The Impact of Group Purchasing Organizations on 1 Healthcare-Product Supply Chains 2 Qiaohai (Joice) Hu 1 , Leroy B. Schwarz 1 , and Nelson A. Uhan 2 3 1 Krannert School of Management, Purdue University, West Lafayette, IN, USA. 4 {hu23, lschwarz}@purdue.edu 5 2 School of Industrial Engineering, Purdue University, West Lafayette, IN, USA. nuhan@purdue.edu 6 May 2011 7 Abstract. This paper examines the impact of group purchasing organizations (GPOs) on healthcare- 8 product supply chains. The supply chain we examine consists of a profit-maximizing manufacturer with a 9 quantity-discount schedule that is nonincreasing in quantity and ensures nondecreasing revenue, a profit- 10 maximizing GPO, a competitive source selling at a fixed unit price, and n providers (e.g., hospitals) with 11 fixed demands for a single product. Each provider seeks to minimize its total purchasing cost (i.e., the cost of 12 the goods plus the provider’s own fixed transaction cost). Buying through the GPO offers providers possible 13 cost reductions, but may involve a membership fee. Selling through the GPO offers the manufacturer possibly 14 higher volumes, but requires that the manufacturer pay the GPO a contract administration fee (CAF); i.e., a 15 percentage of all revenue contracted through it. Using a game-theoretic model, we examine questions about 16 this supply chain, including how the presence of a GPO affects the providers’ total purchasing costs. We also 17 address the controversy about whether Congress should amend the Social Security Act, which, under current 18 law, permits CAFs. Among other things, we conclude that although CAFs affect the distribution of profits 19 between manufacturers and GPOs, they do not affect the providers’ total purchasing costs. 20 1 Introduction 21 Group purchasing organizations (GPOs) play a very important role in the supply chains for healthcare 22 products. A survey by Burns and Lee (2008) reports that nearly 85% of U.S. hospitals route 50% 23 or more of their commodity-item spending, and 80% route 50% or more of their pharmaceutical 24 spending through GPOs. According to the Health Industry Group Purchasing Association (HIGPA), 25 Copyright 2011 by the authors. All rights reserved. This work may not be reproduced or distributed in any form or by any means—graphic, electronic, or mechanical, including photocopying, recording, or information storage—without the express written consent of the authors. The research upon which this manuscript is based was funded entirely by Purdue University. 1