fiscal years  2000, 2004, 2008, and 2012; average, highest, lowest, and most frequent administrative fee  percentages received in fiscal year 2012, by category of medical  product;  total dollar amount of administrative fees received in fiscal years  2000, 2004, 2008, 2012, by category of medical product; average, highest, lowest, and most frequent licensing fee percentages  received in fiscal year 2012, by category of medical product;  total dollar amount of licensing fees received in fiscal years 2000,  2004, 2008, 2012, by category of medical product; average, highest, lowest, and most frequent fee percentages for any  fee that was based on a percentage of the purchasing price of a  product in fiscal year 2012, by category of medical product;  total dollar amount of total fees based on a percentage of the  purchasing price of a product received in fiscal years 2000, 2004,  2008, and 2012, by category of medical product;  total dollar amount of total fees based on the purchasing price of a  product received in fiscal years 2000-2012; average, highest, lowest, and most frequent administrative fee  percentages received in fiscal year 2012 for generic injectable drugs; average, highest, lowest, and most frequent licensing fee percentages  received in fiscal year 2012 for generic injectable drugs;  total dollar amount and percentage of administrative fees shared with  customers and owners in fiscal year 2012;  sources of revenue in fiscal year 2012;  services provided to customers in fiscal year 2012 and how those  services were funded; whether the GPO awarded, or had in effect, any sole-source, bundled,  non-bid, or long-term contracts with vendors; and  key ways that GPOs bring value to their customers.
We reported only the information that was consistently reported by most  of the GPOs in our review. There were several questions that some  GPOs did not answer, or did not answer completely, including, for  example, the following:
For questions requesting information over time, only two of the GPOs  reported information for the entire time period. One GPO was able to  report information back to fiscal year 2003, and two other GPOs were  only able to report information back to fiscal year 2008.  Representatives from both of these GPOs stated that their records  retention policies prevented them from obtaining data before fiscal  year 2008.
For questions requesting information to be broken into multiple  product categories, one GPO was unable to separately report  information for medical devices and commodities. As a result, this  GPO reported information for both categories combined. Another  GPO reported that, for the purposes of the questionnaire, the GPO  only considered cardiac and orthopedic products to be “devices.”  Other products considered to be devices by the Food and Drug  Administration (FDA) were included in either the commodities or  “other” categories.
In addition, we interviewed representatives with knowledge of GPOs,  including  the five largest GPOs to clarify their questionnaire responses, and  discuss their contracting practices, funding structure, and the GPO  safe harbor provision in more depth.  two regional GPOs about how they work with the larger, national  GPOs: Greater New York Hospital Association Services, Inc., and  APS Healthcare. purchasing departments of five hospitals and hospital systems about  how the hospitals purchase medical products, the extent of the  hospitals’ use of GPOs, additional services and total value they  receive from their GPOs, and potential impacts on hospitals if the  GPO safe harbor provision were repealed: the Dana Farber Cancer  Institute, Mt. Sinai Medical Center, the University of Pittsburgh  Medical Center, BJC Healthcare, and Intermountain Healthcare. We  selected hospitals based on variation in: number of hospital beds, the  extent to which the hospital had an ownership interest in a GPO, and  which GPOs they used. eight vendors of medical products about GPO contracting practices,  funding structure, and the GPO safe harbor provision: 3M; ICU  Medical; Alcon; Teva Pharmaceutical Industries, Ltd.; Hospira;  Fresenius Kabi USA; GlaxoSmithKline; AADCO Medical, Inc. We  selected vendors based on variation in the types of products  manufactured.  trade associations representing GPOs and vendors of medical  products about their members’ relationships with GPOs, GPO  contracting practices and funding structure, and the GPO safe harbor  provision: Healthcare Supply Chain Association, Health Industry  Distributors Association, Advanced Medical Technology Association,  Medical Device Manufacturers Association, Generic Pharmaceutical  Association.
In addition, to determine the reported effects of the GPO funding  structure, we interviewed thirteen experts in economics, the healthcare  market, and purchasing cooperatives. We identified these experts through  our search of the relevant literature on GPOs, healthcare markets,  purchasing cooperatives, and economics: David Balto, Roger Blair,  Lawton Burns, Einer Elhauge, Adam Fein, Herbert Hovenkamp,   Michael Lindsay, Diana Moss, Eugene Schneller, LeRoy Schwartz,  Prakash Sethi, Hal Singer, Dave Swanson.
Finally, we interviewed Federal Trade Commission (FTC), Department of  Justice (DOJ) and Health and Human Services (HHS) officials about their  oversight of GPOs, including complaints they had received about GPOs  and any investigations they had opened or actions they had taken against  GPOs since our 2012 report.
To identify literature on the effect of the GPO funding structure, we  conducted a literature review. To conduct this review, we searched 28  bibliographic databases, such as ProQuest and MEDLINE, for articles  published between January 2004 and June 2014. In our search, we used  a combination of search terms such as “group purchasing” and “health  care.” We considered an article relevant to our review if it discussed the  potential effects of the GPO funding structure. Using the articles we  identified as relevant to our review, we then determined which of these  articles included the results of empirical analyses. To confirm that our  search captured all of the relevant literature that met our criteria, we  reviewed the bibliographies of the relevant articles to identify other  potentially relevant studies. We did not assess the methodologies of the  studies we identified or review the reliability of the data used in these  studies.
In addition, we reviewed documentary evidence of the factors that GPOs  consider when contracting for products and services, including  scorecards, spreadsheets, and other templates provided by the GPOs.  We reviewed published articles in economic and law journals, as well as  analyses of the healthcare market. We also reviewed laws, legislative  history, regulations and guidance related to the GPO safe harbor.
section_title: Appendix II: Comments from the Department of Health and Human Services
section_title: Appendix III: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contacts
section_title: Acknowledgments
paragraphs: In addition to the contact named above, Kristi Peterson, Assistant Director;  Kelly DeMots; Leia Dickerson; Sandra George; and Yesook Merrill made  key contributions to this report.