Medical Monopoly

Group Purchasing Organizations are charged with saving hospitals money, but special carve-outs from Congress, a closed and secretive marketplace, and the ability to collect fees and pay rebates all serve to drive up costs for patients.
The price of a replacement knee from a supplier can cost a hospital around $250, but a hospital can turn around and charge a patient more than $5,000 for the same implant prior to surgery.

As politicians and industry experts struggle to contain the country’s spiraling health care prices, a simple metal screw available in any metro Detroit hardware store illustrates the ever-escalating costs consumers, patients, and insurance companies pay for hospital care.

The common screw is identical to ones produced free of bacteria, packaged, and sold in kits of four that are used in spinal reconstruction surgery.

Recent invoices provided by a Northville-based supplier show the company pays a manufacturer $50 per screw. The supplier marks up each screw to $800 and sells them to hospitals. The hospitals, in turn, charge as much as $2,400 per screw and bill that amount to insurance companies.

While the markups on the screws are egregious by any measure, Phil Abraham, a cyber space technology pioneer whose company, Northville-based CloudFace, specializes in health care supply chain management services, says high medical costs are rampant in an industry where the purchase of equipment and drugs is closed to outside competition.

“If you’re the supply chain manager for a hospital, there’s nobody in the phone book and nobody on the internet right now that you can call to get that screw cheaper,” Abraham says. “That supply chain manager can’t walk across the street to Walmart and buy a Johnson & Johnson band-aid for 75 cents. Rather, he or she has to pay $75 for the band-aid because only licensed wholesalers or distributors can sell to hospitals.”

Abraham says he went on eBay and found the same screw from the same manufacturer selling for as cheap as $1.

The backstory of why the hands of supply chain managers at hospitals are tied can be traced to the near-monopoly enjoyed by a handful of large and extremely lucrative Group Purchasing Organizations, or GPOs, that supply medical equipment and supplies to nearly all of the nation’ hospitals and health care providers.

GPOs control hundreds of  billions of dollars in annual sales of medical products, supplies, and services ranging from band-aids, screws, cafeteria food, and laundry necessities to specialty items like artificial joints, pacemakers, and computer software.

The four largest GPOs — which, combined, represent 90 percent of the health care distribution market — include Vizient in Irving, Texas, with self-reported annual revenue of $100 billion; Premier Inc. in Charlotte, N.C., with more than $50 billion in yearly sales; Health Trust in Nashville, at $30 billion; and Intalere in St. Louis, at $9 billion. GPOs primarily buy products from three large distributors: McKesson, AmerisourceBergen, and Cardinal Health.

In metro Detroit, the state’s third largest hospital network, Beaumont Health in Southfield, uses HealthTrust as its GPO, while Detroit-based Henry Ford Health System utilizes Premier, a publicly traded company of which Henry Ford owns a 15-percent share.

*Source: (2018 figures).

Because of Congressional action in 1987, what began as a good idea 80 years ago — individual hospitals banding together to save money on purchasing supplies in volume — has morphed into mega-purchasing organizations where kickbacks and conflicts of interest are exempt from criminal penalties.

Under a regulation added to the Medicare and Medicaid Protection Act of 1987, GPOs — which previously were paid for their services by hospitals — are allowed to charge suppliers “administrative fees” for placing their products in supply line contracts.

In 1991, the U.S. Department of Health and Human Services made the process even more lucrative for GPOs by creating a “safe harbor” regulation that exempts GPOs from anti-kickback laws. That provision allowed GPOs to collect fees from suppliers and pay rebates to buyers in transactions that would otherwise have been deemed illegal kickbacks.

“This whole thing is a complete scam legalized by Congress,” says Phillip L. Zweig, executive director and co-founder of a national patient advocacy group, Physicians Against Drug Shortages. “This whole system has grown to where all the incentives result in higher prices. GPOs are for-profit organizations. The higher the prices, the more money they make.”

Zweig says that based on anecdotal information he’s collected over 20 years, he estimates the health care system could save at least $200 billion annually by repealing the safe harbor exemption. “That includes savings of at least 30 percent on estimated GPO contract volume of $300-plus billion annually,” he says. “Keep in mind that the original and sole purpose of a GPO is to save hospitals money. Under the ‘pay-to-play’ safe harbor business model, they do exactly the opposite.”

Abraham, who has also been studying GPOs and has hands-on experience squeezing excessive costs out of major hospital supply lines, believes the 30-percent estimate is low.

Today’s powerful GPOs don’t resemble their modest predecessors, which date back to 1910 when several New York City hospitals came together and formed a loose-knit, nonprofit “co-op” to buy supplies in bulk at cheaper prices. A forerunner to Costco and Sam’s Club, the hospital members paid annual dues to cover administrative expenses, as group volume-buying returned tangible savings.

For decades, this model continued to grow and serve its members well. That success led entrepreneurs to jump into the hospital purchasing pool with their own purchasing organizations. By the early 1980s, lobbyists representing large GPOs started flexing their muscles in Washington, D.C. Their efforts paid off with the safe harbor exemption approved by Congress.

The changes in the law allowed GPOs to charge manufacturers a 3 percent fee in exchange for including their product in a hospital supply contract. Abraham says that, over time, GPOs morphed into sellers, acquiring medical supply or technology companies and selling their own products and services to hospitals.

A proposed six-year contract between a large- volume GPO and a national hospital group examined by DBusiness showed the hospital group was required to pay the GPO a monthly service fee of $583,000. In addition, the hospital system was also required to take on the GPO’s technology affiliate for another $3.8 million annually.

“The GPOs that are supposed to be driving prices down are also selling products to hospitals,” Abraham says. “There’s a big disconnect there. It’s like letting the wolf watch the sheep. Vendors and suppliers all want the GPOs gone, but they can’t raise their hands and say anything because they fear their businesses would be frozen out of the hospital market.”

GPOs have cemented their place in the system by passing on some of their largesse in “share back” dollars to member hospitals and their executives, critics say.

“The top executives of some hospitals have been sharing in rebates from GPOs for so long, it’s the accepted way of doing business,” Abraham says. “It’s like an IV drip bag they’ve been getting for their whole career, almost all of them. Say you’ve been there for 30 years. They give you a drip bag and every day they’re going to take care of you with a drip, drip, drip (in kickbacks).”

Since 1960, hospital prices have gone up 1,600 percent, while the rate of inflation has increased 500 percent, according to the Altarum Institute in Ann Arbor and the Centers for Medicare and Medicaid Services.

John Kerndl, executive vice president and CFO at Beaumont Health, says the hospital group doesn’t have an ownership interest in HealthTrust, its GPO, nor do any officers receive compensation from that organization. “(Beaumont) Health receives a very small percentage of supply rebates,” he says. “We’re talking about a few cents per dollar.”

He declined to provide an annual cost estimate of the rebates.

Pushback to criticism of GPOs and their role in inflating health care costs comes from the Healthcare Supply Chain Association, the trade group that represents GPOs. “One recent analysis found that GPOs save the health care system up to $55 billion annually, while a recent analysis from former FTC Chairman Jon Leibowitz found that GPOs save providers an average of 10 percent to 18 percent on products and services,” the association proclaims on its website.

In his analysis last year, Leibowitz, now a lawyer in private practice (the HSCA is a client), argues against changing the funding practices or repealing the safe harbor exemption. He claims it would hurt hospitals and their patients.

“We find compelling evidence that GPOs have created value in the marketplace, and we find that vendor funding, which Congress authorized 30 years ago, has contributed to that value,” he says. “Altering the current GPO funding mechanism would likely have adverse effects on providers, consumers, and taxpayers.”

Susan Devore, president and CEO of Premier, said during a recent appearance on CNBC that her company helped 350 hospitals save about $18 billion (from a $3.5-trillion annual market). “To the extent we can help them aggregate their buying and lower the cost of care and improve outcomes, the consumer benefits from that,” she said.

Former Michigander Jeffery R. Lewis, a lawyer who now lives in California, has decades of experience in health care, working at the highest levels of Congress, state government, and in the private sector. He currently serves as president and CEO of Legacy Health Endowment, which supports and helps fund health care solutions and wellness programs in two California counties.

He says the supply chain activities involving GPOs are in dire need of transparency.

Physicians Against Drug Shortages, a nonprofit patient advocacy group, states for-profit GPOs keep hospitals and providers in the dark about prices. The result is that GPOs earn large profit margins.

An extensive analysis of a GPO contract with the state of Florida, conducted by Lewis when he served as president of Heinz Family Philanthropies, revealed that state authorities who negotiated that contract didn’t know of a side relationship the GPO had with a wholesaler.

“That meant the wholesaler in this case could not provide the state with the lowest net price on generics without the permission of the GPO, which means the GPO would lose revenue (if cheaper generics were purchased by the state),” Lewis says. He adds the GPO-dominated health care purchasing system and its safe harbor exemption is ready for an overhaul.

“I believe we’re moving toward a rebate-free system where market-based competition will rule, whether it’s on the product side or the pharmacy side,” Lewis says. “The elasticity of the health care dollar and system is waning. Rebate-driven health care is rapidly losing its value in the marketplace as insurers and consumers seek greater value, meaningful outcomes, increased quality, and effectiveness. Employers and insurers are looking to increase the value of their health insurance investment — rebates don’t achieve this.”

The opaque nature of the health care industry recently hit home for Zweig. As a former business reporter at The Wall Street Journal who covered the banking and finance industry for decades, Zweig says he was dismayed to find out that in 2003, Pharmacy Benefit Managers, or PBMs, who perform the same purchasing functions on the drug side as GPOs do with medical devices and medical supplies, had been quietly granted the same safe harbor kickback exemption that protects GPOs.

Zweig and other critics maintain that this action by an inspector general of the U.S. Department of Health and Human Services triggered the high cost of drugs in the nation today. “In all these hearings in Congress on the (high) price of drugs, nobody has ever focused on the role the HHS inspector general played in extending protection to cover rebates. There was very little said about the role of the rebates that’s driving increases on the prices of these drugs,” Zweig says.

“Altering the current GPO funding mechanism would likely have adverse effects on providers, consumers, and taxpayers.”
— Jon Leibowitz

PBMs administer the prescription drugs benefit of health insurance plans for self-insured employers, insurance companies, and health maintenance organizations, or HMOs. They’re the middlemen between consumers and drug companies negotiating drug prices and creating drug formularies — lists of preferred drugs — that set the price patients pay. They also control the distribution channel.

The three largest PBMs — CVS Health (Caremark), Express Scripts, and OptumRx, a subsidiary of UnitedHealthcare Inc. — control 80 percent of health plan-related drug purchases. Zweig estimates giving the drug industry the same safe harbor protection afforded GPOs has raised annual drug costs more than $100 billion due to PBM rebates.

Keller Rohrback, a national Seattle-based law firm, last year filed a class-action lawsuit in federal court in New Jersey against Caremark, Express Scripts, and OptumRx, along with the three major insulin manufacturers — Sanofi-Aventis, Novo Nordisk, and Eli Lilly — alleging they conspired to inflate the price of insulin for their own benefit.

The plaintiffs say the price of diabetes-related drugs, such as insulin or victoza, are inflated in the U.S. even though they aren’t new and have been in use for many years. In foreign markets, the same drugs produced by the same manufacturers cost one-tenth as much as consumers pay here, they say.

The Los Angeles Times reports that Express Scripts recorded profits of $3.4 billion in 2016, a 34-percent rise over the previous year. Optum’s profit was $2.7 billion, up from $1.7 billion in 2015. CVS doesn’t break out financials for its PBM operation, but that unit filled or managed 1.2 billion prescriptions — or 1.6 billion when 90-day doses are counted as three prescriptions, according to the law firm.

Zweig says chronic shortages of saline solutions nationwide are caused by exclusive deals GPOs make with manufacturers to sell their products. In the aftermath of Hurricane Maria, there were even more widespread shortages of sterile IV solutions. According to Zweig, GPOs blamed the shortages on storm damage to Baxter International plants that produced the saline solutions on Puerto Rico.

The real reason for the shortages, Zweig contends, is that GPOs have relied almost exclusively on Baxter International for those products, concentrating production on the island and discouraging potential competitors that could have picked up the slack. “You’re not supposed to have shortages in a market economy,” Zweig says. “If this were toilet paper, I’m sure Congress would have acted by now.”

A 2003 federal whistleblower lawsuit filed by a former employee of Novation, a GPO that later merged into Vizient, revealed how high a price manufacturers may sometimes pay GPOs to sell their product. Court documents in the case showed that drug maker Ben Venue, of Cleveland, paid fees to Novation that amounted to nearly 57 percent of its annual sales of a heart drug.

Industry observers say the pressure on the company’s finances, among other issues, created underinvestment in plant maintenance and quality control problems, leading Ben Venue to close down after FDA inspections found untenable and unsanitary conditions at the plant in 2012.

Congressional records indicate that for nearly two decades, lawmakers wrestled with the impact of GPOs on health care costs with little success.

Former U.S. Sen. Herbert Kohl (D-Wis.), then chair of the Subcommittee on Antitrust, Business Rights, and Competition, described GPOs in an April 30, 2002, hearing as “a powerful gatekeeper who can cut off competition and squeeze out innovation.

“GPOs determine which medical devices will be used to treat us when we’re sick or injured, which manufacturers will survive and prosper, and, in fact, which ones will fail,” he said. “It doesn’t do any good to invent the next great pacemaker or safety needle if you can’t get it to patients because a GPO stands in your way.  But too often, it seems that GPOs have failed to serve as honest brokers seeking to serve the best interests of hospitals and patients.”

Over a 12-month period and after conducting four hearings into GPOs, Kohl and fellow U.S. Sen. Mike DeWine (R-Ohio) drafted a bill to abolish the safe harbor provision, but the measure failed to get legislative support. Zweig maintains GPO lobbyists pressured lawmakers to whom they contributed campaign money to vote against it.

“When you move the salespeople out of operating rooms, costs go down and outcomes improve.”
— Phil Abraham

A year later, Kohl and DeWine sent a three-page letter to then U.S. Secretary of Defense Donald Rumsfeld, urging him to carefully consider their committee’s findings before signing a Pentagon deal with a GPO. “Our investigation revealed that the purported benefits of GPO purchasing are not always realized, and that GPO purchasing carries risks for competition in the medical device industry,” they wrote.

In 2012, six Congressmen, including Rep. John D. Dingell (D-Mich.) and members of the House Energy and Commerce Committee, called on the Government Accountability Office to investigate the purchasing practices of GPOs. “It is not clear from available evidence that this payment scheme results either in savings to the hospitals or benefits for the patient,” the Congressmen said in a letter to the GAO.

Among the evidence the Congressmen referenced was a study by the Medical Device Manufacturers Association that compared prices for hospital equipment that GPOs paid compared to prices for the same equipment purchased through open competitive bidding. The study concluded that hospitals would save an average of 15 percent, or at least $30 billion in annual equipment purchases, if the anti-kickback safe harbor exemption was eliminated.

As for actually wringing costs out of hospital supply chains, Abraham has hands-on experience with the work he and his CloudFace team did over a two-year period at the Loma Linda University Medical Center in San Bernardino, Calif., where he was hired in 2010 to streamline the supply chain and reduce spending. In that instance, Loma Linda management told its GPO to stand back and allow Abraham to work without interference

Abraham says he found that Loma Linda, like most hospitals, had myriad inferior technology and software that prevented executives from seeing data that would tell them the real costs in their supply chains. He says his CloudFace technology was able to connect the various software systems in the hospital’s pharmacy and medical-surgical operations, giving executives — for the first time — a true picture of supplies coming into their department and costs associated with them.

Phil Abraham

From there, Abraham re-engineered or rewrote the hospital’s processes, practices, and procedures and created a new cloud-based platform that provided for pricing transparency.

One major cost savings was in orthopedic operating rooms. Abraham says he was “surprised” to see GPO salesmen — the “orthocartel,” as he describes them — joining surgeons, nurses, and patients in operating rooms, where they delivered multiple implants for surgeons to choose from for a particular operation.

The artificial knee of choice at Loma Linda, pushed by GPO salesmen, came from a Fortune 500 company to which Loma Linda was paying $5,000 for each knee. Abraham says he ended a pricing system he describes as “chaos” by convincing management to ban salespeople from operating rooms and adopting the use of a generic knee that costs $250 and performs even better than the expensive model.

“When you move the salespeople out of operating rooms, costs go down and outcomes improve,” Abraham says. “Loma Linda tracked better outcomes using the generic knee. Outside of that example, many doctors are reluctant to use the generic knee because they don’t want to lose rebate payments they’re getting, and the gobs of gifts and free stuff salespeople give them.”

The savings realized in the orthopedic operating rooms and elsewhere in the hospital operation — for example, a 50-percent cut on laundry costs, down to 53 cents per pound — resulted in cost reductions of up to 80 percent. The annual savings amounted to $40 million, Loma Linda executives say.

Abraham says Congress needs only to look at the latest U.S. Securities and Exchange Commission filings for Premier, a GPO, and read the paragraph describing its business model to learn why hospital costs are constantly rising.

“We generate revenue in our Supply Chain Services segment from administrative fees received from suppliers based on the total dollar volume of supplies purchased by our members, and through product sales in connection with our integrated pharmacy and direct sourcing activities,” the description reads.

On the opposite page, Premier reported that its Supply Chain Services revenue grew from $791.6 million to $961.4 million for the nine months prior to March 31, 2017. The net revenue for that period was up 21 percent.

“No other industry — not Ford, Walmart, Target, or General Motors — would make any money with this system. GM can’t say we have this large purchasing department (as most hospitals do) and we have a GPO, but the GPO gets paid more as the price of engines or transmissions go up. That would be crazy. But that’s what’s happening in hospitals,” Abraham says.

“The trick bag they’ve got themselves into is that hospitals can only make money when they mark up the patient bill. Right now, everyone across the health care supply chain kind of winks and raises their prices each year. It’s become apparent from ever-rising costs and a lack of transparency that the GPOs are too powerful and they need to be reformed, because they purposely keep hospitals and their drug and equipment suppliers separated so they don’t know what the real prices are. It’s a real racket”


What’s good for General Motors might be good for the country, at least if a new approach the automaker is taking toward curbing America’s runaway health care costs proves successful.

In August, GM and Henry Ford Health System Hospital in Detroit announced a deal in which the automaker’s 24,000 salaried employees in metro Detroit will get their health care and wellness services directly from Henry Ford’s network of 3,000 primary and specialty care doctors.

The ConnectedCare option, to start next year, will cover primary care, more than 40 specialties, behavioral health services, hospitalization, emergency care, pharmacy, and other services.

Employers who pay for their employees’ health care through insurance companies will be paying close attention as the new plan cuts out the intermediary role large insurers have traditionally played in the health care industry.

GM says ConnectedCare will cost employees $300 to $900 less per year than the cheapest plan the company now offers. While employees will be limited to Henry Ford providers and the system’s six hospitals and numerous clinics in the region, the plan will spare them from paying large deductibles.

GM isn’t alone in seeking to drive savings and boost the quality of care.

The most ambitious new attempt at cutting health care costs is a joint health care venture announced earlier this year by CEOs Jeff Bezos, Warren Buffet, and Jamie Dimon, who believe their new nonprofit company will lower costs for their combined 1.2 million employees at Amazon, Berkshire Hathaway, and JPMorgan Chase & Co., respectively.

In June, they introduced Dr. Atul Gawande, 52 — a well-known surgeon, author, and speaker — as the CEO of the yet-to-be-named company, which will be based in Boston. Gawande is best known in medical circles for leading an effort that reduced postsurgical deaths in South Carolina hospitals by 20 percent over several years.

While critics were quick to point out that Gawande has never run a hospital, a health system, or an insurance company, others say he was an excellent choice — an outsider who doesn’t have a financial or personal interest working with health care providers or GPOs.

“Gawande was selected to fundamentally change how health care is structured, paid for, and provided,” writes Dr. Robert Pearl, a bestselling author and professor at Stanford University, on “He was hired to disrupt the industry, to make traditional health plans obsolete, and to create a bold new future for American health care.”