Medtronic Dumps Novation: Why GPOs Should Worry

In case you missed the big news, medical device manufacturer Medtronic (NYSE:MDT) canceled five contracts for cardiovascular and orthopedic products with Novation, the largest healthcare Group Purchasing Organization (GPO). The total annual value of the canceled contracts is reportedly $2 billion. Here’s the official announcement from Novation: Medtronic Inc. Cancels Cardiovascular and Orthopedic Contracts with Novation.

As I see it, Medtronic is questioning the core of a GPO’s business model—pooling member purchase volumes in exchange for lower prices from manufacturers and wholesalers. Medtronic is the first company to make such a bold public move against GPOs, but other manufacturers are already rethinking their channel and contracting strategies.

So, you can add "direct contracting" to the list of existential mega-threats facing the GPO industry. My list of the top four challenges appears below. Email me if you want to chat about the strategy implications.

And if you’re curious about second derivatives, a weaker GPO industry would likely be a net positive for wholesalers, particularly Cardinal Health (NYSE:CAH).

GPO 101

For a brief overview of GPOs and their role in the hospital system, check out this September 2010 General Accounting Office (GAO) report: GROUP PURCHASING ORGANIZATIONS: Services Provided to Customers and Initiatives Regarding Their Business Practices. The report is generally favorable toward GPOs, but does highlight some of the controversies.

Here are the current top 5 GPOs and estimated annual purchasing volume according to Healthcare Purchasing News:

1. Novation ($37.8B)
2. Premier ($36.0B)
3. MedAssets/Broadlane ($35.0B)
4. HealthTrust Purchasing Group ($17.0B)
5. Amerinet ($7.2B)

Given these figures, Medtronic represents about 5% of Novation's total volume.

WHAT ME, WORRY?

Medtronic’s direct contracting strategy would only work for certain manufacturers. The company's specialized implantable devices clearly fall into the “physician preference” category, for which the group purchasing benefit is arguably the weakest. Medtronic also has the #1 market share in many product categories, so it can credibly bypass the GPOs with less fear of retribution.

Here’s my short-list of four trends that are (or should be) keeping GPO executives up at night.

• Hospital systems are consolidating and getting larger, giving them the scale and ability to bypass GPOs and negotiate directly with manufacturers. Medtronic is counting on this trend.

• The big wholesalers can best be described as "frenemies" with the big GPOs. On one hand, wholesalers play a critical role in administering contracts between manufacturers and GPOs. At the same time, wholesalers have their own source programs that compete with GPOs in categories such as generic drugs and commodity med-surg supplies. See my wholesaler economic report for more details.
  

• GPOs are being asked to play in unfamiliar areas. For example, more than half of physician practices are now hospital-owned, creating a need for new services and contracting approaches. The major acute-care-focused GPOs listed above must also contend with the oncology-focused, physician-practice GPOs owned by McKesson (NYSE:MCK) and AmerisourceBergen (NYSE:ABC).

• Pharmacy benefit managers (PBMs) are going after “buy-and-bill” medical benefit drug spending with services that move spending to the pharmacy benefit and eliminate provider spreads on specialty drugs. Just ask a hospital pharmacy director about “white bagging” and you’ll get an earful on this topic.
  

A PEEK BEHIND THE SCENES

Here is Drug Channels exclusive footage showing the final negotiation between Medtronic and Novation. Click here if you can’t see the video.