Group Purchasing Organizations: Funding Structure Has Potential Implications for Medicare Costs
Released: 2014-11-24T00:00:00

Letter

Background

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.

Administrative Fees

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.)

Federal Oversight of GPOs

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.

GPOs Reported Generally Utilizing a Three-Phased Approach to Competitively Negotiate Contracts with Vendors

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.

While Experts’ Views on the Effects of Vendor Funding of GPOs Varied, the Funding Structure May Affect Medicare Payment

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.

GPOs Reported Being Predominately Funded by Vendors

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.

Experts’ Views on the Effects of the GPO Funding Structure Varied Widely, Though Empirical Data on the Effects Are Limited

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.

The GPO Funding Structure May Affect Medicare Payments over Time

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.

Conclusions

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.

Recommendation for Executive Action

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.

Agency and Third- Party Comments and Our Evaluation

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.

Appendix I: Scope and Methodology

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.

Appendix II: Comments from the Department of Health and Human Services

Appendix III: GAO Contact and Staff Acknowledgments

GAO Contacts

Acknowledgments

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.