Academic journal article The McKinsey Quarterly

Group Purchasing Is Not a Panacea for US Hospitals

Academic journal article The McKinsey Quarterly

Group Purchasing Is Not a Panacea for US Hospitals

Article excerpt

Improved purchasing has played an important role in US hospitals' efforts to cut costs and raise profit margins in the competitive market of the past decade. Given that a multihospital system with a $1 billion operating budget spends $300 to $350 million a year on medical supplies and purchased services, it is easy to see why. Improving purchasing can, moreover, reap significant savings without the need for job losses.

To date, many of these savings have been made by channeling purchases through group purchasing organizations (GPOs). The buying power of large GPOs is impressive: the three biggest (Premier, VHA/UHC, and AmeriNet) each bought goods worth more than $4 billion in 1997, giving them the clout to exert price pressure on suppliers, particularly for products in lower demand. And as GPOs have consolidated, manufacturers have offered bigger discounts to hang on to their contracts. None the less, hospitals have so far only scratched the surface of a much larger supply management opportunity.

Compared with the sophistication of supply management in some other industries, supply management in US hospitals is undeveloped. The automotive, electronics, and aerospace industries, for example, have earned billions of dollars in pre-tax profits during the 1990s by moving beyond price discounts to the full range of levers that affect spending productivity. Original equipment manufacturers in the automotive business have standardized chassis and platforms across product lines; electronics manufacturers have accelerated product life cycles by involving suppliers in product development; and aerospace companies have outsourced non-core operations. US hospitals, on the other hand, continue to grapple with fundamental supply management issues.

The first is that despite their scale advantages, GPOs have had relatively little impact on vendor rationalization and product standardization - both powerful methods of cutting vendor prices. Second, GPOs have had limited success in improving the way products are used, leaving hospitals struggling to curb excessive consumption. Third, purchased services, the fastest-growing item on many hospital budgets, now represent a greater expense than medical supplies, yet they rarely get the attention they deserve from the supply management organization and are not usually included in GPO contracts. Finally, purchasing departments continue to be a low-profile, disintegrated function in many hospitals, lacking the skills or support systems to capture the next wave of purchasing management opportunities.

All this suggests that GPOs are only one of many levers by which to improve hospital supply management, and not necessarily the most powerful. Hospital executives must move to a more sophisticated level of supply management, particularly as reductions in patient-care labor and administrative overheads have largely been exhausted as a means of cutting costs. Our experience suggests that hospital systems can reduce supply costs by up to 16 percent, making for a source of real competitive advantage.

To harness this opportunity, hospital executives will need to adopt a number of new principles:

Vendor rationalization and product standardization can be more powerful than scale when dealing with suppliers. The typical GPO offers discounts to hospital purchasers because of the scale of its combined purchases. Even the largest commercial hospital chains do not come close to the purchasing scale of GPOs.

Yet a GPO's size can also hinder it in driving down vendors' prices. Because membership is so diverse, with different hospitals in different parts of the country stipulating different supply needs, GPOs often find it hard to consolidate purchases with fewer suppliers in return for large discounts. Neither is it easy for a GPO to force all of its customers to use similar supplies. As a result, hospital systems that can drive product standardization and, therefore, vendor rationalization, can often negotiate better pricing directly from the manufacturer than a GPO can. …

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