Distributors’ dilemma: Will GPO contracts help them
1) increase market share, 2) reduce margins, 3) both, or 4) neither?

Brandon Vaughan is optimistic. With an automotive and industrial background, Vaughan founded Vet GPO Services a year ago, with the intent of acting as a pure GPO, negotiating contracts on behalf of its members.

“I don’t see any reason for the distributor not to like the arrangement,” he says. “In exchange for a smaller chunk of profit, [the distributor will get] exposure and direct access to a vastly increased number of customers.”

Dale Bizzari, president of Mine Hill, N.J.-based CapsuleNet, is just as optimistic. A licensed veterinary technician and former purchasing agent for multiple practices, Bizzari joined the Internet-based GPO eight years ago. “When vendors realize the turnaround in volume and the new customers we can give them … they look at us as a salesforce,” she says.

But if the medical market is any indication, the road may not be so smooth. GPO contracts cut dealers’ margins, which, they assert, are necessary in order to keep product on the shelf, break down cases, and give the customer the time they deserve. “And they don’t make up for it with a lot of marketing support,” says one medical distribution executive.

In many ways, Vaughan’s and Bizzari’s attitude toward vendors – manufacturers and distributors – mirrors that of medical GPOs. Yet, after many years of co-existence, only now can it be said that GPOs and distributors, particularly those in the physician market, have reached an alliance of sorts, albeit an uneasy one.

From humble beginnings
From their beginnings as humble local, state and regional hospital purchasing groups, GPOs have become huge, national organizations, with contract sales in the billions of dollars. Some of the biggest are Premier, with $33.5 billion in annual contract sales; Novation, with $35.7 billion in annual contract sales (2008 figures); Broadlane (which doesn’t share purchasing volume); Amerinet, $6.9 billion; and MedAssets. Almost all hospitals in the country belong to a GPO … or two.

Given their volume and their roots in hospital associations, it’s no surprise that hospitals took to GPOs quickly and warmly. Manufacturers and distributors a bit less so. Vendors felt that they couldn’t afford not to sign contracts with the GPOs, but were skeptical that the GPOs could deliver the market share they promised.

A watershed event occurred in 1979, when four independent medical products distributors sued American Hospital Supply (now Cardinal Health) for signing an exclusive distribution agreement with a young GPO – Irving, Texas-based Voluntary Hospitals of America (now VHA). The four distributors charged that the GPO contract locked them out of the market. (The distributors initially won the suit, but then lost on appeal.)

Then, in the mid-1980s, VHA (which today is an owner of the Novation purchasing group) changed its strategy and contracted with a handful of “regional distribution agents” for the right to offer VHA’s contract portfolio to VHA member hospitals. Only authorized distributors had access to the group prices, giving them an advantage in the market vis a vis their competitors, who couldn’t match those prices. In turn, the authorized distributors agreed to offer VHA members what was then an astonishingly low, 7 percent cost-plus markup (at least on contract items).

In 1998, another seismic event occurred when Premier signed a 20-year deal with McKesson General Medical (now McKesson Medical-Surgical), making McKesson the distributor of choice to carry the Premier contract portfolio to non-hospital providers, particularly physicians. The deal was made only after Premier had given up its attempt to purchase – or at least to own a share of – a network of distributors through which it could market its non-hospital contract portfolio.

Physician-market GPOs
Although the hospital market was ripe for group purchasing, particularly following reimbursement changes in the early 1980s, the non-hospital market, especially physicians’ offices, was not. And that was true for a number of reasons. Supply expenses for the typical physician’s office don’t approach those of even the smallest hospital, so this market didn’t feel the crying need for group purchasing as did its hospital counterparts.

Second, when it comes to the physician office supply chain, the distributor owns the business. Physician offices are typically smaller and much more difficult to reach than most hospitals, with their loading docks. Orders are smaller, warehouse space is non-existent, and logistics are tougher. Hence, the physician’s office is reliant on its distributor to keep it well-stocked with necessary supplies and equipment.

In the medical market, the top-performing distributor rep owns the relationship with his or her physician-office customers. Many physician offices lack a full-time purchasing or materials management executive, such as those found in every hospital in the country. Consequently, the nursing and management team in the physician practice rely on their distributor reps to guide them in product selection, ordering and delivery. In short, it is a strong bond that ties physician practice to distributor. For both, but especially for distributors, GPOs have been an unwanted third party.

Enter the GPO
But GPOs sensed an opportunity in the non-hospital market. Some of them, such as St. Louis-based Amerinet, developed an interest in it 20 or more years ago. Others have followed.

For some GPOs, developing non-hospital contract portfolios was a way to strengthen their ties to their hospital members. In other words, they developed contract portfolios for the physician office, then handed them over to their hospital members, who could score points with their physicians by passing on the portfolio to them. As they had with hospital distributors, GPOs selected “authorized distributors” to service the non-hospital market (since, in the medical industry, few hospital distributors also service physicians’ offices, and vice versa).

Today, the big hospital GPOs continue to pursue the non-hospital market with vigor. That’s true for a number of reasons. First, medical technology is improving and procedures are moving out of the hospital and into the non-hospital setting, including physicians’ offices. The greater volume not only makes physicians eager for negotiated discounts on their supplies and equipment, but it also means greater revenue for the GPOs, most of whom collect “administrative fees” from the vendors, based on an agreed-upon percentage of sales.

There’s another reason that GPOs are aggressively pursuing the non-hospital market today. Hospitals have become a zero-sum game. Group No. 1 loses a member to Group No. 2, who loses a member to Group No. 1, etc. In contrast, physicians’ offices are virgin territory, with plenty of room for growth.

Here’s an update on where some of the big medical GPOs stand:
• Premier’s Continuum of Care™ division added 9,500 members to its rolls in fiscal year 2009, bringing the total number of non-acute-care members to 64,000. Those new members represent $1 billion of the division’s $5.3 billion annual sales.
• More than 25,500 non-acute-care providers now participate in VHA Non-Acute-Care Services. Collectively they spend about $3 billion annually. In the past three or four years, membership has grown 65 percent, and VHA now has about 50 people – including 14 field reps – focused exclusively on the non-acute-care market.
• Amerinet counts among its members 15,507 clinics; 4,788 long-term-care facilities; 2,906 hospital-based physicians; 2,160 ambulatory surgery centers; and 282 emergency services providers (as well as 2,513 acute-care hospitals.) Approximately 20 percent of the 8,500 member groups of the Medical Group Management Association now participate in a group purchasing program with Amerinet. (MGMA and Amerinet signed their first agreement 21 years ago.)
• Broadlane serves 5,000 ambulatory care facilities and 40,000 physician offices, in addition to more than 1,400 acute-care hospitals.
• MedAssets serves 30,000 non-acute-care healthcare providers (as well as 3,300 hospitals).

Veterinary GPOs
A Google search shows that veterinary purchasing groups have indeed become part of the veterinary supply chain, though it’s difficult to tell how well-established some of these organizations are.

Vet GPO Services promises to negotiate with manufacturers and distributors to reduce veterinarians’ costs of purchased supplies, services, equipment and instrumentation, including office supplies, phone service, medical consumables and more. Like most medical GPOs, Vet GPO Services collects administrative fees from vendors. Membership for veterinarians is free.

“We want to act as a pure GPO, where we’re specifically negotiating contracts for our membership,” says Vaughan. “Through a competitive bid process, we will have preferred vendors. In some cases, more than one. We will work first with manufacturers, then drill down to distribution if the manufacturers are represented with distribution. In many cases, we will work directly with distribution.”

Vaughan believes the concept will catch on in the veterinary market. The biggest hurdle, however, is clearing up some misconceptions on the part of veterinarians themselves, he says. “Most of these veterinarians have been approached by distributors passing themselves off as GPOs, charging fees. Our goal is the exact opposite. We don’t sell product. We negotiate better pricing for our membership. We don’t charge a fee [to veterinarians]. There’s no risk involved in becoming a member.”

Meanwhile, CapsuleNet, LLC is a Web-based portal through which U.S. licensed veterinarians are able to purchase products from a number of veterinary and human distributors, as well as direct-selling companies. It was originally purchased by Managed Healthcare Associates, a human GPO, which started Managed Veterinary Associates, a veterinary GPO, now known as CapsuleNet. “Our service is not just the Web site” says Bizzari. “We provide other services, such as helping veterinarians and their staff track down hard-to-find products.”

Currently, CapsuleNet has contracts with Butler Schein Animal Health, TW Medical Veterinary Supply and PCI Animal Health, as well as several human distributors and direct-selling manufacturers.

“I insist that the vendors keep their price files up to date,” says Bizzari. “They are their price files, available through our Web site. And it’s up to them to make sure customers get accurate information about backorders, etc.” CapsuleNet is free to members, but manufacturers and distributors under contract pay an administrative fee based on contract sales.

“Distributors should look at us as a salesforce,” says Bizzari. “They would have to pay a salesperson to go out and market for them. I don’t have a large staff, nor do I need one, because the Web site runs itself. Our vendors are responsible for keeping their price files current, and we’re responsible for getting them new customers. We have a presence in the market.”

A medical distributor’s analysis
Some off-the-record comments made to Veterinary Advantage by veterinary distribution executives reflect some of the misgivings the industry has about group purchasing organizations. Medical products distributors have shared some of the same misgivings over the years.

In 2003, Alan Grogan of Grogan’s Health Supply, a Lexington, Ky.-based distributor of physician office products, led a group of medical/surgical distributors who alleged that GPO contracts denied them equal competitive access to customers. They commissioned a white paper and legal opinion to stimulate dialogue about it.

The distributors argued the following three points:
• Section 2(a) of the Robinson-Patman Act of 1936 (sometimes called the Anti-Price Discrimination Act) guarantees that similarly situated and competing resellers have access to equal cost from manufacturers when competing for the same customer’s business.
• GPO members often find themselves forced to buy from those suppliers that have been authorized by the GPO to sell products at contract prices.
• As a result, the provider’s current distributor loses equal competitive access to the customer and potentially loses the business.

“This trend threatens the exercise of free choice among suppliers, the survival of many medical products distributors, and open competition in an arena where competition is the primary hope for future cost containment,” Grogan said at the time.

Since then, Grogan has made an uneasy peace with group purchasing organizations. “Sometimes it makes sense to neglect the philosophical in favor of the practical, but that doesn’t change the underlying opinion,” he said, when asked about it last year.

‘Stealth programs’
Speaking recently with Vet-Advantage, Grogan reviewed the development of what he calls distributor “stealth programs,” whereby distributors with access to GPO pricing for manufacturers’ products undersell their competitors who lack access, and do quite well with margins too. It was those “stealth programs” that led to concern on the part of some distributors – including Grogan – about the lack of “equal competitive access” in the market.

“Ultimately, there was little stomach for really solving this problem, and instead there emerged a strategy of appeasement where ‘distributor authorization’ would be broadly pursued by smaller distributors (and distributor co-ops) that had often been locked out previously,” says Grogan. “This was a timely move, as GPOs were being criticized for their business practices that tended to lock out smaller companies.”

Indeed, in the spring of 2002, the New York Times published a series of damaging articles targeting GPOs. TV news coverage followed. Soon thereafter, the U.S. Senate Subcommittee on Antitrust, Competition Policy and Consumer Rights conducted the first of a series of public hearings on group purchasing in Washington. The U.S. Federal Trade Commission, Department of Justice, General Accounting Office and even some state legislatures joined the investigation.

“As a result, some ‘kinder and gentler’ GPOs emerged, ready to be more flexible on what had previously been rigid stands on markups and fees and other practices,” says Grogan.

Suppliers’ costs go up
“GPO membership is increasingly common in the physician and alternate site market today, and becoming widespread, and will continue until virtually all providers are signed up, not just to one GPO, but to many GPOs simultaneously,” continues Grogan. GPOs, he says “are a bit like credit cards, where the perception that something is free can lead to inefficient and excessive utilization.”

It may be true that the healthcare provider typically doesn’t have to pay a fee to belong to a GPO. But the cost to vendors of accommodating GPO contracts adds up, according to Grogan. Administrative fees, contract administration costs (such as loading contracts and determining customers’ eligibility) and sales tracings all go up when dealing with GPOs, he says. “Bottom line is that in a GPO environment, almost no costs to serve go down.

“Maybe you could spread reps a bit thinner,” he adds. “But that is dangerous when GPO membership doesn’t really involve any commitment, and customers are not really willing to sacrifice services they have come to expect.”

For the distributor, margin erosion is almost inevitable, says Grogan. “If a particular GPO agreement does not impose any caps on distributor pricing to GPO members (that is, no cost-plus or other limitation), it is possible that with a lot of effort, the distributor could actually maintain or even increase the gross margin,” he says. “However, most GPO distribution agreements insist on imposing some pricing standards – sometimes just for contract items, and sometimes for all items for customers above a certain volume level, all items period, or some other variation.

“Whenever a customer becomes a GPO member subject to any capped pricing, margin will almost certainly be lost as the GPO limits tend to be below prevailing markups. In the distributor’s best-case scenario, where no price cap exists, there are computational nightmares involved in attempting to maintain margin.”

Common ground?
Grogan credits GPOs with gaining pricing concessions from manufacturers. “Bringing product cost down for small healthcare providers is certainly a positive thing as they struggle with their own reimbursement and other challenges.” Still, he believes some changes in group purchasing could help ensure the financial health of distributors as well as GPOs.

Topping the list would be removal of the Safe Harbor provision, which entitles GPOs to collect administrative fees from contract vendors. (The government-sanctioned Safe Harbor was necessary in order for GPOs to steer clear of Medicare anti-fraud and abuse statutes.) GPOs should return to a fee-for-service model, where members would pay for membership, says Grogan. Such a move would end the perceived “free lunch” perception of group purchasing.

Grogan also believes that a movement from a cost-plus structure to a dollar-discount contracting structure would “increase[e] the chances that distributors can at least get close to maintaining margin.”

Above all, he looks forward to “better GPO recognition of the margin challenges facing distributors in a GPO environment, and more reasonable distribution agreements that address those realities.”