Procurement experts from outside the healthcare industry make it quite clear that the creation of a cost savings requires that the net price paid for a product in the current contract period must be less than the net price paid in the previous contract period. This logical and time-tested approach focuses only on actual invoice cost and does not factor in changes in list price. In fact, for most manufacturing organizations, the raw materials they purchase do not have list prices. Clearly, paying a lower price for a product this year than last year is an essential component of cost savings.

A small but significant percentage of hospital directors of materials management expressed their belief that a cost savings and cost avoidance were of equal value, according to the results of a recent survey. Their viewpoint, however, was wrapped very tightly in their simultaneous belief that without the assistance of group purchasing organizations their (smaller-sized) hospitals would be forced to pay list price for the products they purchase. They clearly believed that they had no market leverage whatsoever and that any discount from a list price, no matter how arbitrary, was a real benefit to them.

However, the only way for their belief to be true would be in a market environment in which there was no competition, and suppliers had monopoly power to use at their discretion. But such a market would seem to strongly contradict the GPO assertion that their existence actually increases market competition. Such a belief also fails to take into consideration the fact that the vast majority of products where GPOs exert their influence are commodities. Yet the very definition of a commodity is grossly at odds with the notion that there can be commodity monopolies and the only way in which such monopolies could exist would be through collusive behavior on the part of GPOs and manufacturers or manufacturers with one another.

As part of the cost analysis complexity confounding many healthcare facilities, too much attention paid to an arbitrary and frequently rising list price can blind buyers to what specific price is desirable or achievable. The notion of the list price increase presents with it an air of inevitability that can effectively disarm the buyer and move him to a defensive position, in which he takes what he can get, versus an offensive position, in which he has identified a fair price for the product in question, and marshals his leverage points to achieve that price.

The relevance of a list price is a critical issue in this discussion. While a list price can serve as a cost marker it generally seems to be more reflective of a supplier’s profit motive rather than providing insight into a particular product market. In healthcare, list prices bear little relevance to the market, and the current contract discounts offered on surgical sutures would seem to bear this out. Discounts approaching the 50 percent mark suggest that list prices are used to create value for a product while significantly discounted contract pricing would seem to detract from that value. There are no controlling factors that would prevent a manufacturer from raising its list price to a point that even a substantial discount would still result in monopolist-like profits. For that reason a list price is a poor point of comparison when attempting to understand the impact of GPOs on product pricing.

The tracking of the spread between list pricing and contract pricing would seem to show a widening spread that some might be tempted to label as cost savings. However, such thinking would suggest that any manufacturer’s list price increase should produce an automatic increase in cost savings produced by the GPO. The problem is that manufacturers can raise their list prices any time they want and as much as they want. There is simply nothing stopping them from doing so. In that scenario, achieving a larger discount than before can still result in a higher net price paid. For that reason any relationship between a list price and a contract price is not a reliable means of measuring the contracting effectiveness of a GPO or a hospital.

According to procurement experts Joseph L. Cavinato and Ralph Kauffman in their 1999 book, The Purchasing Handbook: A Guide for the Purchasing and Supply Professional, in order to claim a cost avoidance there are a number of factors that must be true. First, rules for quantifying cost avoidance must be established in advance. In the case of hospitals and GPOs this would mean that all involved would know and agree on how cost avoidance would be quantified and reported. Second, there must be an actual cost increase. In other words, the buyer must be notified in writing that the price he pays is going up. A change in a list price has no relevance unless the buyer already pays the list price. Third, the buyer (or his representative, i.e., his GPO) must take specific action to reverse the price increase. This action must be active, not passive. It would likely require a serious negotiation or application of leverage on the part of the buyer. Fourth, strict documentation must be kept through the entire process. Fifth, credibility for the cost avoidance must be clearly established between the buyer’s organization (including senior management acceptance) and the seller’s organization.