The Other Side Of The Desk

Edition: September 2001 - Vol 9 Number 09
Article#: 1058
Author: Lynn James Everard, C.P.M., A.P.P. Contributing Ed

GPO bids disrupt long-term relationships between hospitals and distributors that could result in efficiency gains.

For years, distributors and GPOs have seemingly peacefully coexisted in the health care supply chain. Distributors have served as product intermediaries while GPOs have been price intermediaries.

Then managed care arrived on the scene and began the contest with Medicare and Medicaid over who would cover what and how little they would pay. Hospitals across the country watched their financial conditions rapidly deteriorate. Pressured to reduce costs, hospitals increased their emphasis on lowering product costs, thus enhancing the position of GPOs and the power they wielded in the supply chain. Distributors, in addition to providing product on a just-in-time basis for hospitals, grew in their role as bankers not only for manufacturers but for customers as well.

But things change rapidly in health care, and today, GPOs are reaching the limit on just how much more product cost they can drive out. Meanwhile, distributors are reaching the ceiling in their own efficiency gains, only to find that in many cases, those gains are not enough to offset the financial demands of their role as banker.

Distributors face-growing threats from third party logistics companies which, for the time being, sit patiently and wait for any weakness in the distributors' position. Forward-thinking distributors recognize that in order to reduce their own operating costs, they must help their customers become more efficient. As for GPOs, they continue what often appears to be their love/hate relationship with manufacturers, distributors and even their own members. In spite of these conditions, the health care supply chain continues to demand reductions in end-to-end costs. So, where do we go from here?

Distributors' Opportunity

By now it should be clear that for most hospitals, lower product costs by themselves are simply no match for the financial challenges they face. However, the elimination of internal process inefficiencies remains a largely untapped area in which distributors can be of great value to their customers.

Unfortunately, this same area holds very little promise for GPOs. Here is why. The hospital's internal supply chain can be very complicated and inefficient. Although hospitals devote some resources to improving their internal supply chain, they devote far more to the business of providing clinical services. Given the fact that hospitals are paid on the basis of the care they provide and not on their skill at moving boxes, this is how it should be.

Distributors, on the other hand, are in the business of moving boxes. One would expect that they would be able to do so far more efficiently than their hospital customers. That's why distributors are the perfect partners to permit the migration of some of their best practices in logistics and supply chain management into their customers' organizations. (For distributors, a more efficient customer is a more profitable one.) And this is exactly what hospitals need today and in the future.

But this migration requires a long-term trust relationship between the distributor and the customer. The distributor needs to know that it is sharing its internal operating secrets with a long-term partner. This knowledge is just too valuable to impart to a customer whose only focus is the price on the box. At the same time, the customer must have enough time to develop a trust relationship with the distributor to be willing to accept the migration of the expertise. And this is precisely where the conflict with the GPO arises.

Bids Disrupt Relationships

The GPO's power in the supply chain comes from aggregating purchasing volume and offering it to the lowest bidder. In order to maintain that power, the GPO must regularly initiate a bid process. Bids often mean changes in suppliers. The hospital is then faced with a choice: Give up its distributor relationship and move to a new one to get the better price, or keep the current distributor and forfeit the lower price and perhaps the old contract price as well.

The hospital is literally forced to choose between the GPO and the distributor. In many cases the distributor and the hospital both lose. The distributor loses a customer, and the hospital loses its efficiency gains, which may far outweigh the new contract cost-savings. Even if the hospital and the new distributor could recreate the relationship that existed between the hospital and its previous supplier, the next GPO bid cycle could make that moot as well. Now, if the distributor had been on the ball, it would have made certain that the hospital knew in dollars the real value of the efficiency migration. This could play a significant role in allowing the distributor to maintain its relationship with the customer.

Another difficult point for the distributor and hospitals is this: If both know that the length of their relationship is limited by the actions of the GPO, will either find it worthwhile to make the extra effort to make their relationship better and deeper? The result could be more lost opportunity.

Distributors and GPOs have a serious conflict. For distributors to be successful, they must be free to develop relationships with customers that will allow best practice migration. Yet, the GPO seemingly loses its power without the regular bid cycles taking place. The real issue is this: Should hospitals be forced to choose between low product costs and increased supply chain efficiency? Can distributors and GPOs peacefully coexist for much longer? Something will certainly have to give.

Tollbooths on the Supply Chain Turnpike?

This certainly seems to put the GPOs in a bad light. They appear to be little more than tollbooths on the supply chain turnpike. The more frequent the tollbooths, the less speed any car can generate and maintain. In this case, the more tollbooths, the smaller the chances that a distributor and a customer will be able to enter a long-term value-based relationship, which each needs to succeed. Although this assessment may seem unfair and even harsh to some, it is not intended to minimize the important role that GPOs have played historically in helping their members reduce the cost of the products they buy. But going forward, the supply chain just cannot afford for price to be the dominant issue. Hospitals simply have no choice but to maximize their supply chain efficiency or outsource many of their supply chain activities. Distributors are clearly better equipped than GPOs to assist hospitals in this critical area.

Keep in mind that GPOs are not legally prevented from changing their approach to the marketplace and to their customers. GPOs do not have to give up their position in the health care supply chain, only the role that they play. One course of action for GPOs, given the above scenario, may be to become supply chain facilitators who earn revenues not from the collection of tolls, but from the creation of long-term value-based relationships between suppliers and their members. After years of largely adversarial relationships, hospitals and their suppliers may need some help in brokering such relationships. If they are so inclined, GPOs could operate in this space.

Many years ago I worked for a regional industrial supply company. On the bottom of every quotation sent out was a simple phrase: ''Its not the price, it's the cost.'' It is time that the health care supply chain begin to heed those words. We must focus on managing total cost through the supply chain. Total cost can be defined as product cost plus the process cost of managing and moving that product through the chain. Price is only one component of total cost.

If distributors will apply themselves to helping their customers reduce their process costs, they will be well ahead of the game. Although it is sincerely hoped that hospitals won't ever have to choose between their distributor and their GPO, distributors who help their customers reduce their internal supply chain costs and total cost through the chain should be the hospital's clear choice.