Vera Tilson, associate professor of operations management at the University of Rochester, made a visit to The Boeing Center‬ to present her research on the impact of custom contracting and the infomediary roles of healthcare GPOs to our OMM students and faculty. For more research, connect with The Boeing Center on: Facebook: http://j.mp/BCTIM-fb Twitter: http://j.mp/BCTIM-tw LinkedIn: http://j.mp/BCTIM-li Instagram: http://j.mp/BCTIM-ig SlideShare: http://j.mp/BCTIM-ss Google+: http://j.mp/BCTIM-gp Blog: http://j.mp/BCTIM-bl

1. Healthcare Procurement:
Custom Contracting through GPOs
1
Rajib Saha Avi Seidmann Vera Tilson
GPO
Hospitals
Suppliers
Source: Satish Tiwari

2. There are multiple procurement challenges for US
hospitals
1. Difficult to control labor costs,
employee:patient ratios are often mandated
2. Inelastic demand (hospitals must buy clinical
supplies)
3. Supplies are 25% of all hospital expenses
2
4. 3% of line items (mostly physician preference items) are
responsible for 40% of supply expenses
5. Difficult to standardize on expensive supplies because of
diverse physician preferences and training
6. Oligopoly manufacturers of the most expensive supplies e.g.
surgical implants.
7. Hospital industry is fragmented, over 5,000 hospitals in the US

3. There are multiple procurement challenges for US
hospitals
1. Difficult to control labor costs,
employee:patient ratios are often mandated
2. Inelastic demand (hospitals must buy clinical
supplies)
3. Supplies are 25% of all hospital expenses
3
4. 3% of line items (mostly physician preference items) are
responsible for 40% of supply expenses
5. Difficult to standardize on expensive supplies because of
diverse physician preferences and training
6. Oligopoly manufacturers of the most expensive supplies e.g.
surgical implants.
7. Hospital industry is fragmented, over 5,000 hospitals in the US

4. There are multiple procurement challenges for US
hospitals
1. Difficult to control labor costs,
employee:patient ratios are often mandated
2. Inelastic demand (hospitals must buy clinical
supplies)
3. Supplies are 25% of all hospital expenses
4
4. 3% of line items (mostly physician preference items) are
responsible for 40% of supply expenses
5. Difficult to standardize on expensive supplies because of
diverse physician preferences and training
6. Oligopoly manufacturers of the most expensive supplies e.g.
surgical implants.
7. Hospital industry is fragmented, over 5,000 hospitals in the US

5. Physician Preference:
•Orthopedic Implants
•Spinal Implants
•Pacemakers
•AICDs
•Coronary Stents
•Special Procedure Devices
•Heart Valves
•Endosurgical Supplies
•Bone Products
•Perfusion Supplies
•Pacemakers
•Contrast Media
•Balloons and Wires
Physician preference items are 3% of line items
driving 40% of supply expenses
5
Hospital Supply Expenses:
Physician Preference vs. Others
by # Line Items by $$
Food products, gloves, IV solutions, gowns,
wound drainage, tubing, draping, generic drugs,
IV admin kits, disposables

6. Diverse physician preferences are partially
due to training history, and ‘funding’ ties
6

7. Hospital procurement managers “bow” to
physician preferences for particular devices
7

8. There are multiple procurement challenges for US
hospitals
1. Difficult to control labor costs,
employee:patient ratios are often mandated
2. Inelastic demand (hospitals must buy clinical
supplies)
3. Supplies are 25% of all hospital expenses
8
4. 3% of line items (mostly physician preference items) are
responsible for 40% of supply expenses
5. Difficult to standardize on expensive supplies because of
diverse physician preferences and training
6. Oligopoly manufacturers of the most expensive supplies e.g.
surgical implants.
7. Hospital industry is fragmented, over 5,000 hospitals in the US

9. There are multiple procurement challenges for US
hospitals
1. Difficult to control labor costs,
employee:patient ratios are often mandated
2. Inelastic demand (hospitals must buy clinical
supplies)
3. Supplies are 25% of all hospital expenses
9
4. 3% of line items (mostly physician preference items) are
responsible for 40% of supply expenses
5. Difficult to standardize on expensive supplies because of
diverse physician preferences and training
6. Oligopoly manufacturers of the most expensive supplies e.g.
surgical implants.
7. Hospital industry is fragmented, over 5,000 hospitals in the US

10. The US healthcare supply chain often includes
group purchasing intermediaries
10
Oligopolistic manufacturers >5000 Fragmented buyers
Group purchasing organizations
(GPOs)

11. To obtain ‘quantity discounts’ hospitals join a GPO
which aggregates their demand
11
Oligopolistic manufacturers Fragmented buyers
GPO

12. GPO negotiates a purchasing contract with a vendor
12
Vendor Manufacturer Fragmented buyers
GPO

13. Hospitals purchase supplies from the vendor
at GPO-negotiated prices
13
Vendor Fragmented buyers
$$$
@ GPO negotiated price
products
GPO

14. To cover operating expenses, GPO collects an
administrative fee from the vendor
14
Vendor Fragmented buyers
$$$
@ GPO negotiated price
products
GPO

15. Group purchasing organizations advertise
benefits to both hospital and vendors
Benefits to Hospitals:
– Cost savings from quantity discount
– Operational savings in procurement
– Vendor qualification
– Managerial support
Benefits to Vendors:
– Volume sales
– Marketing opportunity
– Reduced marketing costs
– Hospital contract compliance monitoring
15

16. Any problems here?
16
Vendor Fragmented buyers
$$$
@ GPO negotiated price
products
GPO

17. 17
In many settings involving federal contracts, payments from
vendors to procurement departments are illegal

18. 18
However, the hospital GPOs are permitted to receive sales
fees from manufacturers
(a special Congressional exemption from federal anti-kickback laws)

19. 19
GPO practices have been criticized by manufacturers
and distributors

20. GPO practices have been investigated by various
government entities
In 2002 following a series of articles in the New York Times,
Premier and Novation ( two of the largest GPOs) were investigated
by:
• the Federal Trade Commission (FTC) who wanted to know
whether the buying groups wield too much power (negotiated
contracts were worth more than $30 billion)
• the inspector general for the Centers for Medicare and Medicaid
Services (CMS)
• the General Accounting Office, the investigative arm of Congress
• the antitrust subcommittee of the Senate Judiciary Committee
• NY State Attorney General Office
20

21. In response to the various investigations
GPOs promised to adopt a code of conduct
• Eliminate self-dealing, i.e. stop investing in supply
companies.
• Contract with more companies, no longer sign exclusive
contracts with single manufacturers for certain medical
supplies
• Limit the length of the contracts (long contracts protected
incumbents)
• Limit contracts that condition discounts on bundling of
unrelated products
21

22. A 2002 GAO investigation found that GPO contracts
did not always offer hospitals better prices
22

23. The 2010 GAO investigation 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 vendor
23

24. In response -
GPOs introduced custom contracting
The practice of custom contracting is described in GAO-12-126, a
2012 GAO report on hospital purchasing of implantable devices
24

25. Our research focus is custom contracting
25
Who benefits:
• GPO
• GPO vendor
• member hospitals
and to what extent?

26. Relevant literature falls into four broad
categories
o Group purchasing:
• The mechanism for price reduction obtained through GPOs
• Effect of contract administration fees (CAF) on supply chain
participants
• Allocation of savings in group purchasing alliance
o Reasons for existence of supply chain intermediaries
26

27. Relevant literature falls into four broad
categories
o Group purchasing:
• The mechanism for price reduction obtained through GPOs
• Effect of contract administration fees (CAF) on supply chain
participants
• Allocation of savings in group purchasing alliance
o Reasons for existence of supply chain intermediaries
27

28. Analytical game-theoretic models have been used
to examine how GPOs provide savings when
dealing with multiple suppliers
O’Brien and Shaffer(1997), Dana (2003) prices are
lowered through the exclusive dealing mechanism, i.e.
ability to shift demand to a competitor
Marvel and Yang (2008) hospitals differ in preferences
for products from different supplies, price is lowered through
competition-intensifying effect of non-linear tariff.
Hu and Schwartz (2011) GPOs increase competition
between manufacturers and lower prices for healthcare
providers. However, GPOs reduce manufacturers' incentives to
introduce innovations to existing products.
28

29. Relevant literature falls into four broad
categories
o Group purchasing:
• The mechanism for price reduction obtained through GPOs
• Effect of contract administration fees (CAF) on supply chain
participants
• Allocation of savings in group purchasing alliance
o Reasons for existence of supply chain intermediaries
29

30. Hu, Schwartz (2011) conclude that elimination of contract
administration fee (CAF) would not affect any party's profits or
costs.
Hu, Schwartz, and Uhan (2012) conclude that CAF
does not affect hospital costs, but affects distribution of profits
between a GPO and vendors.
30

31. Relevant literature falls into four broad
categories
o Group purchasing:
• The mechanism for price reduction obtained through GPOs
• Effect of contract administration fees (CAF) on supply chain
participants
• Allocation of savings in group purchasing alliance
o Reasons for existence of supply chain intermediaries
31

32. Empirical and analytical studies examine
the stability of purchasing alliances:
• Survey-based studies identify drivers of success and failures of
alliances: Doucette (1997), Nollet & Beaulieu
(2003), Schotanus (2005). Unfair allocation of savings
is identified as one of the reasons for the failure of an alliance.
• Game-theoretic models are used to examine the trade-offs in
allocating cost savings to group members of alliances:
Heijboer (2002), Schotanus (2004), Schotanus
et al. (2008), Nagarajan et al. (2008), Chen et
al. (MSOM Conf., 2013)
32

33. Relevant literature falls into four broad
categories
o Group purchasing:
• The mechanism for price reduction obtained through GPOs
• Effect of contract administration fees (CAF) on supply chain
participants
• Allocation of savings in group purchasing alliance
o Reasons for existence of supply chain intermediaries
33

34. Wu (2004) categorizes supply chain
intermediaries into two broad types:
• Transactional intermediaries – aggregate supply and
demand, reduce costs associated with searching and
matching
• Informational intermediaries – synthesize dispersed
information or reduce information asymmetry, create trusted
institution
Other reasons for existence of intermediaries and intermediary
profits are examined in Belavina and Girotra (2012),
Yang and Babich (2013), Adida et al. (2013)
34

35. None of the literature explains the custom
contracting arrangement,
also healthcare GPOs are unlike most supply
chain intermediaries
• they aggregate demand, but do not hold inventory
• operate in a highly regulated environment
• margins are set externally
35

36. We create a game-theoretic model to
analyze the impact of custom contracting
36

37. Assumption I: From the point of view of any
particular hospital the demand qty is inelastic
37
A hospital will have to purchase needed
implants from some manufacturer.

38. Assumption II: Prices are negotiated, hospitals do
not simply pay the list price
38

39. Assumption II: Price negotiations are costly
for both hospitals and vendors
39

40. 40

41. 41

42. 42

43. 43

44. 44

45. 45

46. Price secrecy exits not only with physician
preference items, but also with
commodities such as saline solution
46

47. In healthcare market, product quality is known,
while price information is not readily available
47
Uncertain
Price
Quality
UncertainKnown
Known

48. In healthcare market, product quality is known,
while price information is not readily available
48
Uncertain
Price
Quality
UncertainKnown
Known

49. In healthcare market, product quality is known,
while price information is not readily available
49
Uncertain
Price
Quality
UncertainKnown
Known
‘Market for Lemons’

50. In healthcare market, product quality is known,
while price information is not readily available
50
Uncertain
Price
Quality
UncertainKnown
Known
‘Market for Lemons’
‘Market for Healthcare’

51. Assumption III: Price attainable through vendor-
hospital negotiations is random &
stochastically decreasing in demand
51
Upper limit on attainable
price
Lower limit on
attainable price
PurchasePrice,$/unit
Expected price
Hospitals’ purchase volume [units/period]

52. Assumption IV: GPO member hospitals are
heterogeneous in terms of demand volume.
This distribution is known to the GPO vendor.
52
#ofmemberhospitals
Hospitals’ purchase volumes [units/period]

53. Assumption V: Decision timing
53
TreePlan Trial Version, For Evaluation Only www.TreePlan.com
Hospital: don't negotiate
0
0 0
0.5
Negotiated price above GPO price
0
0 0
1
0 0 0 0.5
Negotiated price below GPO price
0
0 0
Hospital: negotiate 0.5
1 Negotiated price above GPO price
0 0 0
0 0
0 0 0.5
Negotiated price below GPO price
0
0 0
1
0 0 0.5
Negotiated price above GPO price
0
0 0
GPO vendor: participate
0.5
0 0 GPO vendor selected
0.5 0
0 0
0 0 0.5
GPO vendor not selected
0
0 0For Evaluation Only
GPO
vendor
set price
Pg
λ q P g q P g + c (k,0 )
0 q E [p (q,P g ,0 ) | p <P g ] + c (k,0 )
q P g - k v q E [p (q,P g ,1 ) | p <P g ] + c (k,1 )
Hospital:invite GPO
vendor
Hospital: don't
invite GPO vendor
GPO vendor: don't
participate
Negotiated price
below GPO price
λ q P g q P g + c (k,0 )
0 q E [p (q,P g ,0 ) | p <P g ] + c (k,0 )
λ q E [p (q,P g ,1 ) | p <P g ] - k v q E [p (q,P g ,1 ) | p <P g ] + c (k,1 )
GPO vendor payoff Hospital cost
λ q P g q P g
λ q P g - k v q P g + c (k,1 )
GPO-selected vendor sets the
GPO-wide contract price for all
members

54. Assumption V: Decision timing
54
TreePlan Trial Version, For Evaluation Only www.TreePlan.com
Hospital: don't negotiate
0
0 0
0.5
Negotiated price above GPO price
0
0 0
1
0 0 0 0.5
Negotiated price below GPO price
0
0 0
Hospital: negotiate 0.5
1 Negotiated price above GPO price
0 0 0
0 0
0 0 0.5
Negotiated price below GPO price
0
0 0
1
0 0 0.5
Negotiated price above GPO price
0
0 0
GPO vendor: participate
0.5
0 0 GPO vendor selected
0.5 0
0 0
0 0 0.5
GPO vendor not selected
0
0 0For Evaluation Only
GPO
vendor
set price
Pg
λ q P g q P g + c (k,0 )
0 q E [p (q,P g ,0 ) | p <P g ] + c (k,0 )
q P g - k v q E [p (q,P g ,1 ) | p <P g ] + c (k,1 )
Hospital:invite GPO
vendor
Hospital: don't
invite GPO vendor
GPO vendor: don't
participate
Negotiated price
below GPO price
λ q P g q P g + c (k,0 )
0 q E [p (q,P g ,0 ) | p <P g ] + c (k,0 )
λ q E [p (q,P g ,1 ) | p <P g ] - k v q E [p (q,P g ,1 ) | p <P g ] + c (k,1 )
GPO vendor payoff Hospital cost
λ q P g q P g
λ q P g - k v q P g + c (k,1 )
Hospital decides whether to
purchase supplies at this price,
or to negotiate with other
vendors

55. Assumption V: Decision timing
55
TreePlan Trial Version, For Evaluation Only www.TreePlan.com
Hospital: don't negotiate
0
0 0
0.5
Negotiated price above GPO price
0
0 0
1
0 0 0 0.5
Negotiated price below GPO price
0
0 0
Hospital: negotiate 0.5
1 Negotiated price above GPO price
0 0 0
0 0
0 0 0.5
Negotiated price below GPO price
0
0 0
1
0 0 0.5
Negotiated price above GPO price
0
0 0
GPO vendor: participate
0.5
0 0 GPO vendor selected
0.5 0
0 0
0 0 0.5
GPO vendor not selected
0
0 0For Evaluation Only
GPO
vendor
set price
Pg
λ q P g q P g + c (k,0 )
0 q E [p (q,P g ,0 ) | p <P g ] + c (k,0 )
q P g - k v q E [p (q,P g ,1 ) | p <P g ] + c (k,1 )
Hospital:invite GPO
vendor
Hospital: don't
invite GPO vendor
GPO vendor: don't
participate
Negotiated price
below GPO price
λ q P g q P g + c (k,0 )
0 q E [p (q,P g ,0 ) | p <P g ] + c (k,0 )
λ q E [p (q,P g ,1 ) | p <P g ] - k v q E [p (q,P g ,1 ) | p <P g ] + c (k,1 )
GPO vendor payoff Hospital cost
λ q P g q P g
λ q P g - k v q P g + c (k,1 )
If the hospital is able to find a
lower price from another vendor,
it purchases supplies from that
vendor. Otherwise, from the GPO
vendor at the general price

56. Assumption V: Decision timing
56
TreePlan Trial Version, For Evaluation Only www.TreePlan.com
Hospital: don't negotiate
0
0 0
0.5
Negotiated price above GPO price
0
0 0
1
0 0 0 0.5
Negotiated price below GPO price
0
0 0
Hospital: negotiate 0.5
1 Negotiated price above GPO price
0 0 0
0 0
0 0 0.5
Negotiated price below GPO price
0
0 0
1
0 0 0.5
Negotiated price above GPO price
0
0 0
GPO vendor: participate
0.5
0 0 GPO vendor selected
0.5 0
0 0
0 0 0.5
GPO vendor not selected
0
0 0For Evaluation Only
GPO
vendor
set price
Pg
λ q P g q P g + c (k,0 )
0 q E [p (q,P g ,0 ) | p <P g ] + c (k,0 )
q P g - k v q E [p (q,P g ,1 ) | p <P g ] + c (k,1 )
Hospital:invite GPO
vendor
Hospital: don't
invite GPO vendor
GPO vendor: don't
participate
Negotiated price
below GPO price
λ q P g q P g + c (k,0 )
0 q E [p (q,P g ,0 ) | p <P g ] + c (k,0 )
λ q E [p (q,P g ,1 ) | p <P g ] - k v q E [p (q,P g ,1 ) | p <P g ] + c (k,1 )
GPO vendor payoff Hospital cost
λ q P g q P g
λ q P g - k v q P g + c (k,1 )
When custom contracting is
allowed, a hospital can invite
the GPO vendor to
participate in custom
negotiations

57. Assumption V: Decision timing
57
TreePlan Trial Version, For Evaluation Only www.TreePlan.com
Hospital: don't negotiate
0
0 0
0.5
Negotiated price above GPO price
0
0 0
1
0 0 0 0.5
Negotiated price below GPO price
0
0 0
Hospital: negotiate 0.5
1 Negotiated price above GPO price
0 0 0
0 0
0 0 0.5
Negotiated price below GPO price
0
0 0
1
0 0 0.5
Negotiated price above GPO price
0
0 0
GPO vendor: participate
0.5
0 0 GPO vendor selected
0.5 0
0 0
0 0 0.5
GPO vendor not selected
0
0 0For Evaluation Only
GPO
vendor
set price
Pg
λ q P g q P g + c (k,0 )
0 q E [p (q,P g ,0 ) | p <P g ] + c (k,0 )
q P g - k v q E [p (q,P g ,1 ) | p <P g ] + c (k,1 )
Hospital:invite GPO
vendor
Hospital: don't
invite GPO vendor
GPO vendor: don't
participate
Negotiated price
below GPO price
λ q P g q P g + c (k,0 )
0 q E [p (q,P g ,0 ) | p <P g ] + c (k,0 )
λ q E [p (q,P g ,1 ) | p <P g ] - k v q E [p (q,P g ,1 ) | p <P g ] + c (k,1 )
GPO vendor payoff Hospital cost
λ q P g q P g
λ q P g - k v q P g + c (k,1 )
The GPO vendor can choose
to participate or not to
participate

58. Assumption V: Decision timing
58
TreePlan Trial Version, For Evaluation Only www.TreePlan.com
Hospital: don't negotiate
0
0 0
0.5
Negotiated price above GPO price
0
0 0
1
0 0 0 0.5
Negotiated price below GPO price
0
0 0
Hospital: negotiate 0.5
1 Negotiated price above GPO price
0 0 0
0 0
0 0 0.5
Negotiated price below GPO price
0
0 0
1
0 0 0.5
Negotiated price above GPO price
0
0 0
GPO vendor: participate
0.5
0 0 GPO vendor selected
0.5 0
0 0
0 0 0.5
GPO vendor not selected
0
0 0For Evaluation Only
GPO
vendor
set price
Pg
λ q P g q P g + c (k,0 )
0 q E [p (q,P g ,0 ) | p <P g ] + c (k,0 )
q P g - k v q E [p (q,P g ,1 ) | p <P g ] + c (k,1 )
Hospital:invite GPO
vendor
Hospital: don't
invite GPO vendor
GPO vendor: don't
participate
Negotiated price
below GPO price
λ q P g q P g + c (k,0 )
0 q E [p (q,P g ,0 ) | p <P g ] + c (k,0 )
λ q E [p (q,P g ,1 ) | p <P g ] - k v q E [p (q,P g ,1 ) | p <P g ] + c (k,1 )
GPO vendor payoff Hospital cost
λ q P g q P g
λ q P g - k v q P g + c (k,1 )
The hospital will purchase
supplies at the lowest
negotiated price

59. TreePlan Trial Version, For Evaluation Only www.TreePlan.com
Hospital: don't negotiate
0
0 0
0.5
Negotiated price above GPO price
0
0 0
1
0 0 0 0.5
Negotiated price below GPO price
0
0 0
Hospital: negotiate 0.5
1 Negotiated price above GPO price
0 0 0
0 0
0 0 0.5
Negotiated price below GPO price
0
0 0
1
0 0 0.5
Negotiated price above GPO price
0
0 0
GPO vendor: participate
0.5
0 0 GPO vendor selected
0.5 0
0 0
0 0 0.5
GPO vendor not selected
0
0 0For Evaluation Only
GPO
vendor
set price
Pg
λ q P g q P g + c (k,0 )
0 q E [p (q,P g ,0 ) | p <P g ] + c (k,0 )
q P g - k v q E [p (q,P g ,1 ) | p <P g ] + c (k,1 )
Hospital:invite GPO
vendor
Hospital: don't
invite GPO vendor
GPO vendor: don't
participate
Negotiated price
below GPO price
λ q P g q P g + c (k,0 )
0 q E [p (q,P g ,0 ) | p <P g ] + c (k,0 )
λ q E [p (q,P g ,1 ) | p <P g ] - k v q E [p (q,P g ,1 ) | p <P g ] + c (k,1 )
GPO vendor payoff Hospital cost
λ q P g q P g
λ q P g - k v q P g + c (k,1 )
Result I: The GPO vendor is never worse off
with custom contracting
59
The GPO vendor can always
refuse to participate in
custom negotiations

60. TreePlan Trial Version, For Evaluation Only www.TreePlan.com
Hospital: don't negotiate
0
0 0
0.5
Negotiated price above GPO price
0
0 0
1
0 0 0 0.5
Negotiated price below GPO price
0
0 0
Hospital: negotiate 0.5
1 Negotiated price above GPO price
0 0 0
0 0
0 0 0.5
Negotiated price below GPO price
0
0 0
1
0 0 0.5
Negotiated price above GPO price
0
0 0
GPO vendor: participate
0.5
0 0 GPO vendor selected
0.5 0
0 0
0 0 0.5
GPO vendor not selected
0
0 0For Evaluation Only
GPO
vendor
set price
Pg
λ q P g q P g + c (k,0 )
0 q E [p (q,P g ,0 ) | p <P g ] + c (k,0 )
q P g - k v q E [p (q,P g ,1 ) | p <P g ] + c (k,1 )
Hospital:invite GPO
vendor
Hospital: don't
invite GPO vendor
GPO vendor: don't
participate
Negotiated price
below GPO price
λ q P g q P g + c (k,0 )
0 q E [p (q,P g ,0 ) | p <P g ] + c (k,0 )
λ q E [p (q,P g ,1 ) | p <P g ] - k v q E [p (q,P g ,1 ) | p <P g ] + c (k,1 )
GPO vendor payoff Hospital cost
λ q P g q P g
λ q P g - k v q P g + c (k,1 )
Result II: The GPO is never worse off with
custom contracting
60
If the GPO vendor agreed to
participate means that its
expected revenue is higher
than when it does not
participate

61. Illustrative Example:
GPO with three member hospitals
61
Demand: 52 units per
period
Demand: 69 units per
period
Demand: 180 units per
period

62. Illustrative Example:
GPO with three member hospitals
62
Per unit price attainable in
negotiations with a single
vendor: $6,674 to $10, 674
Per unit price attainable in
negotiations with a single
vendor: $6,173 to $10, 173
Per unit price attainable in
negotiations with a single
vendor: $2,632 to $6,632

63. The unit price the hospitals expect to pay after
negotiations with outside vendors depends on
the contract GPO price
63
This is the
expected
minimum of the
negotiated price
for this hospital
and the GPO-wide
contract price

64. The unit price the hospitals expect to pay after
negotiations with outside vendors depends on
the contract GPO price
64
When the GPO-
wide contract
price is low, the
expected price is
the GPO-wide
contract price

65. The unit price the hospitals expect to pay after
negotiations with outside vendors depends on
the contract GPO price
65
The curves are
different for
different hospitals,
larger hospitals
will start
negotiating at
lower GPO-wide
prices

66. Another way to look at the decisions is to look at
which value of GPO-wide contract price, the
hospitals can expect to experience cost savings
from negotiations
66
larger hospitals
will start
negotiating at
lower GPO-wide
prices

67. Result III: Decision to negotiate is non-decreasing
in hospital size and in GPO-wide contract price
67
larger hospitals
will start
negotiating at
lower GPO-wide
prices

68. The expected demand for the GPO vendor is
a function of the GPO-wide contract price
68
When the GPO-
wide contract
price is low, all the
hospitals buy the
supplies from the
GPO vendor

69. The expected demand for the GPO vendor is
a function of the GPO-wide contract price
69
As the price
increases , the
larger hospital will
buy supplies from
the GPO vendor
only if the hospital
does not find a
lower price
elsewhere

70. The expected demand for the GPO vendor is
a function of the GPO-wide contract price
70
The “jump” results
from the fact that
the negotiations
are not costless for
the hospital

71. The expected demand for the GPO vendor is
a function of the GPO-wide contract price
71
As the GPO-wide
contract price
increases further,
the midsize
hospital also starts
to negotiate with
other vendors

72. The GPO vendor sets the GPO-wide contract
price to maximize its expected profit
72
Price x Expected
Demand

73. Result III: The GPO-wide contract price is never lower than the
price at which the largest hospital is indifferent between
purchasing from the GPO vendor and negotiating further.
73
Setting the price
lower will result
in lower
expected profit

74. Result IV: Having access to a GPO contract results
in expected savings for member hospitals
74
Hospital Demand
Total
180 69 52
Expected price without a GPO $3,431 $6,936 $7,473
Total expected cost without a
GPO
$642,684 $503,642 $413,632
Total cost with GPO contract,
GPO vendor acts optimally.
$540,000 $207,000 $156,000
Savings from having access to
the GPO contract
$102,684 $296,642 $257,632 $656,958
Percentage savings 16% 59% 62% 42%
Assumed
negotiations with
4 vendors

75. Result IV: Having access to a GPO contract results
in expected savings for member hospitals
75
Hospital Demand
Total
180 69 52
Expected price without a GPO $3,431 $6,936 $7,473
Total expected cost without a
GPO
$642,684 $503,642 $413,632
Total cost with GPO contract,
GPO vendor acts optimally.
$540,000 $207,000 $156,000
Savings from having access to
the GPO contract
$102,684 $296,642 $257,632 $656,958
Percentage savings 16% 59% 62% 42%
Includes the cost
of negotiations
with 4 vendors

76. Result IV: Having access to a GPO contract results
in expected savings for member hospitals
76
Hospital Demand
Total
180 69 52
Expected price without a GPO $3,431 $6,936 $7,473
Total expected cost without a
GPO
$642,684 $503,642 $413,632
Total cost with GPO contract,
GPO vendor acts optimally.
$540,000 $207,000 $156,000
Savings from having access to
the GPO contract
$102,684 $296,642 $257,632 $656,958
Percentage savings 16% 59% 62% 42%
Assumes GPO
vendor sets price
of $3K, optimal
for all hospitals
not to negotiate

77. Result IV: Having access to a GPO contract results
in expected savings for member hospitals
77
Hospital Demand
Total
180 69 52
Expected price without a GPO $3,431 $6,936 $7,473
Total expected cost without a
GPO
$642,684 $503,642 $413,632
Total cost with GPO contract,
GPO vendor acts optimally.
$540,000 $207,000 $156,000
Savings from having access to
the GPO contract
$102,684 $296,642 $257,632 $656,958
Percentage savings 16% 59% 62% 42%
Largest % savings for the
smallest hospital

78. Result V: The GPO vendor benefits at the expense
of other vendors
78
Hospital Demand
Total
180 69 52
Expected price without a GPO $3,431 $6,936 $7,473
Expected demand without a
GPO contract
180/4 69/4 52/4
Total expected profit without a
GPO vendor contract
$134,421 $99,661 $77,158
Total profit with GPO vendor
contract
$511,840 $196,205 $147,865
Increase in profit from having
access to the GPO contract
$377,419 $96,544 $70,707 $544,670
Percentage increase in GPO
vendor profit
281% 97% 92% 175%Includes the cost
of negotiations
with the hospital

79. Result V: The GPO vendor benefits at the expense
of other vendors
79
Hospital Demand
Total
180 69 52
Expected price without a GPO $3,431 $6,936 $7,473
Expected demand without a
GPO contract
180/4 69/4 52/4
Total expected profit without a
GPO vendor contract
$134,421 $99,661 $77,158
Total profit with GPO vendor
contract
$511,840 $196,205 $147,865
Increase in profit from having
access to the GPO contract
$377,419 $96,544 $70,707 $544,670
Percentage increase in GPO
vendor profit
281% 97% 92% 175%
Additional
demand plus
lower cost of
negotiations

80. Result V: The GPO vendor benefits at the expense
of other vendors
80
Hospital Demand
Total
180 69 52
Expected price without a GPO $3,431 $6,936 $7,473
Expected demand without a
GPO contract
180/4 69/4 52/4
Total expected profit without a
GPO vendor contract
$134,421 $99,661 $77,158
Total profit with GPO vendor
contract
$511,840 $196,205 $147,865
Increase in profit from having
access to the GPO contract
$377,419 $96,544 $70,707 $544,670
Percentage increase in GPO
vendor profit
281% 97% 92% 175%
Significant increase, due primarily to
capturing the demand of the large
hospital

81. TreePlan Trial Version, For Evaluation Only www.TreePlan.com
Hospital: don't negotiate
0
0 0
0.5
Negotiated price above GPO price
0
0 0
1
0 0 0 0.5
Negotiated price below GPO price
0
0 0
Hospital: negotiate 0.5
1 Negotiated price above GPO price
0 0 0
0 0
0 0 0.5
Negotiated price below GPO price
0
0 0
1
0 0 0.5
Negotiated price above GPO price
0
0 0
GPO vendor: participate
0.5
0 0 GPO vendor selected
0.5 0
0 0
0 0 0.5
GPO vendor not selected
0
0 0For Evaluation Only
GPO
vendor
set price
Pg
λ q P g q P g + c (k,0 )
0 q E [p (q,P g ,0 ) | p <P g ] + c (k,0 )
q P g - k v q E [p (q,P g ,1 ) | p <P g ] + c (k,1 )
Hospital:invite GPO
vendor
Hospital: don't
invite GPO vendor
GPO vendor: don't
participate
Negotiated price
below GPO price
λ q P g q P g + c (k,0 )
0 q E [p (q,P g ,0 ) | p <P g ] + c (k,0 )
λ q E [p (q,P g ,1 ) | p <P g ] - k v q E [p (q,P g ,1 ) | p <P g ] + c (k,1 )
GPO vendor payoff Hospital cost
λ q P g q P g
λ q P g - k v q P g + c (k,1 )
Next, we take a closer look at custom contracting
81

82. Because the GPO vendor can participate in
negotiations, it will occasionally be the low-
price bidder & get additional sales
82
So the additional
revenue can be
thought of as
coming from
expected
additional demand
at the GPO-wide
price

83. Because the GPO vendor can participate in
negotiations, it will occasionally be the low-
price bidder & get additional sales
83
Prob of being lowest
cost bidder
x
Expected per unit
price
x
full demand
/ GPO-wide contract
price

84. Result VI: The GPO vendor does NOT reduce
price when custom contracting is allowed
84
Prob of being
Maximum
expected profit
with custom
contracting

85. Result VI: The GPO vendor does NOT reduce
price when custom contracting is allowed
85
Prob of being
Maximum
expected profit
without custom
contracting

86. An increase in GPO-wide price leads to an increase
in costs even for hospitals that engage in
negotiations
86
Hospital Demand
Total
180 69 52
Per unit GPO-wide price
without custom contracting
$3,000
Total cost with GPO contract,
GPO vendor acts optimally
$540,000 $207,000 $156,000
Per unit GPO-wide price with
custom contracting
$6,900
Total expected cost (including
negotiations) with custom
contracting
$642,684 $476,100 $358,800
Expected increase in costs $102,684 $269,100 $202,800 $574,584
Percentage expected increase 19% 130% 130% 39%
It is optimal for the large
hospital to negotiate, still its
costs are higher

87. The total expected profit for the GPO vendor
increases, even though the expected profit
coming from large hospitals may decrease
87
Hospital Demand
Total
180 69 52
Per unit GPO-wide price
without custom contracting
$3,000
Total cost with GPO
contract, GPO vendor acts
optimally
$523,800 $200,790 $151,320
Per unit GPO-wide price
with custom contracting
$6,900
Total expected cost
(including negotiations) with
custom contracting
$129,788 $461,817 $348,036
Expected increase in costs -$394,012 $261,027 $196,716 $63,731
Percentage expected increase -75% 130% 130% 7%
This large hospital will be
buying the supplies from the
GPO vendor less frequently

88. Interestingly, that with custom contracting the
procurement manager of a large hospital looks
good, because it looks like s/he negotiated
significant savings relative to the GPO price
88
Purchase at GPO price: $6,900 x 180 = $1,242,000
Negotiated unit price: $3,431
Purchase at negotiated price: $3,431 x 180 = $617,684
Cost of negotiations: $25,000
Total cost: $642,684
Savings: 48%

89. Managerial Conclusions (I/II):
Custom contracts generate an illusion
of additional savings
 The ‘Custom Contracting’ flexibility option
comes at a price!
 We prove that Custom contracts:
o increase profits for GPOs and vendors,
o do not increase the savings for hospitals
89

90.  GPO price becomes a misleading benchmark
for measuring relative cost savings
 But, ‘Custom Contracting’ makes the
procurement managers look better
(And they are the one who ‘select’ the GPO to use)
 The hospital industry, therefore, may have a hard
time effectively blocking this costly practice
90
Managerial Conclusions (II/II):
Custom contracts generate an illusion
of additional savings

91. Healthcare Procurement:
Custom Contracting through GPOs
91
Rajib Saha Vera Tilson Avi Seidmann