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May/June 2004 - By Andrew W. Singer

Spattered and Scorched, Premier Seeks The ‘High Road’

Two thousand two was a year that hospital group purchasing organizations (GPOs) would just as soon forget.

The New York Times ran a series of investigative articles through that year, the gist of which was that GPOs stifled competition and were rife with conflicts of interest. Government investigations and Senate hearings followed.

Premier, Inc. (San Diego), the second largest GPO, was subpoenaed as part of an investigation into the buying practices of hospitals. Senator Herb Kohl (D-Wis.), chairman of the Senate Judiciary Antitrust Subcommittee, called Premier’s close financial ties to American Pharmaceutical, a supplier of antibiotics, "scandalous."1

In April, Kohl and Senator Mike DeWine (R-Ohio) demanded "that GPOs produce a code of conduct within 90 days in response to concerns that life-saving medical devices were being shut out of hospitals by anticompetitive business practices of leading GPOs."

By the end of 2002, the Times reported, "Over the last year, more than 100 hospitals have ended or reduced their dealings with the two companies, Premier and Novation, for-profit private companies that negotiate to buy drugs and medical supplies on behalf of nearly 4,000 hospitals."2

The GPOs fought back, citing their own experts and studies, arguing that group purchasing was pro-competitive and socially beneficial. "If GPOs didn’t continue to save their customers money, healthcare organizations wouldn’t continue to use them," noted the president of one healthcare system.3

Seeking ‘best ethical practices’

In the end, however, it was clear that things had to change. Premier, Inc., which purchases $17 billion annually in hospital supplies—everything from floor cleaner and light bulbs to heart pacemakers and CAT scanners—decided that even the appearance of a conflict of interest was unacceptable. It hired business ethicist Kirk O. Hanson to study the group purchasing industry in general, and Premier in particular, and to recommend "best ethical practices" that the company might adopt.

That study, "Best Ethical Practices For the Group Purchasing Industry: A Report to the Audit Committee Of the Board of Directors Of Premier, Inc.," was released in October 2002. The report contained 50 specific recommendations.

"At the center of these recommendations is concern for the ethical conflict of interest which may arise if GPOs play multiple and conflicting roles in the contracting process for hospital supplies and services," wrote Hanson.

Among other things, the report called upon GPOs to appoint an ethics and compliance officer to oversee compliance with its ethics code and to do annual reporting. In January 2003, Premier named Megan Barry its first Vice President for Ethics and Compliance. She was to report directly to Premier’s board of directors.

Going beyond industry norms

Premier implemented a number of Hanson’s other recommendations. Many of these went above and beyond industry norms. (The Health Industry Group Purchasing Association, or HIGPA, the trade association for GPOs, released its own ethics code on July 30, 2002. Of that code, Hanson wrote, "while not going as far as the recommendations in this report [it] is an important foundation for the ethics work of the individual GPOs.")

To cite one key example, Premier no longer enters into supplier contracts of more than three years. Earlier, six, seven and eight year contracts were more the norm. Why is this an issue? Supplier contracts, in fact, go to the heart of the recent controversy.

To wit: As GPOs evolved, particularly in the 1980s and 1990s, periods of growth and consolidation, they found that that if they aggregated their purchasing power they could get better prices from suppliers.

Premier forged what Barry called "blockbuster contracts" with large manufacturers like Johnson & Johnson that lasted six, seven and eight years. The GPO reaped discounts of anywhere from 7 to 10 percent as a result. This was seen as a big plus for Premier’s owners, "almost entirely non-profit, tax-exempt hospitals and hospital systems" (although Premier itself operates on a for-profit basis), according to Hanson.

The problem was the contracts’ length. Some manufacturers, usually smaller suppliers, believed that they were being shut out of the market. They complained: "We can’t get access to this market," recalls Barry. "That’s where the U.S. Senate got interested."

Thomas J. Shaw, President and CEO of Retractable Technologies, Inc., a Texas-based maker of safety syringes, for instance, asserted that Premier and Novation, the largest GPO, "negotiated exclusive, multi-billion dollar long-term contracts with the dominant syringe makers that prevent Retractable from even demonstrating its products in most acute care facilities," according to an April 30, 2002 company release.

"There was already a perception of conflicts," recalls Barry. If the GPO was locked into a seven-year contract, and the technology had become obsolete, then it could surely be argued that the patients weren’t getting the best technology. And it’s critical that GPOs stay on the technological cutting edge.

As noted, the longest contract that Premier will enter into now is three years "unless economic conditions require longer term agreements in the best interest of hospital members." In that case, the decision must go to Premier’s board.

One can’t please everyone, of course. "The manufacturers are not happy with us," notes Barry. "The Johnson & Johnson and Baxters of the world want long-term contracts." Nor are all of Premier’s critics necessarily mollified, as will be seen shortly.

Formed in 1996

Premier was formed in 1996, the product of a merger of three regional groups. Today it is affiliated with 1,500 hospitals and other healthcare sites. Their client hospitals are "dependent on physicians for patients coming through their doors," notes Barry. This makes them somewhat different from other businesses. A physician could say, "I have to have this pen." Another physician could say the same. So they may have to purchase six different pens, unlike ordinary businesses. The critical point is: "What do physicians need. It’s one thing buying bed sheets. It’s another buying a heart pacemaker or a hip or knee replacement," says Barry.

Megan Barry is the former Associate Director of the Cal Turner Program for Moral Leadership at Vanderbilt University. Before that she was director of corporate social responsibility at Nortel Networks/Northern Telecom. During her five-year tenure at Nortel, in the 1990s, the corporation posted its ethics code on the Internet, one of the first companies to do this. (See ethikos, March 1996, "Nortel’s Code of Conduct: ‘Hyperlink’ on the World Wide Web.") Now, of course, it is fairly common.

Viewed from afar, there are some positive consequences from the scorching the GPOs took in 2002. It offers a learning opportunity for other companies, suggests Barry. "The whole group purchasing industry was under a lot of scrutiny—and it still is—regarding some of its practices." The issues raised, however, are applicable to any organization that buys significant supplies. After all, "Every organization has some mechanism for purchasing."

Within this context, issues remain: "How to build in competitiveness, so that people who are in new technologies, but are small, can come in" if they have a good, new product, says Ted Pickens, Senior Director of Communications in Premier’s Purchasing Partners unit. The way healthcare GPOs were initially set up was that major suppliers had influence over purchasing decisions. At Premier, "We could only control a small part of that world." Maybe 15 percent of the market. Still, they have made changes in that sector.

The new conflict-of-interest rules

Employees have to follow new conflict of interest rules. They must divest all equity interest in suppliers. This is easier said than done. Premier’s suppliers include companies like Dell, Starbucks and IBM. (Starbucks supplies coffee to hospitals, for example.) Indeed, 65 percent of the companies that make up the Dow Jones industrial average are represented on Premier’s supplier list, says Barry. "So a lot of employees were perplexed" when told they had to sell their Dell and Starbucks shares.

This required "a lot of education" for the company’s 1,000 employees, recalls Barry—everyone from the maintenance staff to the leadership team. And for those individuals who dealt directly with contracting, the divestiture was extended to spouses and dependents.

"It was a big deal," she recalls. The reactions ranged from "I’m glad management is taking a pro-active approach" to "this is a real pain." Still, "Once we laid out the case, why it was so important in the marketplace, why it’s so important for the Senate to see us taking these steps, they understood."

Premier employees went through a two-and-a-half hour workshop on the ethics code, and the company’s business conduct guidelines. Committee members also received training. (These are the blue ribbon committees that evaluate healthcare products and make recommendations on those products to member hospitals.) Barry herself attended all 18 committee meetings, mostly to answer questions.

The company also conducted training for suppliers who want to know how the code affects them. Some suppliers asked why the hospitals weren’t abiding by the code.

Committee members have to disclose their equity stakes in suppliers too. If those investments are deemed significant, they may have to resign from the committees.

Committee members typically include purchasing officers at member hospitals (i.e., materials managers) as well as clinicians, like doctors and nurses. If a physician who serves on a committee goes skiing with a catheter manufacturer, for example, he would now be required to recuse himself on any decision involving catheters, according to the new rules.

Something similar extends to gifts and entertainment. Say Boston Scientific invites a committee member to a conference, paying for his airfare and hotel. (There’s been a lot of new technology in the cardiology field lately, notes Barry; Johnson and Johnson and Boston Scientific are competing with new drug-coated stents, for instance.) If the total comes to more than $50, the committee member would now have to recuse himself from any purchasing decision involving Boston Scientific.

Asked if this wasn’t beginning to sound like government contracting rules, Barry answers, "Like the government, we don’t want to be seen by anyone as yielding to undue influence."

Premier has 18 committees, each with about 17 members. Overall, 253 people serve on the committees. What was the biggest annoyance for committee members? "The stock rule," answers Barry, i.e., having to sell their stock in suppliers.

Does Premier have less leverage with committee members than it does with its employees regarding these new rules? "No, because there’s a real cachet for a hospital to have someone on the committee to represent them." They want to be on the committees and remain there.

Maintaining independence

When Premier hired Hanson, executive director of the Markkula Center for Applied Ethics at Santa Clara University, to write his report, it gave him access to all individuals in the company. It also pledged to help him get to suppliers, and it gave him "final control over the product," he says. He insisted that the report be made public, as he did eight years ago when writing a similar study for The Body Shop. Even though he was hired by the company, a mandatory public release of the findings was one way to ensure a degree of independence. These ground rules were written into his contract.

He provided the company with an initial draft of the report. "We went back and forth" for about three weeks. Premier was encouraged to correct errors and present new data. Hanson, admittedly, didn’t know everything about the GPO industry. "In eight to ten places I toned things down" as a result of this input. In other places, though, he strengthened his recommendations.

The report was presented to the board’s Audit Committee. They accepted all 50 recommendations—with one exception. That had to do with publishing the annual salaries of the company’s top five executives. After some soul searching—Hanson wasn’t privy to the deliberations—Premier declined. "No one else in the industry publishes," Hanson notes, and this was one place, apparently, where the company didn’t want to fly solo.

What were the most significant recommendations in his view? Those touching on the equity investments in suppliers by the company, and equity investments in suppliers by individuals within Premier. This involved a "rigorous implementation process," one that involved "a huge sell-off by people in the company." What he called for here was much broader than what the HIGPA industry code required.

In a March 26, 2002, article, "When a Buyer for Hospitals Has a Stake in Drugs It Buys," The New York Times noted that Premier helped to set up a pharmaceutical firm, American Pharmaceutical Partners, in 1996. It invested a small sum of money in it. In return, according to the Times, Premier received American Pharmaceutical stock worth $46 million when the company went public.

Regarding its institutional investments, Premier "did sell off a large amount of investments in companies," says Hanson. They didn’t do this all at once, though, not wanting to create a fire sale. (In July 2002, American Pharmaceutical announced that it had repurchased the approximately 2.9 million shares of its common stock owned by Premier Purchasing Partners in a privately negotiated transaction.) Within a year, though, the divestiture was largely completed. "They really did take that seriously," says Hanson.


The fund-raising efforts of committee members may be affected by the new rules. Many non-profit hospitals go to vendors—companies like Baxter or Johnson & Johnson—when raising money. Sometimes they’ll get the hospital’s materials manager to draft the fund-raising letter. There’s a possibility here for a conflict of interest. If committee members are soliciting multi-million dollar hospital grants, "They need to let us know," says Barry.

Committee members work largely for not-for-profit hospitals, and every dollar they get from suppliers is a dollar that the hospital doesn’t have to spend. Hence, there may be some resistance to these new rules—and not necessarily because they expect to lose out personally

Overall, Premier wants to be able to demonstrate that all purchasing decisions are "evidence-based," says Pickens. It seeks to create an evidence trail that others can follow, if need be, one that shows exactly how decisions were made, i.e., "How did you get to that contract decision point." It is a trail that makes clear that no preferential treatment was involved.

There have been other changes. Premier makes its money from administrative fees, usually a percentage on the volume of goods and services purchased for the hospitals. (These administrative fees are permitted under an antitrust exemption originally granted by Congress in 1987.) Now there will be no administrative fees in excess of 3 percent.

Questions remain

Overall, Premier appears to have "tried to put its best foot forward," says Mark Leahey, Executive Director of the Medical Device Manufacturers Association (Washington), a group that represents independent (and often smaller) manufacturers of medical devices and that has assailed GPO practices in the past. Capping the administrative fees at 3 percent, for instance, seems to lessen "the temptation to steer contracts" toward manufacturers who may offer a higher fee rate (if not necessarily a better device), he tells ethikos.

Premier has done a relatively good job on the issue of conflicts of interest, says Leahey. It appears increasingly unlikely now that a top Premier executive can enrich himself by signing a purchasing agreement with a certain manufacturer, a key complaint in the past—and a focus of the Times articles.

These sorts of issues seem to have been effectively dealt with by the code changes. But the jury is still out on some of the contract and practices issues, like the "bundling" of products. Here a GPO might want to buy a manufacturer’s sutures, but may be required to take its mechanical devices, its clips, and many other products, too. A smaller, more efficient manufacturer that makes better clips, say, and offers them at a lower price, might then be shut out. "To Premier’s credit, they broke up [a recent contract of this sort] into eight different categories," says Leahey.

That said, and despite these "steps in the right direction," Leahey is concerned that the new contract provisions are "prospective in nature" and apply only to contracts moving forward. A seven-year contract signed in 2001 is still in force, presumably. He also worries about some of the "caveats" in the code. Premier says contracts will only be for three years, as noted, "unless economic conditions require longer term agreements in the best interest of hospital members." That could be turned into a loophole. Leahey would prefer to see some of these provisions codified in federal regulation.

And then there is the still larger issue of how a GPO—Premier, Novation, or anyone else—can serve two masters. GPOs are purchasing products in bulk on behalf of the hospitals, but they are taking money from the manufacturers in the form of administrative fees.

Leahey tells of one medical device manufacturer whose patent was due to expire in November. Several generic manufacturers were ready to jump in with comparable devices that offered hospitals a 60 percent saving. But the GPO (not Premier) never told the hospitals about the expiring patent. It recommended staying with the existing manufacturer for three more years. Why? If the overall contract is larger, the GPO’s administrative fees are larger too. That’s the suspicion, at any rate.

Indeed, this issue of "two masters" can be seen as a fundamental flaw in the whole GPO structure. It is one that no code or corporate governance reform or ethics office will ever fix, in the view of Retractable Technologies’ CEO Shaw.

Shaw, who sued and later reached a settlement with Premier in a federal antitrust action, asserts that nothing has changed at Premier, Inc., despite the Hanson report. "There’s no improvement, none," he tells ethikos. The only equitable solution would be for the GPOs to "stop taking administrative fees from the manufacturers." (As noted, they are only able to do so because of a "safe harbor" provision within the nation’s antitrust laws.) But that isn’t likely to happen soon. Meanwhile, those administrative fees are not going back to the small, rural hospitals who are supposedly represented by the GPOs—"and are going broke"—but to a relatively few, large, urban-based "shareholder hospitals."

All of this has the effect of raising prices across the board, says Shaw. ("No one in the loop is remotely interested in bringing down prices.") And because the GPOs are taking money from the manufacturers, they are still colluding with the larger medical makers to keep other competitors out of the market. Shaw calls the system "structurally crooked." (Along these lines, his company claims in its 2003 annual report to "have been blocked from access to the market by exclusive marketing practices engaged in by Becton Dickinson and Co." Retractable Technologies has brought suit against Becton Dickinson.)

‘We’ve been out front’

Premier’s Barry was asked what has been the biggest challenge in dealing with all this. "Externally, we’ve been out front in the industry," she answers. They are the only GPO to take such a stringent approach so far. "Our competitors haven’t stood up to the same standard." This raises a key question: "Are we less competitive? I don’t think we are"

Hanson says that he was "disappointed that the Senate Committee has not pressed other GPOs to accept ‘best practices.’" They seem to be hiding behind the HIGPA industry code. Overall, Premier’s adoption of higher standards "will benefit them in the long run, but in the short term it may be a competitive disadvantage." Why? "They may have less flexibility in negotiations than other GPOs," says Hanson, as in the question of administrative fees.

Will they pay a price? "I don’t think so," answers Hanson. Larger GPOs have lost members to smaller, regional purchasing groups recently, but the early indications are that Premier has lost fewer members than other large GPOs. "Yes, there’s a chance they may be harmed. But so far Premier doesn’t perceive that they’ve been harmed."

Still, without those long-term contracts, will they lose more money than the competition? "I don’t think we are at a particular disadvantage," says Communications Director Pickens.

‘Breakthrough technology’

Then there is the issue of "breakthrough technology." Premier has developed a separate process for any company that thinks it has a "breakthrough technology," notes Pickens. If that company can demonstrate that they do, "we’ll add them to the contracts we have."

Such a case arose recently. Premier was challenged by a small company that said, in effect, "I think my company can do this ten times better." They had gotten some attention from some officials on a regional level. Premier put the company through its evaluation process, which included an examination by one of the committees.

What they found was that the company’s marketing claims far exceeded its clinical results. This examination process could be useful in rebutting charges of preferential treatment that might later arise, Pickens notes. It’s one example where the new regimen could actually help the company.

It’s important that people know that they will be heard, adds Pickens. "In the end, people came away and said, ‘We understand.’"

Barry adds that many of the things they’ve implemented—like transparency, shorter contracts, more accessibility—are relevant for other corporations, including those outside the health care industry. They touch on purchasing issues that have broad applications.

Today, says Hanson, "There’s no question Premier’s practices are better than any other GPO." Overall, the company has been "extraordinarily wise," in his view. They were singled out in the newspapers as a symbol of the problem, for "an appearance of bad faith." It became clear to management that they "needed to get out front" on this issue, and they did so. "They took the high road," says Hanson. "They asked, ‘What are the best practices?’ and then, ‘Is it practical to implement them?’" They decided that it was.

  1. New York Times, March 26, 2002 Times article, "When a Buyer for Hospitals Has a Stake in Drugs It Buys."
  2. New York Times, December 28, 2002, "More Hospitals Change the Way They Buy Drugs and Supplies."
  3. Dan Wilford, president of Memorial Hermann Healthcare System (Houston), quoted in American Outlook Today, June 25, 2002, "They Report, They Decide."

Andrew W. Singer is Co-Editor of ethikos.
Reprinted from the May/June 2004 issue of ethikos.
© 2004 Ethikos, Inc. All rights reserved.

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