Group Purchasing Increases Healthcare Supply Chain Savings

July 11, 2017 - Group purchasing organizations (GPOs) increased healthcare supply chain savings between 10 percent and 18 percent by reducing transaction costs and supplier prices, a recent Healthcare Supply Chain Association (HSCA) study revealed.

The literature review also revealed that the GPO market is intensely competitive. Based on the healthcare supply chain savings and competitive nature of the market, researchers concluded that the vendor versus provider-paid fee mechanism used to fund GPOs should be maintained.

“At a time of great change for the healthcare system, when American hospitals and their patients face uncertainty and significant new challenges, GPOs are delivering the best products at the best value and providing critical cost-savings that allow hospitals and other healthcare providers to focus on their core mission: first-class patient care,” stated Todd Ebert, RPh, HSCA President and CEO. “This report confirms what GPOs and their hospital and provider members see every day: that GPOs reduce costs, operate in a highly competitive market, and increase competition and innovation in the healthcare marketplace.”

GPOs primarily increase healthcare supply chain savings by reducing transaction costs. The opportunity for healthcare cost reductions significantly increases when the number of negotiations for healthcare supplies drops.

For example, if 1,000 vendors each sell about ten products to 2,000 hospitals, about 2 million negotiations would need to take place to determine approximately 20 million prices. Group purchasing dramatically decreases the number of negotiations, lowering the transaction costs of contract management.

READ MORE: Leveraging Group Purchasing for Hospital Supply Chain Management

As a result, healthcare providers avoid wasting resources on contract development, negotiation, and management for each vendor they use. A cited 2009 survey found that hospitals would need an 115 percent boost in labor to replace the functions performed by their GPOs. That equates to about nine full-time equivalent employees.

Transaction cost reductions also result in direct healthcare spending decreases for providers. Vendors share in lower transaction costs via group purchasing methods similar to providers. Therefore, they can pass savings onto to providers by decreasing the price of supplies.

GPOs typically determine healthcare supply prices by issuing a request for proposal (RFP) for suppliers. In an auction-like process, suppliers bid for the right to supply certain products to the organization’s members. GPO leaders consider each supplier’s bid for price and quality and select the bid with the greatest value.

“Holding nonprice issues aside for the moment, competitive bidding by the vendors will drive the prices vendors propose down to their unit costs,” researchers explained. “Thus, if the GPO reduces the vendor’s transaction costs, then the RFP process will reduce the vendor’s prices by the amount of the cost savings.”

If vendors demonstrate differences in supply quality, then the RFP process generally passes on some portion of the cost savings onto providers via lower prices.

READ MORE: 3 Most Common Healthcare Supply Chain Management Challenges

Healthcare providers also face reduced healthcare supply chain costs from lower prices through group purchasing. Joining a GPO increased a provider’s bargaining power with suppliers, resulting in price drops.

“When an individual provider negotiates with a supplier, the provider’s bargaining strength depends on the incremental benefit to the supplier of serving the provider one-on-one,” the study elaborated. “When multiple providers form a GPO and negotiate as a single unit, their strength depends on the average benefit the supplier experiences in serving all the providers.”

Individual providers do not typically produce enough incremental benefit to offset the average benefit of group purchasing. Therefore, GPOs achieve greater bargaining power for supply chain prices.

In addition, GPOs realize lower healthcare supply chain prices through volume discounts. Vendors tend to offer volume discounts to GPOs because their cost per unit either declines with volume or they want to boost their market power. Some vendors can reach more customers by reducing their marginal price and selling higher quantities.

Group purchasing also allows providers to buy expensive equipment at lower costs by merging their purchasing power.

READ MORE: How Clinicians Add Value to Healthcare Supply Chain Management

The study also showed that GPOs generate lower healthcare supply chain prices by intensifying supplier competition.

“A recurring theme in the economic literature on procurement is that buyers can sometimes intensify competition among suppliers—and thereby obtain lower prices—by committing in advance to limit the number of supply sources,” the analysis stated.

The GPO market itself also functions in an intensely competitive manner, resulting in healthcare supply chain cost reductions for providers, researchers continued.

Many GPOs are fully or partially owned by members. This factor disincentivizes GPOs from engaging in anti-competitive behavior and other activities that could increase supply prices.

Hospitals also purchase about one-quarter of their supplies on their own. With the opportunity to self-supply, GPOs must remain competitive and continue to offer lower prices to attract provider organizations.

With healthcare supply chain savings and the competitive nature of GPOs, researchers concluded that the funding mechanism of charging vendor fees rather than providers should continue.

Stakeholders criticize vendor-paid fee structures because the fees could discourage GPOs from negotiating lower prices since fees are based on price, exclude rival suppliers who cannot afford fees, and promote provider fraud. The mechanism could impact provider fraud if providers neglect to report share back information from GPOs, resulting in high cost-based claims reimbursement.

However, researchers countered that the neutrality principle supports vendor-paid fees and providers could substantially suffer if the mechanism shifted to provider-paid fees.

The neutrality principle states that the total amount transacted is the same whether the buy or seller pays a tax or fee for the transaction. Researchers applied the neutrality principle to GPO funding mechanisms and found that it makes no difference who pays the fees.

However, collecting payments from vendors is more efficient and shifting the fee to providers could increase administrative costs.

“Congress took deliberate action to support the current GPO funding model in order to encourage the cost savings that GPOs provide,” stated report co-author Dan O’Brien, former FTC Deputy Director of Bureau of Economics and partner at Bates White. “Our analysis of the vendor-paid administrative fee funding model, which is common across a broad range of industries, finds that it likely reduces healthcare costs, and a disruption to the model would likely raise healthcare costs for American consumers and taxpayers.”