An additional view on how GPOs effect on generic drug shortages.

After a recent blog post where I noted Peter Pitts' op-ed on Group Purchasing Organizations (GPOs) in the Washington Examiner, financial journalist Phil Zweig wrote to me to gently correct one of Peter's assertions:

In his article, Peter Pitts rightly attributes the drug shortages to the anticompetitive, exclusionary contracting practices and other abuses of hospital group purchasing organizations (GPOs). Those of us who have been trying to draw congressional and public attention to the GPOs' pernicious role in this crisis certainly welcome his support. Unfortunately, however, he is mistaken in stating that GPOs "keep costs low." In fact, overwhelming anecdotal and empirical evidence demonstrates that they grossly inflate healthcare costs. The reason is that GPOs are paid by vendors, including generic drug makers, in the form of "administrative" and other fees, which are calculated as a percentage of sales volume. So the higher the price of a product, the more money a GPO makes.

This perverse incentive was created by a misguided 1987 statute called the Medicare anti-kickback "safe harbor" provision, which exempted GPOs from criminal penalties for accepting vendor kickbacks. Overnight, GPOs became the marketing agents for suppliers, not the servants of hospitals. Under the original business model, which had worked well for nearly 80 years, GPOs operated like co-ops, covering their expenses out of the savings they achieved for members hospitals through volume discounts. The new kickback-based business model gave rise to a pay-to-play scheme in which GPOs awarded exclusive contracts to vendors in return for huge fees. But higher costs for providers, insurers and taxpayers are just part of the problem. Worse still, these abuses have denied patients and healthcare workers access to the best, safest, and most cost effective supplies, devices, and drugs.

This has been documented in four Senate Antitrust Subcommittee hearings held from 2002 to 2006, federal and state investigations, independent studies, media exposes, and numerous antitrust lawsuits against GPOs and/or their dominant supplier partners. A 2002 Government Accountability Office pilot study found that hospitals often got lower prices on their own. As Sen. Herb Kohl (D-WI) and former Sen. Mike DeWine (R-OH), then ranking member and chairman, respectively, of the Senate panel, pointed out in a joint 2003 letter to then Secretary of Defense Donald Rumsfeld (DOD was then considering using GPOs to procure health supplies), "the savings figures that GPOs frequently use as benchmarks to demonstrate savings are based on a manufacturer's list price that hospitals rarely, if ever, pay."

A September 2010 study initiated by Sen. Charles Grassley (R-IA), then ranking member of the Senate Finance Committee, concluded that empirical data was "lacking to support claims of savings with group purchasing organizations." More recently, a study in the current issue of the Journal of Contemporary Health Law and Policy found that in 2010 hospitals were able to save an average of 15% compared with GPO contract prices in competitive "aftermarket" bidding for capital equipment. In contrast, the GPOs have presented no independent data to support their specious claims of cost savings---only "surveys" of hospital materials managers conducted by academics hired by the powerful GPO lobby. As history has shown time and again, cartels drive up prices, competition lowers them.

Accordingly, to end the drug shortage, Congress must restore integrity and free market competition to the healthcare supplies industry. And that can only be achieved by repealing the Medicare antikickback "safe harbor" exemption.

A recent GAO report notes a general dearth of enforcement actions by relevant federal agencies who have jurisdiction over GPOs, at least since 2004, but also notes that in an earlier 2010 report GAO was unable to "identify any published peer-reviewed studies that included an empirical analysis of pricing data that indicated whether or not GPO customers obtain lower prices from vendors."

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