Group Purchasing Organizations: Use of Contracting Processes and 
Strategies to Award Contracts for Medical-Surgical Products	 
(16-JUL-03, GAO-03-998T).					 
                                                                 
Hospitals have increasingly relied on purchasing		 
intermediaries--GPOs--to keep the cost of medical-surgical	 
products in check. By pooling purchases for their hospital	 
customers, GPOs'in awarding contracts to medical-surgical product
manufacturers--may negotiate lower prices for these products.	 
Some manufacturers contend that GPOs are slow to select products 
to place on contract and establish high administrative fees that 
make it difficult for some firms to obtain a GPO contract. The	 
manufacturers also express concern that certain contracting	 
strategies to obtain better prices have the potential to limit	 
competition when practiced by GPOs with a large share of the	 
market. GAO was asked to examine certain GPO business practices. 
It focused on seven large GPOs serving hospitals nationwide	 
regarding (1) their processes to select manufacturers' products  
for their hospital customers and the level of administrative fees
they receive from manufacturers, (2) their use of contracting	 
strategies to obtain favorable prices from manufacturers, and (3)
recent initiatives taken to respond to concerns about GPO	 
business practices.						 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-03-998T					        
    ACCNO:   A07544						        
  TITLE:     Group Purchasing Organizations: Use of Contracting       
Processes and Strategies to Award Contracts for Medical-Surgical 
Products							 
     DATE:   07/16/2003 
  SUBJECT:   Medical equipment					 
	     Medical supplies					 
	     Cost analysis					 
	     Antitrust law					 
	     Hospitals						 

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GAO-03-998T

Testimony Before the Subcommittee on Antitrust, Competition Policy and
Consumer Rights, Committee on the Judiciary, U. S. Senate

United States General Accounting Office

GAO For Release on Delivery Expected at 2: 30 p. m. Wednesday, July 16,
2003 GROUP PURCHASING

ORGANIZATIONS Use of Contracting Processes and Strategies to Award
Contracts for Medical- Surgical Products

Statement for the Record by Marjorie Kanof Director, Health Care* Clinical

and Military Health Care Issues

GAO- 03- 998T

The seven GPOs we studied varied in how they carried out their contracting
processes. The GPOs were able to expedite their processes for selecting
products to place on contract, particularly when they considered these
products to be innovative. The GPOs also reported receiving from
manufacturers administrative fees in 2002 that were generally consistent

with the 3- percent- of- purchase- price threshold in regulations
established by the Department of Health and Human Services. However, for
certain products, they reported receiving higher fees* in one case, nearly
18 percent. The seven GPOs also varied in the extent to which they used
certain

contracting strategies as leverage to obtain better prices. For example,
some GPOs, including one of the two largest, used sole- source contracting
(giving one of several manufacturers of comparable products an exclusive
right to sell a particular product through the GPO) extensively, whereas
others used it on a more limited basis. Most GPOs used some form of
product bundling (linking price discounts to purchases of a specified
group of products), and the two largest GPOs used bundling for a notable
portion of their business. In response to congressional concerns raised in
2002 about GPOs'

potentially anticompetitive business practices, the Health Industry Group
Purchasing Association (HIGPA) and GPOs individually established codes of
conduct. (See figure.) The conduct codes are not uniform in how they
address GPO business practices. In addition, some GPOs* conduct codes
include exceptions and qualified language that could limit their potential
to effect change.

Figure: Business Practices Addressed in Codes of Conduct Business practice
GPO A GPO B GPO C GPO D GPO E GPO F GPO G

Product selection contracting processes Contract administrative fees Sole-
source contracting Bundling Commitment level requirements Contract
durations

HIGPA members Non- HIGPA members

Not identified in code of conduct Source: Codes of conduct provided by
HIGPA and the seven GPOs in our study.

Identified in HIGPA code of conduct Identified in both HIGPA and
individual GPO code of conduct

Identified in individual GPO code of conduct

Note: A code of conduct was determined to identify a business practice if
it was mentioned in the code*s text.

Hospitals have increasingly relied on purchasing intermediaries* GPOs* to
keep the cost of medicalsurgical products in check. By pooling purchases
for their hospital customers, GPOs* in awarding contracts to medical-
surgical product manufacturers* may

negotiate lower prices for these products.

Some manufacturers contend that GPOs are slow to select products to place
on contract and establish

high administrative fees that make it difficult for some firms to obtain a
GPO contract. The manufacturers also express concern that certain
contracting

strategies to obtain better prices have the potential to limit competition
when practiced by GPOs with a large share of the market.

GAO was asked to examine certain GPO business practices. It focused on
seven large GPOs serving hospitals nationwide regarding (1) their
processes to select manufacturers* products for their hospital customers
and the level of administrative fees they receive from manufacturers, (2)
their use

of contracting strategies to obtain favorable prices from manufacturers,
and (3) recent initiatives taken to respond to

concerns about GPO business practices.

www. gao. gov/ cgi- bin/ getrpt? GAO- 03- 998T. To view the full product,
including the scope and methodology, click on the link above. For more
information, contact Marjorie Kanof at (202) 512- 7114. Highlights of GAO-
03- 998T, a statement

for the record for the Subcommittee on Antitrust, Competition Policy and
Consumer Rights, Committee on the Judiciary, U. S. Senate

July 16, 2003

GROUP PURCHASING ORGANIZATIONS

Use of Contracting Processes and Strategies to Award Contracts for
Medical- Surgical Products

Page 1 GAO- 03- 998T

Mr. Chairman and Members of the Subcommittee: We are pleased to have the
opportunity to comment on the role of group purchasing organizations (GPO)
in the marketplace for medical- surgical products. Faced with persistent
pressures to cut rising costs, hospitals over the past two decades have
increasingly relied on purchasing intermediaries* GPOs* to keep the cost
of medical- surgical products in check. Hospitals buy everything from
commodities* for example, cotton balls and bandages* to high- technology
medical devices, such as pacemakers and stents, 1 through GPO- negotiated
contracts. By pooling the purchases of these products for their hospital
customers, GPOs may negotiate lower prices from vendors (manufacturers,
distributors, and other suppliers), which can benefit hospitals and,
ultimately, consumers and payers of hospital care (such as insurers and
employers).

Some manufacturers* especially small manufacturers of medical devices*
have contended that GPOs employ a slow process for selecting products to
place on contract and establish high administrative fees that have made it
difficult for some firms to obtain a GPO contract. They have also
expressed concerns about certain contracting strategies that GPOs use as
leverage to obtain better prices. They contend that these strategies have
the potential to limit competition when practiced by GPOs with a large
share of the market.

At the request of the subcommittee, we examined certain GPO business
practices that critics contend have the potential to create an uneven
playing field for manufacturers. This statement focuses on seven large
GPOs serving hospitals nationwide regarding (1) their processes to select
manufacturers* medical- surgical products for their hospital customers and
the level of administrative fees they receive from manufacturers, (2)
their

use of contracting strategies to obtain favorable prices from
manufacturers, and (3) recent initiatives taken to respond to concerns
about GPO business practices. In a subsequent report for this
subcommittee, we will expand our earlier work and examine the extent to
which hospitals benefit from participation in GPOs. In April 2002, we

1 A stent is a device used to provide support for tubular structures like
blood vessels. It can be made of rigid wire mesh or may be a metal wire or
tube.

Page 2 GAO- 03- 998T

reported that for two products in one local market, a hospital*s use of a
GPO contract did not guarantee that the hospital paid a lower price. 2 We
focused our current work on purchases made by acute care hospitals

for medical- surgical products, including commodities, such as cotton
balls and bandages, and medical devices, such as pacemakers and stents. 3
We did not investigate GPOs* business practices with regard to other
products that hospitals purchase, such as pharmaceutical products, capital
equipment, and food supplies. Our findings are based on structured
interviews with representatives of seven major national GPOs. We also
interviewed representatives of 13 medical- surgical product manufacturers
of various sizes and representatives of trade associations from the
following industries: group purchasing, medical- surgical product
manufacturing, supply distribution, and venture capital. We also consulted
with experts, including representatives from two hospitals, three venture
capital firms, two industry consultants, and one technology assessment
company. In addition, we reviewed literature on group purchasing and
antitrust law. We did not independently verify the information we
obtained. The information GPOs provided was self- reported. We conducted
our work from May 2002 through July 2003 in accordance with generally
accepted government auditing standards.

The GPOs we studied were able to alter the duration of their process for
selecting products to place on contract, particularly when they considered
these products to be innovative. GPOs* product selection processes
generally took 6 months, and ranged from as short as 1 month to as long as
18 months. One GPO specifically reported expediting or modifying its
formal selection process when it considered a product to be innovative and
wanted to award a contract quickly. The seven GPOs also reported receiving
from manufacturers administrative fees in 2002 that were generally
consistent with the 3- percent- of- purchase- price threshold in
regulations established by the Department of Health and Human Services
(HHS). However, for certain products, they reported higher fees* in one
case, nearly 18 percent.

2 U. S. General Accounting Office, Group Purchasing Organizations: Pilot
Study Suggests Large Buying Groups Do Not Always Offer Hospitals Lower
Prices, GAO- 02- 690T (Washington, D. C.: Apr. 30, 2002). 3 We did not
include government hospitals, such as those of the Department of Veterans
Affairs, in our study. Results in Brief

Page 3 GAO- 03- 998T

The seven GPOs we studied, including two with the largest market shares,
used sole- source contracting (giving one of several manufacturers of
comparable products an exclusive right to sell a particular product
through a GPO), product bundling (linking price discounts to purchases of
a specified group of products), and other contracting strategies to
varying

degrees to obtain favorable prices. For example, while all seven GPOs
reported using sole- source contracts, some GPOs, including one of the two
largest, used them extensively, whereas others used them on a more limited
basis. Most GPOs used some form of bundling, and the two largest GPOs used
either contracts or programs that bundle multiple products for a notable
portion of their business.

In response to congressional concerns raised in 2002 about GPOs*
potentially anticompetitive business practices, the group purchasing
industry*s trade association established a code of conduct that directs
member GPOs to, among other things, address their contracting processes.
The conduct code also includes reporting and education responsibilities
for the trade association. The seven GPOs we studied drafted or revised
their own codes of conduct, but the conduct codes are not uniform in how
they address GPO business practices. Moreover, some GPOs* conduct codes
include exceptions and qualified language that could limit the potential
of the conduct codes to effect change. It is too soon to evaluate the
effectiveness of these codes of conduct in addressing concerns about
potentially anticompetitive practices, as many conduct codes are recently
adopted and sufficient time has not elapsed for GPOs to demonstrate
results.

In seeking to provide their hospital customers with medical- surgical
products at favorable prices, GPOs engage with manufacturers in certain
contracting processes and sometimes use certain strategies to obtain price
discounts. Many manufacturers bid for GPO contracts because hospital
purchases with these contracts may increase manufacturers* market share.
GPOs are subject to federal antitrust laws. A statement developed by
enforcement agencies helps GPOs determine whether their business practices
are likely to be challenged under the antitrust laws.

Many manufacturers use GPO contracts to sell their medical- surgical
products. These products include two types* commodities and medical
devices. Commodities such as cotton balls and bandages are examples of
items for which physicians and other clinicians generally do not have
strong preferences. Manufacturers commonly use GPO contracts to sell
Background

Manufacturers Contract with GPOs to Sell Their Medical- Surgical Products

Page 4 GAO- 03- 998T

hospitals these non- preference products because hospitals purchase these
items in large quantities. In contrast, medical devices can be *clinical
preference* items* that is, those for which physicians and other
practitioners are likely to express a preference. High- technology medical
devices such as pacemakers and stents are examples of clinical preference

items. Some manufacturers prefer to sell these items directly to
hospitals. The GPO industry that purchases products for hospitals is large
and moderately concentrated. Experts have not determined a precise number
of GPOs currently in business, but some estimate that there are hundreds
of GPOs. While some GPOs operate regionally, this study focused on seven
national GPOs with purchasing volumes over $1 billion that account for
more than 85 percent of all hospital purchases nationwide made through GPO
contracts. In 2002, the combined purchasing volume of these GPOs totaled
about $43 billion, excluding distribution dollars. (See table 1.)

Table 1: Seven GPOs* Purchasing Volumes for Total Customer Purchases Made
through Contracts, 2002

GPO Purchasing volume (dollars in millions)

GPO 1 $14,330 GPO 2 14,413 GPO 3 4,400 GPO 4 3,233 GPO 5 2,837 GPO 6 2,564
GPO 7 1,466

Total $43,243

Source: GPO- reported data. Note: These purchasing volumes exclude
distribution dollars.

Among the GPOs in our study, the two largest GPOs account for about 66
percent of total GPO purchasing volume for all medical products
(including, among other things, medical- surgical products,
pharmaceuticals, capital equipment, and food). These two GPOs also account
for 70 percent of the seven GPOs* total medical- surgical product volume.
One of the two largest GPOs has as members 1,569 of the nation*s A Few
GPOs Dominate the

Market for MedicalSurgical Products Sold through Contracts

Page 5 GAO- 03- 998T

approximately 6,900 hospitals; the other has 1,469 hospital members. 4 One
of the two largest GPOs permits its members to belong to other national
GPOs, whereas the other largest GPO does not.

A GPO*s contracting process for manufacturers* medical- surgical products
generally includes several phases* namely, product identification and
selection, requests for proposals or invitations to bid, review of
submitted

proposals and applications, assessment of product quality, contract
negotiation, and contract award. The contract negotiation phase may
include the negotiation of a contract administrative fee. This fee is
designed to cover a GPO*s operating expenses and serves as its main source
of revenue. 5 Contract administrative fees are calculated as a percentage
of each customer*s purchases of the particular product included in a GPO
contract.

In negotiating contracts, GPOs use certain contracting strategies as
incentives for manufacturers to provide deeper discounts and for hospital
members to concentrate purchasing volume to obtain better prices. These
strategies are not limited to use by GPOs, as some manufacturers also use
them in negotiating contracts with GPOs to increase market share. Key
contracting strategies include the following:

 Sole- source contracts give one of several manufacturers of comparable
products an exclusive right to sell a particular product through a GPO.

 Commitment refers to a specified percentage of purchasing volume that,
when met by the GPO*s customer (such as a hospital), will result in a
deeper price discount. Commitment levels can be set either by the GPO or
the manufacturer. For example, a manufacturer 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 the customer to commit to
different percentages of purchasing volume: the higher the percentage, the
lower the price.

4 The approximately 6,900 hospitals include government hospitals such as
those of the Department of Veterans Affairs and county hospitals. 5 In
addition to using these fees to cover their operating expenses, GPOs often
distribute surplus fees to member hospitals. They may also use
administrative fees to finance new ventures, such as electronic commerce,
that are outside their core business. GPOs* Business Practices

Encompass Contracting Processes and Strategies

Page 6 GAO- 03- 998T

 Bundling links price discounts to purchases of a specified group of
products. GPOs award several types of bundling arrangements. One type
bundles combinations of products from one manufacturer. A manufacturer may
find this arrangement advantageous because it allows increased sales of
products in the bundle that may not fare well as stand- alone products.
Another type bundles products from two or more manufacturers. Also,
contracts can be bundled for complementary products, such as protective
hats and shoe coverings used in hospital operating rooms, while others
bundle unrelated products such as patient gowns and intravenous solutions.
Hospitals that purchase bundles of unrelated products receive a price
discount on all products included in the bundle.

 Contracts of long duration* those in effect for 5 years or more* can
direct business to manufacturers for an extended period.

When used by GPOs with a large market share, these contracting strategies
have the potential to reduce competition. For example, if a large GPO
negotiates a sole- source contract with a manufacturer, the contract could
cause an efficient, competing manufacturer to lose business and exit from
the market and could discourage other manufacturers from entering the
market.

Certain aspects of GPOs* operations are specifically addressed by federal
statute, regulation, and policy. While *anti- kickback* provisions of the
Social Security Act prohibit payments in return for orders or purchases of
items for which payment may be made under a federal health care program,
the act also contains an exception for amounts paid by vendors of goods or
services to a GPO. 6 Therefore, GPOs are allowed to collect contract
administrative fees from manufacturers and other vendors that

could otherwise be considered unlawful. In addition, regulations issued by
the Department of Health and Human Services establishing *safe harbors*
for purposes of the *anti- kickback* provisions provide that GPOs are to
have written agreements with their customers either stating that fees are
to be 3 percent or less of the purchase price, or specifying the amount or
maximum amount that each vendor will pay. 7 The GPOs must also disclose in
writing to each customer, at least annually, the amount received from each
vendor with respect to purchases made by or on behalf of the

6 See 42 U. S. C. S: 1320a- 7b( b) (2000). 7 See 42 C. F. R. S: 1001.952(
j) (2002). Federal Safe Harbor and

Antitrust Safety Zone Exist for GPOs

Page 7 GAO- 03- 998T

customer. The Office of Inspector General in the Department of Health and
Human Services is responsible for enforcing these regulations.

Recognizing that GPO arrangements may promote competition among
manufacturers and yield lower prices in some cases and may reduce
competition in other cases, the U. S. Department of Justice and the
Federal Trade Commission issued a statement in 1993 for joint purchasing
arrangements. This statement sets forth an *antitrust safety zone* 8 for
GPOs that meet a two- part test, under which the agencies will not
generally challenge GPO business practices under the antitrust laws.
Essentially, the two- part test in the context of medical- surgical
products is as follows: (1) purchases through the GPO account for less
than 35 percent of the total sales of the product in the relevant market,
9 and (2) the cost of the products purchased through the GPO accounts for
less than 20 percent of the total revenues from all products sold by each
GPO member.

In recent years, some manufacturers of medical- surgical products have
contended that GPOs employ a slow product selection process and set high
administrative fees that have made it difficult for some firms to obtain
GPO contracts. These firms tend to be small manufacturers that may have
fewer financial resources available to successfully complete GPOs*
contracting processes than large manufacturers. The GPOs we studied
reported generally having contracting processes that can be modified for
certain types of products. They also reported receiving from manufacturers
administrative fees that were generally consistent with federal
regulations established by HHS.

8 Statements of Antitrust Enforcement Policy in Health Care, Statement 7,
p. 23. 9 Although the GPOs in this study each has less than 35 percent of
total GPO purchasing volume for all medical products, it is possible, for
example, that a GPO could have greater than 35 percent of the total sales
of one or more particular products. GPOs Reported Modifying Contracting

Processes When Desirable and Receiving Administrative Fees That Were
Generally Consistent with Federal Regulations

Page 8 GAO- 03- 998T

In discussing GPOs* selection of products and negotiation of fees, several
manufacturers we contacted pointed to the paperwork and duration of these
processes as burdensome. Not all manufacturers shared the same
perspective. One small manufacturer commented that the process could
sometimes be relatively easy but that the selection process can be more
difficult if the manufacturer is selling only one product.

The GPOs we studied were able to alter the duration of their process for
selecting products to place on contract, particularly when they considered
these products to be innovative. Based on their reported information,
GPOs* product selection processes generally took 6 months, and ranged from
as short as 1 month to as long as 18 months. One GPO specifically reported
expediting or modifying its formal selection process when it

considered a product to be innovative and wanted to award a contract
quickly. Most GPOs did not have a distinctly separate process for
selecting innovative technology but reported that these products were
generally selected in a shorter amount of time compared with other
products.

Figure 1 shows, across the seven GPOs, the average minimum, most frequent,
and maximum times taken for product selection. GPOs Reported Expediting

Reviews and Using a Public Solicitation Process for Certain Products

Page 9 GAO- 03- 998T

Figure 1: Duration of the GPO Product Selection Process

Note: Averages weighted by GPO- reported dollar purchasing volume,
excluding distribution dollars. The GPOs in our study reported consulting
various sources before making a decision, including the GPO*s customers
requesting the product; published studies about the product; internal and
external technology assessments; and different manufacturers of the
product, both with and without a GPO contract. In all cases, the GPOs
cited customer requests for products as the most important factor in
identifying which products to place on contract.

In selecting a manufacturer, six of the seven GPOs, including the two
largest, solicit proposals publicly either through requests for proposals
or requests for bids through their Web sites. The extent to which these
processes are open to all manufacturers varies by GPO and by product. For
example, one of the GPOs solicits proposals publicly for clinical
preference products, but not for commodities.

0 2

4 6

8 10

12 14

Average minimum length of selection

process Average most frequent

length of selection

process Average maximum

length of selection

process Months

Innovative products Other medicial- surgical products Source: Interviews
with representatives of seven GPOs.

Page 10 GAO- 03- 998T

GPO- reported information on new contracts awarded in 2002 suggest that
GPOs* solicitations were not limited to manufacturers already on contract.
Nearly one- third of all the newly negotiated contracts awarded by the
seven GPOs in 2002 were awarded to manufacturers with which the GPO had
not previously contracted. The percentage of such contracts ranged from 16
percent to 55 percent for the GPOs in our study. For the two largest GPOs,
this share was 29 percent and 55 percent. We could not determine, from the
information provided, whether these first- time contract awardees were,
for example, small manufacturers or companies new to the industry or
whether the products purchased through these contracts were clinical
preference items or commodities.

Manufacturers have expressed concerns that contract administrative fees,
which are typically calculated as a percentage of each customer*s purchase
of products under contract, can be too high for some manufacturers. These
fees, combined with lower prices negotiated by the GPO, may decrease
revenue for manufacturers and may make it more difficult to obtain a GPO
contract for newer and smaller manufacturers with fewer financial
resources than for larger, more established companies.

Five out of seven GPOs reported that the maximum contract administrative
fee received from manufacturers in 2002 did not exceed the 3- percent- of-
purchase- price threshold contained in federal regulations established by
HHS. The most frequent administrative fee level that 4 out of 7 GPOs
received from manufacturers in 2002 was 2 percent; the lowest fee level
received by each GPO was 1 percent or less. Except for one of the two
largest GPOs, the GPOs reported that they have not negotiated any new or
renewed contracts in 2003 that include administrative fees from medical-
surgical product manufacturers that exceed 3 percent.

In 2002, fee levels for private label products *products sold under a
GPO*s brand name* were an exception: The typical contract administrative
fee paid by private label manufacturers was 5 percent. For one of the two
GPOs in our study with private label products, the

maximum administrative fee was nearly 18 percent. In addition to an GPO-
Reported Information

Indicates That Contract Administrative Fees Received Were Generally
Consistent with Federal Regulations

Page 11 GAO- 03- 998T

administrative fee, the other GPO charged a separate *licensing* fee for
private- label products. 10 GPOs use certain contracting strategies* which
include sole- source

contracts, product bundling, and extended contract duration* to obtain
discounts from manufacturers in exchange for providing the manufacturer
with increased sales from an established customer base. Manufacturers and
other industry observers have expressed concerns that use of these
strategies by the two largest GPOs can reduce competition. For example,
when GPOs with substantial market shares award long- term sole- source
contracts to large, well- established manufacturers, some newer,
singleproduct manufacturers* left to compete with other manufacturers for
a significantly reduced share of the market* may lose business and be
forced to exit the market altogether.

The seven GPOs we studied, including two with the largest market shares,
used these contracting strategies to varying degrees. For example, while
all study GPOs reported using sole- source contracts, some GPOs, including
one of the two largest GPOs, used it extensively, whereas others used it
on a more limited basis. GPOs also varied in their approach to requiring
commitment levels from their customers. With respect to bundling, most
GPOs used some form of bundling, and the two largest GPOs used either
contracts or programs that bundled multiple products for a notable portion
of their business. With respect to contract duration, the two largest GPOs
typically negotiated longer contract terms than the other five GPOs.

The use of sole- source contracting by the study GPOs varied widely with
respect to the relative amount of sole source contracting they did and the
types of products included in the contracts. For five of the GPOs,
solesource contracts accounted for between 2 percent and 46 percent of
their medical- surgical product dollar purchasing volume. 11 For the rest*
the two largest GPOs* the shares of dollar purchasing volume accounted for
by sole- source contracts were 19 percent and 42 percent. Such levels of
sole

10 Some manufacturers pay this GPO licensing fees in exchange for using
the GPO*s brand name. 11 One GPO did not provide us information on
purchasing volume for medical- surgical products through sole- source
contracts. Seven National GPOs Varied in the Extent

to Which They Used Certain Contracting Strategies

For Some of the GPOs, Sole- Source Contracts Accounted for a Substantial
Portion of the Purchasing Volume

Page 12 GAO- 03- 998T

sourcing are worth noting, given the sizeable market shares of these two
GPOs.

GPOs also varied in their use of sole- source contracts for commodity
products as compared to medical devices for which providers may desire a
choice of products. Six of the seven GPOs in our study reported their use
of sole- source contracts for commodity products as compared to clinical
preference product. For one of the two largest GPOs, clinical preference
products accounted for the bulk* 82 percent* of its sole- source dollar
purchasing volume. 12 Two GPOs reported cases in which manufacturers
refused to contract with the GPO unless they were awarded a sole- source
contract. In contrast, commodities accounted for the bulk* between 62
percent and 91 percent* of the dollar purchasing volume that the smaller
of the seven GPOs purchased through sole- source contracts. GPOreported
data indicate that the proportion of contracts that were sole source, as a
share of all contracts for medical- surgical products for the past 3
years, remained relatively consistent for GPOs.

The seven GPOs in our study reported that hospital customers* commitment
to purchase a certain percentage of their products through GPO contracts
was an important factor in obtaining favorable prices with manufacturers,
and all reported establishing commitment level requirements to some
degree. Most of the smaller of the seven GPOs reported that customer
adherence to commitment levels and contracts were the most important
factor in obtaining favorable pricing with manufacturers. In principle,
for GPOs with a smaller customer base, the assurance of customer
commitment to purchasing helps enable them to achieve the higher volumes
needed to leverage favorable prices from manufacturers. The two largest
GPOs reported that volume was the most

important factor for obtaining favorable prices and that customer
compliance with commitment level and contracts was next in importance. For
the two largest GPOs, a sizable customer base may provide the volume
levels needed to obtain favorable prices.

GPOs varied in their approach to requiring purchasing commitment levels.
One GPO requires customers to commit to an overall average dollar
purchasing level of 80 percent for those products available through the

12 One of the two largest GPOs in our study did not provide us information
on sole- source purchases represented by the two product types. GPOs
Considered Customer Commitment to

Be Important, but Commitment Requirements Varied

Page 13 GAO- 03- 998T

GPO, although the percentage could vary for individual products. The GPO
reported terminating the membership of at least one customer that did not
meet this target. Other GPOs reported establishing customer commitment
levels in certain contracts in order to obtain a certain price level, but
customers were not required to buy under the contract or buy at the
commitment level in order to retain GPO membership. Some GPOs* contracts
include multiple, or tiered commitment levels so that customers can choose
from a range of commitment levels and obtain price discounts accordingly.
All but one of the GPOs in our study reported using some form of

bundling, including the bundling of complementary products, bundling
several unrelated products from one manufacturer, and bundling several
products for which there are commitment- level requirements. One bundling
arrangement that GPOs reported using gave customers a discount when they
purchased a bundle of complementary products, such as protective hats and
shoe coverings. Four GPOs reported bundling

complementary products. These bundles were included in a small percentage
of the GPOs* contracts; each of the four GPOs reported having no more than
three contracts that bundle complementary products. One GPO reported
awarding only one bundling arrangement for two complementary products* the
only bundling arrangement the GPO had in effect at the time it reported to
us.

A second type of bundling reported by three GPOs, including the two
largest, gave customers a discount if they purchased a group of unrelated
products from one manufacturer. We define this type of bundling as a
corporate agreement. One of the two largest GPOs reported that corporate
agreements for medical- surgical products accounted for about 40 percent
of its dollar purchasing volume for medical- surgical products under
contracts in effect on January 1, 2003.

Four GPOs, including one of the two largest, used a third type of
arrangement that typically bundled products from different manufacturers
and required customers that chose this arrangement to purchase a certain
minimum percentage from the product categories specified in the bundle

in order to obtain the discount. We defined this type of bundling as a
structured commitment program. A structured commitment program available
through one GPO bundled brand name and GPO private label

items for 12 product categories and had a 95 percent commitment- level
requirement. In 2002, one of the two largest GPOs reported receiving Most
GPOs Use Some Form of Bundling, and the

Two Largest GPOs Use It for a Notable Portion of Their Business

Page 14 GAO- 03- 998T

about 20 percent of its medical- surgical dollar purchasing volume from
its structured commitment programs.

The use of bundling arrangements may be declining. For example, data
reported by one GPO showed a decline in the percent of its contracts that
were corporate agreements from 2001 to 2003. 13 This trend was consistent

with comments made by one manufacturer and two medical- surgical product
distributors. The manufacturer told us that GPOs are less interested in
bundling different manufacturers together. Two distributors*
representatives told us that since the summer of 2002, GPOs have fewer
bundling arrangements and that some bundles were *pulled apart.*

Our analysis of data reported by the study GPOs showed that, in 2002, the
two largest GPOs typically awarded 5- year contracts, whereas the other
five GPOs typically awarded 3- year contracts. For some of these
contracts, potential renewal periods constitute a portion of the contract
duration. Those contract terms remained fairly consistent between 2001 and
2003, although two of the five GPOs reported that their most frequent
contract term declined by about 1 year. Some GPOs reported implementing
policies that may lead to a future reduction in contract terms. One of the
two largest GPOs began in the first quarter of 2003 to exclude from new
contracts the option for two 1- year contract extensions, so that when a
contract expires, this GPO will solicit proposals for a new contract.

In response to congressional concerns raised in 2002 about GPOs*
potentially anticompetitive business practices, the group purchasing
industry*s trade association established a code of conduct that directs
member GPOs to, among other things, address their contracting processes.
The conduct code also includes reporting and education responsibilities
for the trade association. The seven GPOs we studied drafted or revised
their own codes of conduct, but the conduct codes are not uniform in how
they address GPO business practices. Moreover, some GPOs* conduct codes
include exceptions and qualified language that can limit the potential of
the conduct codes to effect change. It is too soon to evaluate the
effectiveness of these codes of conduct in addressing concerns about
potentially anticompetitive practices, as many conduct codes are recently

13 This period reflects contracts in effect on three dates* January 1,
2001, January 1, 2002, and January 1, 2003. The Two Largest GPOs

Typically Award Contracts with Longer Terms Than the Other Five

GPOs Have Taken Initiatives to Address Concerns about Business Practices,
but It Is Too Early to Evaluate Their Efforts

Page 15 GAO- 03- 998T

adopted and sufficient time has not elapsed for GPOs to demonstrate
results.

On July 24, 2002, the Health Industry Group Purchasing Association (HIGPA)
adopted a code of conduct providing principles for GPO business practices.
HIGPA represents 28 U. S.- based GPOs* including five of the seven major
GPOs that we studied. HIGPA members also include health care systems and
alliances, manufacturers, and other vendors. The HIGPA

code of conduct principles address GPO business practices and actual,
potential, or perceived conflicts of interest. Among other things, the
HIGPA code of conduct provides that GPOs

 allow hospital and other provider members to purchase clinical
preference items directly from all vendors, regardless of whether the
vendors have a GPO contract;

 implement an open contract solicitation process that allows any
interested vendor to seek contracts with the GPO;

 participate in processes to evaluate and make available innovative
products;

 address conflicts of interest, such as disallowing staff in positions of
influence over contracting to hold equity interest in, or accept gifts or
entertainment from, *participating vendors*; 14 and

 establish accountability measures, such as appointing a compliance
officer and certifying annually that the GPO is in compliance with the
HIGPA code.

The HIGPA code also includes several provisions regarding the trade
association*s education and reporting responsibilities, including

 assessing and updating the code of conduct to be consistent with new
developments and best business practices;

14 Participating vendors are those that have a contract or submit a bid or
offer to contract with a GPO. Trade Association Code of

Conduct Laid Groundwork for Industry SelfRegulation

Page 16 GAO- 03- 998T

 implementing industry wide educational programs on clinical innovations,
contracting strategies, patient safety, public policy, legal requirements,
and best practices;  making available a Web- based directory that posts
manufacturers* and

other vendors* product information; and  publishing an annual report
listing GPOs that have certified their

compliance for the year with the HIGPA code of conduct. As of May 19,
2003, HIGPA*s 28 U. S.- based GPO members certified that they are in
compliance with the HIGPA code of conduct principles.

Although the HIGPA code of conduct laid the groundwork for many GPOs to
change their business practices, its guidelines do not comprehensively
address certain business practices. Specifically, the HIGPA code of
conduct requires GPOs to address business practices associated with
contracting, conflicts of interest, and accountability, and it grants GPOs
discretion in using contracting strategies. It recommends that GPOs
consider factors such as vendor market share, GPO size, and product
innovation when using multiple contracting strategies. However, the HIGPA
code of conduct does not directly address levels of contract

administrative fees or the offering of private label products. Since
August 2002, the seven GPOs we studied, even those that were not HIGPA
members, drafted and adopted their own codes of conduct or revised their
existing conduct codes. One GPO stated that its revised code, while
consistent with the HIGPA code, was more specific than HIGPA*s principles,
particularly in the GPO*s rules on stock ownership, travel, and
entertainment. Another GPO reported expanding on HIGPA*s code by including
provisions to cap administrative fees and prohibit bundling. Similarly,
GPOs who were not HIGPA members said they had revised their existing codes
of conduct and that their conduct codes were in some respects stronger
than HIGPA*s.

Nevertheless, GPOs* individual codes of conduct varied in the extent to
which they addressed GPOs* business practices, such as contracting
processes and strategies. Figure 2 provides an overview of the seven GPOs*
conduct codes with respect to their business practices. The table
indicates whether a business practice was identified in a code of conduct,
but not how the practice was to be addressed. Variations Exist in GPOs*

Efforts to Address Business Practices

Page 17 GAO- 03- 998T

Figure 2: Business Practices Identified in GPOs* Codes of Conduct

Note: A code of conduct was determined to identify a business practice if
it was mentioned in the conduct code*s text.

Business practice GPO A GPO B GPO C GPO D GPO E GPO F GPO G Product
selection contracting processes

Innovative product selection Contract administrative fees

Sole- source contracting Bundling Commitment level requirements

Contract durations Private labeling Conflicts of interest- equity

Conflicts of interest- other Internal accountability External
accountability

HIGPA members Non- HIGPA

members

Identified in HIGPA code of conduct Identified in both HIGPA and
individual GPO code of conduct Identified in individual GPO code of
conduct Not identified in code of conduct Source: Codes of conduct
provided by HIGPA and the seven GPOs in our study.

Page 18 GAO- 03- 998T

As figure 2 shows, the conduct codes of all the study GPOs explicitly
mentioned conflict of interest issues such as those dealing with equity
holdings and other conflicts such as receipt of gifts and entertainment
and the need for internal accountability. In addition, the conduct codes
of most

GPOs, including the two largest, included provisions dealing with the
contracting strategies, such as sole- source contracting and bundling. For
GPOs that are HIGPA members, the lack of additional provisions in their

individual conduct codes for certain business practices such as
contracting processes may not be significant, as provisions covering these
areas are included in the HIGPA code. However, for one of our study GPOs
that is not a HIGPA member, the conduct code lacked any provisions
pertaining to contracting processes, product selection, administrative
fees, sole- source contracting, commitment level requirements, contract
duration, and private labeling.

The code of conduct provisions for the GPOs in our study were not uniform
in how they addressed business practices. For example:

 Four GPOs, including one of the two largest, had unqualified provisions
for capping administrative fees at the 3- percent threshold contained in
federal regulations established by HHS. The other largest GPO had a
provision for capping administrative fees at 3 percent only for clinical
preference items and only for contracts awarded after the establishment of

the GPO*s conduct code.  Four conduct codes had provisions limiting the
use of sole- source

contracts for clinical preference items specifically. Another conduct code
limited the use of sole- sourcing to contracts meeting certain criteria,
such as approval for use by a 75- percent majority of the GPO*s
contracting committee. The language of one of the remaining GPO*s conduct
codes was vague with respect to sole- sourcing, stating that the GPO will
provide customers with choices for each product or service, without
explicitly mentioning the use of sole- source contracts.

 In their conduct codes, two GPOs had provisions prohibiting the practice
of bundling of unrelated products, two GPOs prohibited and two limited
bundling for clinical preference items, and three GPOs prohibited the
practice of bundling products from different manufacturers. One GPO*s
conduct code stated that the GPO would not obligate its customers to
purchase bundles of unrelated products, allowing the possibility for
bundles to be available to customers on a voluntary basis.

Page 19 GAO- 03- 998T

Exceptions and qualified language in the provisions have the potential to
weaken the codes of conduct. Table 2 shows examples of exceptions and
qualified language that can limit the potential of the individual GPOs*
conduct codes to effect change.

Table 2: Examples of Exceptions and Qualifications in Code of Conduct
Provisions for the GPOs in Our Study Business practice Specific provision
including exceptions and

qualifiers (in italics) Potential implications

Product selection contracting processes Will use public request for
proposal process for clinical

preference products but not for most commodities. Contract bids for most
commodities will not go through public solicitation process.

Contract administrative fees Will reduce contract administrative fees that
are

greater than 3 percent to 3 percent for clinical preference products on a
prospective basis. For clinical preference products, contract
administrative fees negotiated prior to adoption

of conduct code are not subject to provision; in future contracts,
administrative fee for all other items may continue to exceed 3 percent.
Sole- source contracting No sole- source contracts for clinical preference

products unless there is no other means by which the GPO can obtain access
to the product for customers.

Manufacturers have incentives to link price discounts in return for
exclusive contract awards. Bundling No bundling of clinical preference
products on a

prospective basis, and no bundling of products across different vendors.

For clinical preference products, bundled contracts awarded prior to
adoption of conduct code are not subject to provision; contracts for
bundles of unrelated, non- clinical preference products with one
manufacturer are not subject

to the provision. Commitment level requirements No commitment level
requirements for clinical

preference products, on a prospective basis. For clinical preference
products, commitment levels negotiated prior to adoption of conduct

code are not subject to provision; all other products could have
commitment requirements. Commitment level requirements not to exceed 80
percent of purchasing volume for clinical preference products, unless
relevant committee approves otherwise.

Commitment- level requirements for clinical preference products have
potential to remain as high as 80 percent of purchasing volume and, under
certain circumstances, may be higher. Conflicts of interest- equity No
equity interests may be held by GPO management

and other staff with influence over contracting in any participating
vendors.

Other GPO staff may hold equity interest in participating vendors, that
is, those on contract or bidding for a contract. GPO staff with influence
over contracting may hold equity interest in nonparticipating vendors.

Source: Individual GPOs* codes of conduct.

Given the individual GPOs* relatively recent adoption of codes of conduct*
since August 2002* sufficient time has not yet elapsed for GPOs to develop
a history of compliance with certain conduct code provisions. Two of the
manufacturers and two distributors we interviewed reported noticing
improvements, stating that some GPOs are no longer using certain
contracting strategies. This observation is consistent with the suggestion
that the use of bundling may be declining. One manufacturer Too Soon to
Evaluate

Impact of GPOs* Codes of Conduct

Page 20 GAO- 03- 998T

that had difficulty in obtaining a contract with a large national GPO
prior to 2002 said it has since been awarded a contract for a clinical
preference item. The manufacturer also noted that, since September 2002,
it has been awarded several new contracts. However, two other
manufacturers told us

they are skeptical that improvements have been made with regard to
business practices. Notwithstanding such anecdotal evidence, because of
the recency of GPOs* actions taken, the ability to assess the impact of
the conduct codes systematically remains limited. One year is not
sufficient time for the codes of conduct to produce measurable trends that
could demonstrate an impact on the industry.

For more information regarding this statement, please contact Marjorie
Kanof at (202) 512- 7101. Hannah Fein, Mary Giffin, Kelly Klemstine, Emily
Rowe, and Merrile Sing made key contributions to this statement. Contact
and

Acknowledgments

(290198)

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