Making the case for competition - Having My Say

A wise purchasing executive, Paul Lombardi of the Swedish Medical Center in Seattle, told me, "Competition is the mother of lower costs," and I couldn't agree more. Yet certain group purchasing organizations are eliminating competition at the cost of higher prices and stagnation of innovation. In our system of capitalism, no seller will reduce its prices unless it fears losing the business to a lower bidder. But competition delivers much more than just better prices, it ensures constant innovation by suppliers who know that price competitiveness alone is not enough to guarantee them sales. If they don't improve their products, some other company will and they will lose sales because of it.

At the heart of the debate over GPO practices is the effect on competition. Certain GPOs, primarily Premier and Novation, have seemed intent on driving an ever-increasing volume of business to the largest suppliers. They argue that, with greater commitment to these vendors, come lower prices. Yet the recent study released by the General Accounting Office found that this was not the case. Prices on the same items were not necessarily lower through a GPO and larger GPOs did not necessarily provide better pricing than smaller GPOs. In fact, hospitals paid up to 39 percent more for certain device models bought through GPOs. This GAO finding did not surprise us because we have witnessed it first hand.

How could this be possible? The reason for this is that the fee-based relationships between the GPOs and the vendors have all but eliminated competition. The negotiations between vendors and GPOs have more to do with how the GPO can earn more in fees by driving more volume to the market share leader, who probably uses the "carrot and the stick" to get exclusive arrangements. The carrot is the offer to pay GPOs higher than standard fees and the stick is to threaten to pay no fees if the market share leader vendor doesn't get exclusivity. But what about other vendors who offer improved products, better pricing and are also willing to pay the fees? They are usually ignored due to the "carrot and stick" tactics of large vendors and the sheer size of the fees being paid by them in exchange for exclusion of their competitors. In effect, the fees buy the large vendors "closed" negotiations. The GPOs will sometimes go through the motions of conducting what appears to be an open bidding process, but in many cases, the se are only a sideshow to the real process going on behind closed doors.

A good example of this process can be seen in how pulse oximetry contracting was handled by both Premier and Novation over the past several years. Over the last 15 years, Nellcor has dominated the U.S. pulse oximetry market, with little challenge to its business. It wasn't until 1998 that Nellcor faced a legitimate challenge. Masimo introduced its breakthrough Signal Extraction Technology pulse oximetry, which was clinically proven in more than 20 studies published in peer-reviewed journals to significantly improve pulse oximetry performance. Today there are at least 50 such studies. With a commanding lead in market share, Nellcor was in a predictable position of not investing enough in research and development over the years to improve its technology. In fact, Nellcor even turned down a license from Masimo, which we offered from 1992 to 1999. We believe that they turned this offer down due to their belief that their GPO contracts would guarantee their market position.

Masimo began its attempt to get into Premier hospitals by first meeting with the Premier technology assessment group in December 1998. This group later issued a position paper dated May 6,1999, which concluded that improved pulse oximetry was needed for critical patients, that Masimo's technology was superior to Nellcor's, and that an exception contract should be issued to Masimo. They also acknowledged that Masimo's technology was widely available in both a standalone unit from Allegiance and in many more configurations through other monitoring companies, including three of the four patient monitoring providers on the Premier contract.

The contracting group within Premier chose to ignore this report and instead offered Masimo to again apply, but this time under the "breakthrough technology" program. We agreed, but were told that we would need to wait until Nellcor had its "competitive" product, the N-395, ready. Nellcor was reportedly notified by Premier of the clinical demand for Masimo and the need for FDA clearance for accuracy during motion similar to Masimo's. Nellcor launched this monitor in late 1999 and in early 2000, we were then told to submit our breakthrough application.

In March 2001, more than two years after we began this process, we were told that we would not be granted breakthrough status since Nellcor's unit was not substantially inferior to ours. Premier cited a survey that they had conducted with their members to rationalize their decision. Through the investigative work of The New York Times, in March 2002 we learned that actually 15 of the 20 Premier hospitals that were familiar with Masimo's technology said it was more accurate than other pulse oximetry devices or eliminated false alarms. It should be interesting for the reader to know that Premier renewed its five-year agreement with Nellcor for another five years without even asking us for a price. In fact, the Nellcor sensor prices have remained unchanged for the entire 10-year contract period.

Our experience with Novation serves as another example of competition and hospital choice being eliminated. Our efforts with Novation began about three years ago when we heard that Novation was going to conduct open bidding for pulse oximetry. Even more appealing was Novation's stated intent to award a dual or multi-source contract to satisfy its members' wishes for more choice. To increase our chances of being put on the Novation contract, we even entered into an agreement with a much larger vendor, Datex-Ohmeda, for our products to be offered through them. During the process, we had every indication that we would be offered a spot on the contract. We had insiders, including a member of the selection committee from a member hospital, who assured us that there was strong clinical support for Masimo. Despite all attempts by concerned clinicians, Novation chose to award a 95 percent commitment sole-source contract to Nellcor. Novation justified its decision on a member survey where Novation ended up ignoring th eir own members' indication of the three most important criteria (accuracy, motion performance, and price, respectively). What made this even more odd was the fact that we later found out that our prices, without any volume commitment, were at least 30 percent lower than Nellcor's best pricing per their final contract. Since then, we have discovered what we believe was the reason for this decision. In addition to the normal administrative fee and customary marketing fee, Nellcor reportedly offered to pay an extra $1 per sensor fee on Novation's privately labeled (Novaplus) line of Nellcor sensors to Novation. This amounts to an extra 11 percent fee on a $9 adult sensor. So in the end, we believe that Nellcor bought this exclusive contract with above market pricing.

As mentioned earlier, the negative impacts on innovation should not be ignored. I am primarily talking about revolutionary improvements to an existing product or technology or new technologies that replace old ones. These types of innovations upset incumbent vendors because they threaten their positions. As with the Nellcor example, companies with dominant market share and no competitors will not spend much money on improving their products if the GPOs are keeping the gates closed on new competitors. And if new competitors/innovators are not given a fair opportunity at the market, entrepreneurs and investors will not be willing to invest the time and money to even make an effort.

GPOs will point to examples of new and innovative products that they have accepted and put on their contracts. In the Senate hearing, Premier's CEO Rick Norling told the committee of a new device that is essentially a camera in the shape of a pill that can take pictures inside the colon and how Premier immediately put it on contract. The problem with this example is that this is an entirely new device, which does not compete with any others on contract. Premier had nothing to lose, but potential administration fees to gain, by putting it on contract. Except for safety products, which were mandated by local government officials, we have not yet heard of the award of a contract for a new product that competes with a high market share vendor, no matter how revolutionary the product may be.

GPOs have painted a very attractive picture of significant savings gained from contract compliance. But, behind the sales pitch, they have struck deals with vendors that seem to revolve around more GPO fees in exchange for exclusive dealing, all or nothing exclusionary pricing schedules and bundling plans, which tie benefits for multiple products together and which include severe penalties on hospitals for the slightest shortfall in compliance. Are these types of terms necessary to deliver the greatest value to the members? Remember that value is based on a combination of cost and quality. If product and vendor choices are limited, to only one in many cases, the quest for maximizing value becomes almost impossible.

Product standardization can be beneficial from a cost and quality standpoint. But these benefits are most applicable on a hospital-by-hospital basis where clinical practices can be decided by the resident clinicians, and the product standardization choices are much more appropriate and better adhered to when made by each hospital rather than by a GPO on behalf of 1,000 to 2,000 hospitals. In fact, most clinicians and researchers would argue that standardization across all U.S. hospitals on one product or process would impede improvement and innovation in healthcare.

A few questions hospital administrators should ask are: Why does a GPO need to commit to a level of exclusivity up front? Why are incentives offered based on a 90-plus percent percentage purchased from the vendor rather than on volume? Why are these restrictive bundling programs necessary? Why couldn't contracts be structured with tiered pricing schedules based on actual volume achieved by all member hospitals instead of hospital by hospital? Hospitals could simply be offered a price schedule and would be paid additional rebates based on combined GPO volume achieved and each hospital's portion. If multiple vendors' products were offered, the hospitals would be able to purchase the products that best fit their value equation and get the competitors to compete for the business.

Group purchasing claims that it is necessary to make compliance commitments to vendors to get the best pricing from them. As a vendor selling to hospitals, I can tell you that this is not the case. We will give our most competitive pricing to hospitals, if, either alone or with others, they represent more than 500 beds. So for a GPO the size of Premier and Novation, who each control close to one-third of all U.S. hospitals, access to their member hospitals alone can get these GPOs the best level of pricing from any vendor. And if hospitals had choice between two or more competitive products, that could be the beginning of further negotiations and competition.

The current system backs hospitals and clinicians into a corner. The system inherently promotes more market share for the market share leader. Eventually, every product category will be dominated by one or a few vendors ending up in monopolies or oligopolies. At that point, if not already, the power will have been shifted from the GPOs to the vendors, where the hospitals, and even their GPOs, will have very little power in negotiations over pricing and terms. And as discussed previously, there will be little or no innovation as a result of this.

We do not believe that GPOs were initially conceived with bad intentions. But today, with massive consolidation of GPOs, two GPOs control over 70 percent of sales to hospitals. These GPOs are primarily funded by vendors through fees based not on savings to hospitals, but on volume of sales through their member hospitals, and it is only natural for any business to work with its largest customers (payers) to make them happy and maximize revenues with them. Even though most of the hospitals that belong to GPOs are not-for-profit, most GPOs, including Premier and Novation, as well as their "Corporate Partners," the vendors, are for-profit. The problem is that in the GPO/vendor negotiations, the member hospitals' purchasing volume has become the product being sold and the interest of the members comes in a distant third behind the vendors and the GPOs.

In trying to do what's best for their institutions, and assuming belonging to a large GPO means lowered cost of products, hospital executives have signed up their hospitals to these GPOs. In fact as Mr. Lombardi told us, it took him two years to convince hospital administration that Mr. Lombardi and his small purchasing department could get better prices on its own. Based on the GAO information that has recently become available, we hope that other hospitals will save their money and support reforms to ensure that the hospitals are the benefactors of the GPO system and not the victims.

Joe Kiani is the founder of Masimo Corporation and has served as its chief executive officer and chairman of the board since Masimo's inception in 1989. Kiani was also product engineer at Unisys. Kiani, an inventor on more than 30 patents related to signal processing, sensors and patient monitoring, serves on the board of SABA, a publicly traded company, Concentric Medical, The Orange County March of Dimes and Medical Device Manufacturing Association.

COPYRIGHT 2002 Nelson Publishing
COPYRIGHT 2002 Gale Group