Hospitals’ budgets for medical devices and other goods are substantial. Many hospitals buy medical devices and other supplies through GPOs, which are generally owned by member hospitals and vary in size and scope of services. GPOs are expected to use volume purchasing as leverage in negotiating prices with vendors. In exchange for administrative services and the ability to sell through a GPO to its member hospitals, vendors pay administrative fees to a GPO based on the hospitals’ purchases made using that GPO’s contract. These fees, sanctioned under Medicare law, cover the GPO’s costs; GPOs often distribute surplus fees to their owners. Federal antitrust guidelines help a GPO determine whether its business practices and market share are likely to be questioned as anticompetitive by enforcement agencies. According to an American Hospital Association (AHA) survey, roughly 4,900 nonfederal community hospitals spent an estimated $173 billion on nonlabor supplies, services, and capital in 2000. A significant share of hospitals’ nonlabor costs include such goods as pharmaceuticals and medical devices. Hospitals buy these goods through their own purchasing departments, and many hospitals—in addition to contracting on their own with vendors—use GPO-negotiated contracts for at least some of their purchasing. Some hospitals have large or more sophisticated purchasing operations, but even hospitals belonging to large chains or health systems often do at least some purchasing through a GPO. The proportion of hospitals belonging to at least one GPO is substantial: estimates range from 68 percent to 98 percent. Medical devices that hospitals buy span a wide array of products, such as pacemakers, implantable defibrillators, and infusion pumps. Some device manufacturers are small companies that offer one product or a few closely related products while others are large firms that offer many, often unrelated, products. The Medical Device Manufacturers Association estimates that some devices become obsolete within 2 to 3 years—when the next generation of a particular device becomes available. Manufacturers market medical devices in medical journals and trade shows but place considerable value on having access to clinicians in hospitals as well as to hospital purchasing departments, which make the final buying decisions. According to the Health Industry Group Purchasing Association, hundreds of GPOs operate today, but only about 30 negotiate sizeable contracts on behalf of their members. The emergence of these large GPOs in part stems from GPO mergers in the mid-1990s. Joint ventures and mergers created the two largest GPOs, Novation and Premier, which have annual purchases by member facilities using their contracts of $17.6 billion and $14 billion, respectively. Other GPOs in our pilot study have less than $6 billion in annual purchases by member facilities. (See appendix I for purchasing volumes of GPOs in our pilot study.) In addition to differences in size, GPOs differ in scope. Some negotiate national contracts and offer many services beyond purchasing, such as programs emphasizing the gains in safety and economic value resulting from standardization, or specialized software to help ensure that hospitals are not overcharged. Others serve regional or local hospital markets and provide fewer additional services. GPOs differ in their corporate structures and their relationships with member hospitals. All large GPOs and many smaller GPOs are for-profit entities, some of which are owned by not-for-profit hospitals. Other GPOs have shareholders independent of the member hospitals, which themselves do not necessarily hold an ownership stake. An example of a for-profit GPO owned by not-for-profit hospitals is Premier. Premier is owned by 203 not-for-profit health care organizations that operate approximately 900 hospitals. Other for-profit GPOs are owned by investors that are not member hospitals; for example, InSource is owned by MedAssets, a private purchasing and contract services company. Broadlane’s owners consist of individual investors as well as for-profit and not-for-profit organizations including Tenet Healthcare, a nationwide provider of health care services. Some GPOs are jointly owned. For example, both Novation and Healthcare Purchasing Partners International (HPPI) are owned by the same two networks of hospitals and physicians. Network members purchase using Novation contracts. However, non-network members purchase using HPPI contracts, which are negotiated by Novation. Some GPOs, such as HealthTrust, require that members do not belong to other GPOs. In addition, some GPOs, such as Novation and Amerinet, contract with manufacturers to supply products sold under the GPO’s own “private-label” brand name. (See appendix I for a summary of characteristics of GPOs in our pilot.) According to officials of GPOs and a GPO trade organization, benefits that GPOs provide to member hospitals include, in addition to lower prices, reduced costs due to hospitals being able to reduce the size of purchasing departments, as well as assistance with product-comparison analysis and standardization of products. Benefits that GPOs say they provide to manufacturers with which they contract include, in addition to access to hospital decisionmakers, cost savings due to reducing manufacturers’ contracting, marketing, and sales activities. According to representatives of some manufacturers, many GPOs act as gatekeepers to hospital purchasing decisionmakers and charge the manufacturers administrative fees as the price of access to their member hospitals. In order to sell to hospitals through GPO contracts, vendors generally submit proposals to a GPO—in response to Requests for Proposals (RFP)—that are then evaluated. Based on these evaluations, the GPO enters into negotiations with select vendors to determine prices and, in some cases, administrative fees that vendors pay to the GPO. Hospitals then buy directly from the manufacturer for a price specified in a GPO contract. Often prices through a GPO-negotiated contract vary based on each hospital’s volume of purchases and the extent to which the member hospital delivers on its “commitment” to buy an agreed-upon share of its purchases of a certain product from a particular manufacturer. The more of a product that a hospital purchases, the lower the price per unit it may pay the manufacturer. A hospital’s price may also vary depending upon the share of a product it purchases from a manufacturer. For example, a hospital that buys only 25 percent of its cardiac stents from one manufacturer may pay nearly three times more per stent than one that purchases all its stents from that manufacturer. Member hospitals may have an additional financial incentive to use the GPO contract. The extent to which a hospital buys using the GPO’s contracts may affect the share of the administrative fees that the GPO returns to the hospital. Although GPOs provide services to hospitals and are often organized by hospitals, many finance their operations primarily through the administrative fees paid by manufacturers and other vendors. These fees are typically calculated as a percentage of each hospital’s purchases from a vendor. The Social Security Act, as amended in 1986, allows these fees, which would otherwise be considered ‘kickbacks’ or other illegal payments to the GPO. Regulations establishing appropriate administrative fees, enforced by the Office of Inspector General in the Department of Health and Human Services, state that the fee structure must be disclosed in an agreement between the GPO and each participating member. The agreement must state that fees are to be 3 percent or less of the purchase price, or if not fixed at 3 percent or less, the amount or maximum amount that each vendor will pay. The GPO must also disclose in writing to each member, at least annually, the amount received from each vendor with respect to purchases made by or on behalf of the member. The fees tend to be higher on purchases by hospitals that buy most or all of an item from one vendor. In addition to covering their operating expenses with these fees, GPOs, with the approval of their boards of directors, often distribute surplus fees to member hospitals but may also use administrative fees to finance new ventures, such as electronic commerce, that are outside their core business. (See fig. 1.) The complex financial flows among vendors, GPOs, and hospitals have raised concerns that GPOs’ interests may diverge from those of hospitals. According to some small manufacturers, GPOs have an incentive not to seek the lowest price because higher prices yield higher administrative fees. These manufacturers further suggest that GPOs, by relying on vendors’ fees, become agents of manufacturers and assist them in limiting competition. By contrast, according to some GPOs, they act as an extension of hospitals and GPO members have input into the GPOs’ product selections. GPOs acknowledge that a manufacturer dominant in a product line may contract with a GPO, or agree to a favorable contract, to preserve its market share and exclude competitors. However, GPOs assert that this selective contracting is part of a competitive process allowing the GPO to negotiate lower prices. GPOs also emphasize that participation in a GPO is voluntary, so the GPO must reflect what the hospitals want if it is to retain their business. Recognizing that joint purchasing arrangements among hospitals may enable members to achieve efficiencies that will benefit consumers but may, in some cases, pose risks of harming consumers by reducing competition, DOJ and the Federal Trade Commission (FTC) issued in 1993 a guideline to help GPOs and others gauge whether a particular GPO arrangement is likely to raise antitrust problems. This guideline sets forth an “antitrust safety zone” for GPOs that meet a two-part test, under which the agencies, absent extraordinary circumstances, will not challenge the arrangement as anticompetitive. Essentially, the two-part test is as follows: 1. Purchases through a GPO must account for less than 35 percent of the total sales of the product or service in question (such as pacemakers) in the relevant market. This part of the test addresses whether the GPO accounts for such a large share of the purchases of the product or service that it can effectively exercise increased market power as a buyer. If the GPO’s buying power drives the price of the product or service below competitive levels, consumers could be harmed if suppliers respond by reducing output, quality, or innovation. 2. The cost of purchases through a GPO by each member hospital that competes with other members must amount to less than 20 percent of each hospital’s total revenues. This second part of the test looks at whether the GPO purchases constitute such a large share of the revenues of competing member hospitals that they could result in standardizing the hospitals’ costs enough to make it easier to fix or coordinate prices. However, the guideline states that a purchasing arrangement is not necessarily in violation of the antitrust laws simply because it falls outside the safety zone. Likewise, the guideline suggests that even a purchasing arrangement that falls within the safety zone might still raise antitrust concerns under “extraordinary circumstances.” Each arrangement has to be examined according to its particular facts. In this regard, the guideline also describes factors that reduce antitrust concerns with purchasing arrangements that fall outside the safety zone. GPOs did not always obtain better prices for member hospitals. The advantage or disadvantage of GPO prices varied by the model purchased and size of hospital—but lacked a clear relationship to size of GPO. In our pilot study, we compared median GPO and median non-GPO prices for purchases by hospitals and found the following: Among hospitals of all sizes, hospitals using GPO-negotiated contracts to buy pacemakers and safety needles often paid more than hospitals negotiating on their own. This finding also held for hospitals using large GPOs, compared to hospitals negotiating on their own. Between hospitals of different sizes, small and medium-sized hospitals buying pacemakers were more likely than large hospitals to save money when using GPO-negotiated contracts. We also compared prices between large GPOs and smaller GPOs: Hospitals of all sizes using a large GPO’s contracts almost always saved money on safety needles but often paid more for pacemakers, compared to those using smaller GPOs’ contracts. Large GPOs would be expected to achieve price savings consistently. In all these comparisons, the price savings or additional cost that hospitals realized—for example, by using a GPO or by negotiating on their own—often varied widely from model to model. Purchasing with GPO contracts did not ensure that hospitals saved money. Among hospitals of all sizes in our study market, those using GPO- negotiated contracts for pacemakers and safety needles often paid more than those negotiating on their own. The median GPO-negotiated price was higher than the median price hospitals paid on their own for all six safety needles models and over three-fifths of the 41 pacemaker models that could be compared. Similarly, the use of a large GPO—one with an annual purchase volume greater than $6 billion—did not guarantee price savings. Hospitals using contracts negotiated by a large GPO paid more than hospitals purchasing on their own for the six safety needle models and roughly half of the 22 pacemaker models that could be compared. The price savings or additional costs that hospitals obtained using GPO- negotiated contracts varied by model. For different safety needle models, median GPO-negotiated prices exceeded prices negotiated by a hospital buying on its own by from 1 percent to 5 percent. For different pacemaker models, the variation was much greater: median GPO-negotiated prices ranged from 26 percent less to 39 percent more than the median price paid by hospitals purchasing on their own. (See fig. 2.) We examined how hospitals of different sizes using GPOs fared relative to their peers purchasing pacemakers on their own and found that whether there were savings depended on the size of the hospital. The 4 small hospitals (those with fewer than 200 beds) always did better with a GPO contract. The 11 medium-sized hospitals (those with 200 to 499 beds) did better with a GPO contract for 40 percent of the models (see fig. 3), and the 3 large hospitals rarely did better with a GPO contract—compared with their respective peers purchasing on their own (see fig. 4). Even though small hospitals buying on their own generally paid higher prices than the small hospitals using GPOs, the GPO-negotiated price was not much lower—from 1 to 6 percent—than what they paid on their own. As figures 3 and 4 show, the range of price savings or additional costs associated with GPO contracts was considerable. For example, for medium-sized hospitals, the median GPO-negotiated price was 39 percent lower for model 1 and 25 percent higher for model 25 than the median price paid by these hospitals purchasing on their own. The size of a GPO was not related consistently to whether a hospital, when using a GPO contract, obtained a better price. Whether use of large GPOs offered price savings varied by type of device: for safety needles, they were more likely to obtain better prices and for pacemakers, they were less likely to do so. Specifically, the median price paid by hospitals using a large GPO’s contract to purchase safety-needles was nearly always lower—for 18 of the 19 types of needles we could compare—than the median price paid by hospitals using a smaller GPO’s contract. For pacemakers, a large GPO’s contract infrequently yielded better prices than smaller GPOs’ contracts— for only 5 of the 18 pacemakers we could compare. In this case, the higher prices associated with most of these pacemaker purchases run counter to the expectation that large GPOs yield substantial price advantages. (See fig. 5.) Figure 5 shows that, as with the previous comparisons, the range of price savings or additional costs associated with large GPOs was wide. For hospitals using large GPOs’ contracts to buy pacemakers, the median price paid ranged from 20 percent less for one model to 26 percent more for another, compared with the median price paid by hospitals using smaller GPOs’ contracts. Regardless of whether a GPO contract was used, hospitals bought pacemakers and safety needles predominantly from large manufacturers. In our study, 5 of the 16 manufacturers from which hospitals purchased were small; however, purchases from these 5 represented a small minority of the models bought (1 of 121 pacemaker models and 22 of 196 safety needle models). Almost all purchases from small manufacturers in our pilot were made by hospitals buying on their own; only one hospital purchased from a small manufacturer using a GPO contract. We could not determine the extent to which hospitals’ reliance on large manufacturers of these two devices reflected hospital preference or the effects of GPOs’ contracting practices, because almost all hospitals in our sample belonged to GPOs. Representatives from small manufacturers whom we interviewed stated that some incentives in GPO contracts penalize hospitals purchasing off-contract. However, hospital personnel whom we interviewed emphasized different factors as influencing their purchasing decisions, including clinical considerations for pacemakers and cost for safety needles. Seventy-one percent of hospitals purchased a pacemaker and 15 percent a safety needle outside of their GPO contracts. While this is a pilot study based on one market, the data raise questions about one of the intended benefits from having large GPOs. In our study market, GPOs of different sizes realized comparable savings for member hospitals. Buying through a large GPO did not guarantee a hospital the lowest prices. In fact, there were several instances in which individual hospitals using a large GPO’s contracts paid prices that were at least 25 percent higher than prices negotiated by hospitals on their own, and smaller GPOs also sometimes offered better prices. Clearly, more evidence on GPOs and their effects is needed, since our data pertain to one urban market, two types of medical devices, eight GPOs, and 18 hospitals. To assist the Subcommittee, we plan to obtain data from a broader array of geographic areas and for other devices, hospitals, and GPOs. Gathering additional information on GPOs’ benefits and possible drawbacks could inform an examination of antitrust policy toward GPOs. For more information regarding this statement, please contact Janet Heinrich at (202) 512-7114 or Jon Ratner at (202) 512-7107. JoAnne R. Bailey, Hannah F. Fein, Kelly L. Klemstine, and Michael L. Rose made key contributions to this statement. The information in this appendix illustrates how GPOs in our study market vary in size, ownership structure, and profit status. The appendix contains information obtained both from GPO Web sites during April 2002 and through telephone interviews. We did not independently verify the information in this appendix. (See table 1.)

Summary: This testimony discusses group purchasing organizations (GPO) for medical devices and supplies used in hospitals. By pooling the purchases of their member hospitals, these specialized firms negotiate lower prices from vendors. GAO found that a hospital's use of a GPO contract did not guarantee that the hospital saved money: GPOs' prices were not always lower and were often higher than prices paid by hospitals negotiating directly with vendors. GAO studied price savings with respect to: (1) whether hospitals using GPO contracts received better prices than hospitals that did their own contracting, (2) the size of the hospital, and (3) size of the GPO. This data raises questions about whether GPOs, specially large GPOs, achieve consistent price savings.