Everyone is familiar with Costco. It is a staple of North American life. It is a club. Individuals or families pay a fee to become members. The purpose of the club is, “To continually provide members with quality goods and services at the lowest possible prices.” It is a buying club focused on bulk purchasing of a limited number of items. Purchasing on a massive scale enables them to negotiate significant volume discounts. In turn, they pass on most of these discounts to the members. For the purposes of this discussion, we will focus on the group purchasing..
A group purchasing organization (GPO) is a similar type of club. It is focused on business-to-business buyers, not individual consumers. For each category it covers, the GPO will have a limited number of suppliers. As in the case of Costco, this enables the GPO to concentrate the force of its group purchasing. It still needs to offer some choice, but it restricts the number of options.
All GPOs charge the supplier a fee; most of them charge buyers a fee. The GPO negotiates a volume-discounted contract with each supplier that contains terms and pricing for the supplier’s product that are preferable to what an individual buyer could obtain.
A general rule of thumb is that businesses can save 20 to 25% by using the same contract the GPO negotiated. The suppliers pay the GPO a fee, typically between 1% and 5% of the value of each sale.
Some GPOs focus on a particular sector such as healthcare; others consist of members from a variety of industries. In this latter case, the buyers purchase certain goods and services in common. This may be more applicable to indirect expenditure, e.g., for office furniture or stationery.
In a sense, buyers outsource their procurement function for the categories they purchase via the GPO. The GPO learns the requirements of its members, researches the supplier base, conducts some sort of selection process, and negotiates the final contract. When the buyer is ready to execute, she can complete the transaction in a matter of days. All that remains to be done is to choose a supplier from the GPO’s short list for a given item. Ideally, the GPO is fully informed of developments in the category and, depending on the needs of their members, can incorporate other dimensions of spending such as diversity.
The GPO’s extension of the buyer’s procurement function is especially attractive for smaller firms that lack a sophisticated procurement department or for ones that prefer to use their internal resources on more strategic projects. GPOs specialize in purchasing, so we may infer that they employ best practices and they have access to better data with which to make decisions.
Earlier, we referred to a selection process that the GPO uses to choose suppliers for its short list in a particular category. The most logical one to employ would be a competition in the form of a Request for Proposals (RFP). In fact, members may assume that the GPO has used an RFP to vet suppliers with which to negotiate a contract subsequently. This is often not the case.
“GPO/Supplier direct contractual negotiations often eliminate the Request for Proposal (RFP) process, saving additional costs for both suppliers and members. Additionally, this provides overall speed-to-savings for members and speed-to-revenue for suppliers. For private equity companies, these cost savings are efficient, sustainable improvements that require minimal effort.”
Buyers, in effect, use the GPO to short-circuit sourcing best practices. The GPO may just pick a supplier based on the GPO’s own interests and enter into negotiations directly. It is process arbitrage.
“In summary, the core value proposition of GPOs is providing pre-negotiated contracts that eliminate the need for their members to conduct lengthy RFP processes with suppliers. Instead, GPOs follow their own methodologies to vet, select and directly negotiate contract terms with suppliers from across their portfolios, replacing RFPs with their purchasing expertise and scale. RFPs may be used by organizations when initially choosing a GPO partner, but not in the GPOs’ regular supplier contracting processes.”
GPOs develop a list of buyer requirements and search for a short list of relevant supplier solutions. It is a one-size-fits-all approach.
However, the bulk of the revenue GPOs collect comes from suppliers. Member fees are incidental. They may exist to convince the buyer that they are obtaining something of value, masking the possibility that the buyer is the product being delivered to the supplier, in fact. Buyers may be unaware of the fees the GPO earns from suppliers.
The GPO’s incentive is to pick contracts that will be used most frequently and in the greatest volume. After all, there is a fixed cost to selecting, vetting, onboarding, and contracting with a supplier. The kinds of contracts that are most likely to fit this description are consumable inputs. The best members are the largest buyers. When supplies get tight, the big get allocations, the small get waitlisted.
What does the supplier receive from these arrangements? The supplier gets a sales channel (without having to go through an RFP) in which the sales cycle is accelerated. This is certainly worth paying a 1-5% commission to the GPO and discounting already grossed-up list prices.
GPOs get paid by vendors to deliver customers by arbitraging sourcing best practices.
The GPO business model exists because of the historical difficulty in coordinating purchases across different buyer organizations. If running a single-buyer RFP process is difficult, the complexity of a multi-buyer RFP compounds exponentially. Buyers want simplicity and speed. Implicit is the assumption that price is the one dimension around which they should optimize. GPO members sacrifice flexibility because they have limited supplier choice. They give up problem-solution fit because the GPO’s assessment of requirements in a category (which may be dictated by their supplier customers) may not align with those of the individual buyer. One size does not fit all.
A better alternative to the GPO would digitize the hard part: coordinating buyers in a procurement context. It would enable smaller groups of buyers to execute joint purchases.
There’s nothing wrong with the common contracting model, as long as it’s understood to be a common contracting model and the contract is the fruit of an RFP process. NASPO ValuePoint executes this wonderfully in the public sector space.
EdgeworthBox simplifies procurement. Organizations can coordinate their own joint purchases in a contained space.
Give us a shout. We love talking about this stuff.
