NVCA: GPOs Threaten VC-backed Medical Device Companies –

High profile antitrust lawsuits in the technology sector have heightened public awareness of anti-competitive practices in the marketplace. Airlines, oil companies and prescription drug manufacturers all have come under fire in recent months. Now in the crosshairs: Hospital buying groups, or so-called group purchasing organizations (GPOs), and the business practices under which they award contracts to medical product and supply manufacturers.

In April, a U.S. Senate judiciary subcommittee investigated complaints that small companies have been hurt by practices including contract exclusivity, substantial fee structures and product bundling. Lawmakers from both parties took aim at “sole-source” contracts awarded by GPOs, particularly those buying groups that previously had received fees from large medical device manufacturers. Said Sen. Herb Kohl (D-Wis.): “We have heard startling allegations of scandal and conflicts of interest.” While GPOs assert these buying groups are designed to reduce hospital costs, what they have done, in fact, is exclude small company products from the hospital marketplace while keeping prices high.

What’s the harm? Ultimately, patient care is at stake.

Currently, venture capitalists invest more than $40 billion per year in companies driving innovation in biotechnology, drug development, medical devices and therapeutics. Many of the standard medical treatments we take for granted today, which allow patients to lead longer and healthier lives, have been brought to market following venture capital investment.

Small medical technology companies already face a major gauntlet before they can bring a product to market, including proving product safety and efficacy, securing patent protection, securing a good distribution channel, facing entrenched competition, and avoiding running out of money before the product can reach a significant portion of the market. Potential obstacles from GPOs will severely impede these companies’ progress. This, in turn, makes them less viable candidates for venture funding. Many of these companies and their innovations will die as a result, even if they offer a dramatic breakthrough or diagnostic improvement over an existing solution.

GPO roadblocks have greatly diminished the attractiveness of medical device and biotechnology investments, because they reduce venture investor confidence that these companies will have fair access to medical markets and, thereby, achieve a meaningful return on very risky investments. To put this in perspective, between 1990 and 1994 at least 22% of all companies financed by venture capitalists were medical device or biotechnology companies. By comparison, during the period from 1999 to 2001 these companies made up only 8.9% of all companies receiving venture capital financing.

The assertions made by GPOs that the “administrative” savings they provide to members could be applied to every single sector of the economy are virtually identical to the arguments made by the anti-competitive “trusts” a century ago. The idea that the GPOs “save” money for hospitals by extracting larger price discounts from producers than they could achieve by themselves is not provable and most likely wrong. In fact, a recent study by the General Accounting Office found that GPO-negotiated contracts did not always save money for hospitals. In product areas where GPOs collude with producers who already have virtual monopolies, the “discounted” price that the GPOs claim to achieve is almost certainly well above what the market price would be in an open and competitive marketplace.

In medicine, reduced innovation affects patients’ lives. In light of this, the special antitrust exemptions granted to GPOs should be viewed with greater skepticism, and legislation to correct these abuses should be considered immediately.

One outcome of the April subcommittee hearing was a request from Sens. Kohl and Mike DeWine (R-Ohio) that the Federal Trade Commission and Department of Justice investigate whether GPO practices are violating federal antitrust laws.

At the recent senate hearing, lawmakers heard from two hospital GPOs that purchase medical supplies for many of the nation’s not-for-profit hospitals. Senior executives from Novation LLC and Premier Inc. agreed to develop the industry code of conduct by the end of July.

Unfortunately, the GPO code of conduct is not expected to address the administrative fee concerns raised at the hearing and being examined by the FTC and the Justice Department as the most egregious GPO practice. Instead, the GPO working group will attempt to determine whether current GPO practices unfairly exclude small device manufacturers, limit overall hospital cost savings and permit financial conflicts of interest. Given the disconnect between the GPO working group objectives and the committee expectations for a code of conduct, it is clear this issue will again be at the forefront in July.

If you invest in medical devices and life science, it is in your interest to see GPO reform. If you’re not an investor in either of these industry sectors, your interest is personal because continued support of medical innovation and access to breakthrough technologies will enable you and your loved ones to lead healthier and happier lives.

Elizabeth H. Weatherman is a managing director of Warburg Pincus LLC. She also serves as the vice chair of the National Venture Capital Association Medical Group.