[Senate Hearing 107-899]
[From the U.S. Government Printing Office]



                                                        S. Hrg. 107-899
 
  HOSPITAL GROUP PURCHASING: LOWERING COSTS AT THE EXPENSE OF PATIENT 
                    HEALTH AND MEDICAL INNOVATIONS?
=======================================================================




                                HEARING

                               before the

                       SUBCOMMITTEE ON ANTITRUST,
                    BUSINESS RIGHTS, AND COMPETITION

                                 of the

                       COMMITTEE ON THE JUDICIARY
                          UNITED STATES SENATE

                      ONE HUNDRED SEVENTH CONGRESS

                             SECOND SESSION

                               __________

                             APRIL 30, 2002

                               __________

                          Serial No. J-107-76

                               __________

         Printed for the use of the Committee on the Judiciary









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85-986                         WASHINGTON : 2003
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                       COMMITTEE ON THE JUDICIARY

                  PATRICK J. LEAHY, Vermont, Chairman
EDWARD M. KENNEDY, Massachusetts     ORRIN G. HATCH, Utah
JOSEPH R. BIDEN, Jr., Delaware       STROM THURMOND, South Carolina
HERBERT KOHL, Wisconsin              CHARLES E. GRASSLEY, Iowa
DIANNE FEINSTEIN, California         ARLEN SPECTER, Pennsylvania
RUSSELL D. FEINGOLD, Wisconsin       JON KYL, Arizona
CHARLES E. SCHUMER, New York         MIKE DeWINE, Ohio
RICHARD J. DURBIN, Illinois          JEFF SESSIONS, Alabama
MARIA CANTWELL, Washington           SAM BROWNBACK, Kansas
JOHN EDWARDS, North Carolina         MITCH McCONNELL, Kentucky
       Bruce A. Cohen, Majority Chief Counsel and Staff Director
                  Sharon Prost, Minority Chief Counsel
                Makan Delrahim, Minority Staff Director
                                 ------                                

      Subcommittee on Antitrust, Business Rights, and Competition

                   HERBERT KOHL, Wisconsin, Chairman
PATRICK J. LEAHY, Vermont            MIKE DeWINE, Ohio
RUSSELL D. FEINGOLD, Wisconsin       ORRIN G. HATCH, Utah
CHARLES E. SCHUMER, New York         ARLEN SPECTER, Pennsylvania
MARIA CANTWELL, Washington           STROM THURMOND, South Carolina
JOHN EDWARDS, North Carolina         SAM BROWNBACK, Kansas
               Victoria Bassetti, Majority Chief Counsel
                 Peter Levitas, Minority Chief Counsel












                            C O N T E N T S

                              ----------                              

                    STATEMENTS OF COMMITTEE MEMBERS

                                                                   Page
DeWine, Hon. Mike, a U.S. Senator from the State of Ohio.........     4
Hatch, Hon. Orrin G., a U.S. Senator from the State of Utah......    68
Kohl, Hon. Herb, a U.S. Senator from the State of Wisconsin......     1
Leahy, Hon. Patrick J., a U.S. Senator from the State of Vermont.     8
Schumer, Hon. Charles E., a U.S. Senator from the State of New 
  York...........................................................    20
Thurmond, Hon. Strom, a U.S. Senator from the State of South 
  Carolina.......................................................    69

                               WITNESSES

Barrett, Trisha, BSN, Assistant Director, Materiel Services, 
  Value Analysis Facilitator, University of California, San 
  Francisco Medical Center, San Francisco, California............    21
Detlor, Lynn R., Principal, GPO Concepts, Inc., San Diego, 
  California.....................................................    40
Goldstein, Mitchell, M.D., Neonatologist, Citrus Valley Medical 
  Center, West Covina, California................................    27
Kiana, Joe E., President and Chief Executive Officer, Masimo 
  Corporation, Irvine, California................................    24
McKenna, Mark, President, Novation, LLC, Irving, Texas...........    11
Norling, Richard A., Chief Executive Officer, Premier, Inc., San 
  Diego, California..............................................     9
Weatherman, Elizabeth A., Vice Chair, Medical Group, National 
  Venture Capital Association and Managing Director, Warburg 
  Pincus, LLC, New York, New York................................    42

                         QUESTIONS AND ANSWERS

Responses of Mark McKenna to questions submitted by:
    Senator DeWine...............................................    76
    Senator Hatch................................................    87
    Senator Leahy................................................    71
Responses of Richard A. Norling to questions submitted by:
    Senator Hatch................................................    87
    Senator Leahy................................................    71
Responses of Joe E. Kiana to questions submitted by Senator Leahy    75

                       SUBMISSIONS FOR THE RECORD

Brown, Thomas V., Executive Vice President, Biotronik, Inc.......    95
Cohen, Gary, President, BD Medical Systems, Becton Dickinson and 
  Company........................................................    90
ECRI, Jeffrey C. Lerner, President and Chief Executive Office, 
  Plymouth, PA...................................................   110
Emory University School of Medicine, Augusto Sola, MD, Professor 
  of Pediatrics and Obstetrics and Gynecology, Director, Division 
  of Neonatal-Perinatal Medicine, Atlanta, Georgia, letter.......   184
Engibous, Doris, President, Nellco Tyco Healthcare, Pleasenton, 
  CA, letter.....................................................   163
Hazen, Paul, President and CEO, National Cooperative Business 
  Association....................................................   157
Hipps, Julia Naumhein, RN BS.....................................   135
Holden, Larry, President, Medical Device Manufacturers 
  Association....................................................   144
Muris, Hon. Timothy, Chairman, Federal Trade Commission and Hon. 
  Charles James, Assistant Attorney General, Letter..............   142
Pevco Systems International, Inc., Frederick M. Valerino, Jr., 
  President......................................................   169
Saint Vincent, Catholic Medical Centers, Daved J. Campbell, 
  President, Chief Executive Officer.............................   183
Scanlon, William J., GAO, Director, Health Care Issues...........   112
Shaw, Thomas J., President & CEO, National Cooperative Business 
  Association....................................................   172
















  HOSPITAL GROUP PURCHASING: LOWERING COSTS AT THE EXPENSE OF PATIENT 
                    HEALTH AND MEDICAL INNOVATIONS?

                              ----------                              


                        TUESDAY, APRIL 30, 2002

                              United States Senate,
                Subcommittee on Antitrust, Business Rights,
                                           and Competition,
                                Committee on the Judiciary,
                                                   Washington, D.C.
    The committee met, pursuant to notice, at 2:54 p.m., in 
room SD-226, Dirksen Senate Office Building, Hon. Herb Kohl, 
chairman of the subcommittee, presiding.
    Present: Senators Kohl, Leahy, Schumer, and DeWine.

 OPENING STATEMENT OF HON. HERB KOHL, A U.S. SENATOR FROM THE 
                       STATE OF WISCONSIN

    Chairman Kohl. This hearing will come to order. I held it 
for Senator DeWine, who is unavoidably detained for just a few 
minutes and he requested that we proceed.
    Today, this subcommittee turns its attention to an issue 
affecting the health and safety of every American who has ever 
or will ever need treatment at a hospital, in other words, 
every one of us. This issue is how hospitals form buying groups 
to purchase nearly everything used by hospitals, everything 
from pacemakers to thermometers, from surgical devices and CAT 
scanners to needles and band-aids, and how these groups affect 
the cost and quality of patient health and medical innovation 
throughout our country.
    These guying groups, known as group purchasing 
organizations, or GPOs, are at the nerve center of our health 
care system. Because they determine what products are in our 
hospitals, they directly affect patient health and safety. 
Because they control more than $34 billion in health care 
purchases, they impact the cost we all pay for our health 
system. Because they represent more than 75 percent of the 
nation's hospital beds, they are a powerful gatekeeper who can 
cut off competition and squeeze out innovation.
    Gaining a GPO contract is essential for any medical 
equipment supplier. GPOs determine which medical devices will 
be used to treat us when we are sick or injured, which 
manufacturers will survive and prosper, and, in fact, which 
ones will fail. It does not do any good to invent the next 
great pacemaker or safety needle if you cannot get it to 
patients because a GPO stands in your way.
    With that kind of power comes responsibility. But too 
often, it seems that GPOs have failed to serve as honest 
brokers seeking to serve the best interests of hospitals and 
patients. We are going to detail three major concerns.
    First, conflicts of interest raise the specter of critical 
health care decisions being influenced by financial ties to 
suppliers. We have heard startling allegations of scandal and 
conflicts of interest that have infected the GPOs. Premier's 
chief executive received millions of dollars worth of stock 
options from a company with a contract supplying pharmaceutical 
services to Premier hospitals. His response, that he recused 
himself from contracting decisions with respect to the company 
at issue and that his financial interests were disclosed and 
approved by Premier's board, is good, but not good enough. He 
should have severed all ties to the company when he joined 
Premier.
    On another occasion, Premier steered business to a 
pharmaceutical supply company and thereby helped turn its $100 
investment into a stake worth $46 million last year. Novation 
today demands that medical suppliers it contracts with sell 
their products on a for-profit e-commerce site in which 
Novation has a substantial interest and in which many of 
Novation's senior executives hold personal stakes.
    These practices, in our judgment, are appalling and should 
not be tolerated. We cannot accept a situation where a decision 
on which medical device will be used to treat a critically ill 
patient could conceivably or even theoretically turn on the 
stock holdings of a GPO executive.
    Second, contracting practices may reduce competition and 
innovation in health care and narrow the ability of physicians 
to choose the best treatment for their patients. In one case we 
know of, a hospital denied a physician permission to use a 
vital pacemaker for a patient on the operating table, but not 
yet anesthetized, and all because there was no GPO contract for 
that particular pacemaker. The pacemaker that was on contract 
that the hospital required him to use was in the midst of an 
FDA investigation into its effectiveness and safety. Hospitals 
have failed to buy safety syringes which prevent accidental 
needle sticks because doing so would mean buying off the GPO 
contract. As a result, nurses have suffered easily preventable 
injuries and have developed HIV and hepatitis.
    GPO contracting policies have created a system that keeps 
many good products out of circulation while enabling large 
manufacturers to entrench their market position. Practices such 
as sole sourcing, high commitment levels, which require a 
hospital to purchase as much as 90 percent of a product from 
one company in order to get the maximum discount, and bundling, 
which gives hospitals extra discounts and bonuses for buying a 
group of products, can seriously damage the ability of doctors 
to choose the best products for their patients and for 
competitive manufacturers to survive and innovate.
    Third, the General Accounting Office today revealed that 
these buying groups, whose goal, after all, is to save money, 
do not always get the best deal. We all support the basic 
purpose of GPOs, to hold down health care costs with volume 
purchasing. But the GAO study raises serious doubts as to 
whether GPOs are doing a good enough job in achieving this 
goal. In many cases, hospitals can get a better deal if they go 
outside the GPO. It seems like sometimes GPOs may produce the 
worst of both worlds, little savings and fewer choices.
    We, therefore, call on the entire GPO industry to work with 
us to create a code of conduct that will address these ethical 
problems and contracting issues. The industry should clean up 
its own act, and we believe they want to, but without quick and 
effective self-regulation, we would have to consider 
Congressional action.
    In addition, Senator DeWine and I are today writing to the 
Justice Department and the Federal Trade Commission to request 
that they reexamine their guidelines that protect GPOs from 
Federal antitrust scrutiny in most cases.
    Our goal should be to ensure that the GPO system truly 
achieves cost savings in the cost of medical equipment and that 
these savings do not come at the expense of patient health and 
medical innovation. We thank our witnesses for coming here to 
testify and we look forward to hearing their views.
    [The prepared statement of Senator Kohl follows:]
Statement of Hon. Herb Kohl, a U.S. Senator from the State of Wisconsin
    Today our subcommittee turns its attention to an issue affecting 
the health and safety of every American who has ever, or ever will, 
need treatment at a hospital--in other words, all of us. This issue is 
how hospitals form buying groups to purchase nearly everything used by 
hospitals--everything from pacemakers to thermometers, from surgical 
devices and CAT scanners to needles and Band-Aids--and how those groups 
affect the cost and quality of patient health and medical innovation.
    These buying groups--known as group purchasing organizations or 
GPOs--are at the nerve center of our health care system. Because they 
determine what products are in our hospitals, they directly affect 
patient health and safety. Because they control more than $34 billion 
in health care purchases, they impact the cost we all pay for our 
health system. Because they represent more than 75 percent of the 
nation's hospital beds, they are a powerful gatekeeper who can cutoff 
competition and squeeze out innovation. Gaining a GPO contract is 
essential for any medical equipment supplier. GPOs determine which 
medical devices will be used to treat us when we are sick or injured, 
which manufacturers will survive and prosper--and which ones will fail. 
It doesn't do any good to invent the next great pacemaker or safety 
needle if you can't get it to patients because the GPO stands in your 
way.
    With that kind of power comes responsibility. But too often it 
seems GPOs have failed to serve as honest brokers seeking to serve the 
best interests of hospitals and patients.
    We have three main concerns.
    First: conflicts of interests raise the specter of critical health 
decisions being influenced by financial ties to suppliers. We have 
heard startling allegations of scandal and conflicts of interests that 
have infected the GPOs. Premier's chief executive received millions of 
dollars worth of stock options from a company with a contract supplying 
pharmaceutical services to Premier hospitals. His response--that he 
recused himself from contracting decisions with respect to the company 
at issue and that his financial interests were disclosed, and approved 
by, Premier's Board--is good, but not good enough. He should have 
severed all ties to the company when he joined Premier. On another 
occasion, Premier steered business to a pharmaceutical supply company 
and thereby helped turn its initial $100 investment into a stake worth 
$46 million dollars last year. Novation today demands that medical 
suppliers it contracts with sell their products on a for-profit e-
commerce site in which Novation has a substantial interest and in which 
many of Novation's senior executives hold personal stakes.
    These practices are appalling and cannot be tolerated. We cannot 
accept a situation where a decision on which medical device will be 
used to treat a critically ill patient could conceivably or even 
theoretically turn on the stock holdings of a GPO executive.
    Second: contracting practices may reduce competition and innovation 
in health care and narrow the ability of physicians to chose the best 
treatment for their patients. In one case we know of, a hospital denied 
a physician permission to use a vital pacemaker for a patient on the 
operating table but not yet anaesthetized--all because there was no GPO 
contract for that pacemaker. The pacemaker that was on contract--that 
the hospital required him to use--was in the midst of an FDA 
investigation into its effectiveness and safety. Hospitals have failed 
to buy safety syringes which prevent accidental needle sticks because 
doing so would mean buying off the GPO contract. As a result, nurses 
have suffered easily preventable injuries and have developed HIV and 
Hepatitis.
    GPO contracting policies have created a system that keeps many good 
products out of circulation while enabling large manufacturers to 
entrench their market position. Practices such as sole sourcing, high 
commitment--levels--requiring a hospital to purchase as much as 90 
percent of a product from one company in order to get the maximum 
discount--and bundling--giving hospitals extra discounts and bonuses 
for buying a group of products--can seriously damage the ability of 
doctors to choose the best products for their patients and for 
competitive manufacturers to survive and innovate.
    Third: the General Accounting Office today revealed that these 
buying groups--whose goal is to save money--don't always get the best 
deal. We all support the basic purpose of GPOs--to hold down health 
care costs with volume purchasing. But the GAO study raises serious 
doubts as to whether GPOs are doing a satisfactory job achieving this 
goal. In many case, hospitals can get a better deal if they go outside 
the GPO. It seems like sometimes GPOs may produce the worst of both 
worlds--little savings and fewer choices.
    We therefore call on the entire GPO industry to work with us to 
create a code of conduct that will address these ethical problems and 
contracting issues. The industry should clean up its own house, and we 
believe they want to. But without quick and effective self-regulation, 
we would have to consider congressional action. In addition, Senator 
DeWine and I are today writing to the Justice Department and Federal 
Trade Commission to request that they re-examine their Guidelines that 
protect GPOs from Federal antitrust scrutiny in most cases.
    Our goal should be to ensure that the GPO system truly achieves 
cost savings in the cost of medical equipment, and that these savings 
do not come at the expense of patient health or medical innovation. We 
thank our witnesses for testifying today and look forward to hearing 
their views.

    Chairman Kohl. I call now on my colleague and the ranking 
member of this subcommittee, Senator Michael DeWine.

STATEMENT OF HON. MIKE DEWINE, A U.S. SENATOR FROM THE STATE OF 
                              OHIO

    Senator DeWine. Mr. Chairman, thank you very much. Let me 
begin by saying that I am also quite disturbed by some of what 
we have learned in our investigation of group purchasing 
organizations.
    There is certainly some anecdotal evidence and some 
indication that GPOs in some cases have strayed from their 
original purpose of allowing hospitals to work together to 
limit costs. We clearly have some specific incidents that we 
need to explore today, and I know we will, and we need to 
decide how to prevent them in the future.
    In addition, we need to examine the enormous changes in the 
medical supply marketplace and the changes that have occurred 
in GPOs. As medical costs have skyrocketed, many hospitals 
struggle on a daily basis. They struggle to reduce costs while 
attempting to maintain high quality health care
    GPOs have become an increasingly important part of this 
effort to reduce costs. However, I think it is fair to say that 
due to consolidation and other changes in the GPO system, GPOs 
today look very different than the system that was originally 
planned and contemplated.
    Some reports indicate that hospitals channel as much as 70 
to 80 percent of their non-labor expenditures through GPOs. 
Within that 70 to 80 percent of purchasing, two large GPOs, 
Premier and Novation, handle purchasing for over 60 percent of 
the nation's hospitals. This level of concentration gives these 
two firms a very important role in the medical device market, 
and their buying arrangements have a tremendous impact on the 
market.
    This importance is magnified by the fact that Premier and 
Novation will often have only one or two suppliers on contract 
for a given product or product category. For the one or two 
suppliers who are able to make a deal with them, they are 
virtually assured a very big market for their products. The 
others, however, will face real problems in gaining access to a 
large or significant segment of the market.
    As long as these contracting and purchasing decisions are 
based on a reasonable mix of quality and cost factors, these 
outcomes are not necessarily troubling, and we have been told 
that, often, health practitioners do play a significant role in 
determining which products are placed on GPO contracts, a role 
which helps to assure that product quality and patient care are 
part of the decision.
    However, there are some indications that other factors have 
sometimes been considered, factors that have more to do with 
the financial health of the GPO than the health of the patient. 
For example, information provided to this subcommittee 
demonstrates that executives of some GPOs have a financial 
interest in companies that have been granted GPO contracts. 
Obviously, it is completely unacceptable for private financial 
interests to play any role in contracting decisions.
    More broadly, I am concerned about the extensive range of 
businesses and programs run by GPOs and the manner in which 
they are funded. Approximately 15 years ago, Congress gave the 
GPOs an exemption from the anti-kickback laws in order to allow 
them to collect administrative fees from suppliers. But the 
result of that decision is a system in which some believe the 
GPOs have conflicting interest and mixed incentives. It is not 
always clear whether GPOs are serving the hospitals who own 
them or the suppliers who have in some ways become their 
clients. We need to explore this issue today.
    Furthermore, Mr. Chairman, we need to examine the 
competitive implications of the GPO system. It is critical that 
we maintain a competitive environment in which new and improved 
medical devices are able to gain a foothold in the marketplace. 
However, many have complained that the GPO structure is acting 
as an impediment to innovation by allowing incumbent suppliers 
to lock in large portions of the buying market for their 
products.
    That assessment seems to have some support among those in 
the investment community. In fact, we will hear testimony today 
that investors are increasingly unwilling to fund start-ups, 
the kind of companies that often provide technological 
improvements, because the odds are stacked too heavily in favor 
of incumbents on GPO contracts. This is a very troubling 
possibility.
    On balance, it does seem likely that GPOs have delivered 
savings to hospitals. Many of the hospitals in my home State of 
Ohio have reported that to me, although, as the recent GAO 
study indicates, GPOs do not necessarily always save money for 
hospitals. As I have noted, legitimate questions have been 
raised about what impact the current structure of the GPO 
market is having on innovation and health care. We cannot 
overlook the long-term costs that we will pay, both in dollars 
and in quality of care, if we allow our purchasing structure to 
impede innovation in medical devices.
    So, Mr. Chairman, I look forward to hearing from our 
witnesses. I will closely evaluate everything that we hear 
today. Certainly, we must remain focused, focused on making 
health care affordable to all Americans. It is equally 
important to ensure that the system operates in a way that will 
provide the best possible health care for patients.
    As an initial step, as Senator Kohl has already indicated, 
the chairman and I both agree that a code of conduct addressing 
a number of specific practices will help address our concerns. 
In the meantime, Senator Kohl and I have sent a letter to the 
Justice Department Antitrust Division and the Federal Trade 
Commission asking them to examine the competitive effects of 
the GPO system.
    If, after careful evaluation, we determine that further 
changes are, in fact, necessary, we will work closely with all 
interested parties as we seek a system that will provide our 
hospitals with the best products at competitive prices. Thank 
you, Mr. Chairman
    Chairman Kohl. Thank you, Senator DeWine.
    [The prepared statement of Senator DeWine follows:]
  Statement of Hon. Mike DeWine, a U.S. Senator from the State of Ohio
    Let me begin by saying that I am also quite disturbed by some of 
what we have learned in our investigation of group purchasing 
organizations. There is certainly some anecdotal evidence, and some 
indication that GPOs in some cases have strayed from their original 
purpose of allowing hospitals to work together to limit costs. We 
clearly have some specific incidents that we need to explore today, and 
we need to decide how to prevent them in the future.
    In addition, we need to examine the enormous changes in the medical 
supply marketplace, and the changes that have occurred in GPOs. As 
medical costs have skyrocketed, many hospitals struggle on a daily 
basis to reduce costs while attempting to maintain high-quality health 
care.
    GPOs have become an increasingly important part of this effort to 
reduce costs. However, I think it is fair to say that due to 
consolidation and other changes in the GPO system, GPOs today look very 
different than the system that was originally contemplated.
    Some reports indicate that hospitals channel as much as 70 to 80 
percent of their nonlabor expenditures through GPOs. Within that 70 to 
80 percent of purchasing, two large GPOs, Premier and Novation, handle 
purchasing for over 60 percent of the nation's hospitals.
    This level of concentration gives these two firms a very important 
role in the medical device market, and their buying arrangements have a 
tremendous impact on the market.
    This importance is magnified by the fact that Premier and Novation 
will often have only one or two suppliers on contract for a given 
product or product category. For the one or two suppliers who are able 
to make a deal with them, they are virtually assured a very big market 
for their products; the others will face real problems in gaining 
access to a large segment of the potential market.
    As long as these contracting and purchasing decisions are based on 
a reasonable mix of quality and cost factors, these outcomes are not 
necessarily troubling. We have been told that often health 
practitioners do play a significant role in determining which products 
are placed on GPO contracts, a role which helps to assure that product 
quality and patient care are part of the decision.
    However, there are some indications that other factors have 
sometimes been considered, factors that have more to do with the 
financial health of the GPO than the health of the patient. For 
example, information provided to the Subcommittee demonstrates that 
executives of some GPOs have a financial interest in companies that 
have been granted GPO contracts. Obviously, it is completely 
unacceptable for private financial interests to play any role in 
contracting decisions.
    More broadly, I am concerned about the extensive range of 
businesses and programs run by GPOs, and the manner in which they are 
funded. Approximately 15 years ago, Congress gave the GPOs an exemption 
from the anti-kickback laws in order to allow them to collect 
administrative fees from suppliers. But the result of that decision is 
a system in which some believe the GPOs have conflicting interests and 
mixed incentives. It is not always clear whether GPOs are serving the 
hospitals who own them or the suppliers, who in some ways, have become 
their clients. We need to explore this issue today.
    Furthermore, we need to examine the competitive implications of the 
GPO system. It is critical that we maintain a competitive environment 
in which new and improved medical devices are able to gain a foothold 
in the marketplace. However, many have complained that the GPO 
structure is acting as an impediment to innovation, by allowing 
incumbent suppliers to lock in large portions of the buying market for 
their products.
    That assessment seems to have some support among those in the 
investment community. In fact, we will hear testimony today that 
investors are increasingly unwilling to fund startups, the kind of 
companies that often provide technological improvements, because the 
odds are stacked too heavily in favor of incumbents on GPO contracts. 
This is a very troubling possibility.
    On balance, it does seem likely that GPOs have delivered savings to 
hospitals. Many of the hospitals in my home State of Ohio have reported 
as much to me, although, as the recent GAO study indicates, GPOs do not 
necessarily always save money for hospitals. As I have noted, 
legitimate questions have been raised about what impact the current 
structure of the GPO market is having on innovation and health care.
    We cannot overlook the long-term cost that we will pay, both in 
dollars and in quality of care, if we allow our purchasing structure to 
impede innovation in medical devices.
    I look forward to hearing from our witnesses, and I will closely 
evaluate everything we hear today. Certainly we must remain focused on 
making health care affordable to Americans. It is equally important to 
ensure that the system operates in a way that will provide the best 
possible health care for patients. As an initial step, I agree with 
Senator Kohl that a code of conduct, addressing a number of specific 
practices, will help address our concerns. In the meantime, Senator 
Kohl and I have sent a letter to the Justice Department Antitrust 
Division, and the Federal Trade Commission, asking there to examine the 
competitive effects of the GPO system. If, after careful evaluation, we 
determine that further changes are necessary, we will work closely with 
all interested parties as we seek a system that will provide our 
hospitals with the best products at competitive prices.

    Chairman Kohl. Now, to our witnesses. I will introduce the 
seven and then we will start with their testimony.
    Mr. Richard Norling is Chairman and CEO of Premier, 
Incorporated. He joined Premier in 1997, first as Chief 
Operating Officer. Before that, Mr. Norling was President and 
CEO of Fairview Hospital and Health Care System, headquartered 
in Minneapolis-St. Paul, Minnesota.
    We have with us Mr. Mark McKenna, President of Novation. He 
served on the management team that structured the joint venture 
between VHA and UHC, resulting in the creation of Novation. 
Prior to joining VHA in 1987, Mr. McKenna was Director of 
Marketing for IMED Corporation of San Diego.
    Ms. Trisha Barrett is a registered nurse and Assistant 
Director of Materiel Services and Value Analysis Facilitator at 
the University of California Medical Center in San Francisco. 
Ms. Barrett serves on the Novation Nursing and Clinical 
Practice Council.
    Mr. Joe Kiani is the co-founder and CEO of Masimo 
Corporation, a privately-held medical technology company. He is 
also an inventor on more than 30 patents related to signal 
processing sensors and patient monitoring.
    Dr. Mitch Goldstein is a physician at the Citrus Valley 
Medical Center and the University of California-Irvine Medical 
Center. He specializes in neonatal medicine.
    Ms. Elizabeth Weatherman is the Managing Director of 
Warburg Pincus, where she has been a member of the health care 
group since 1988. Ms. Weatherman also serves as the Vice Chair 
of the National Venture Capital Association Medical Group.
    Mr. Lynn Detlor is the Principal of GPO Concepts, Inc. He 
served as President of Premier Purchasing Partners from 1986 to 
1999. Mr. Detlor joined Premier through a merger with the 
American Health Care Systems, where he served as President.
    We welcome you all here today. We request that you hold 
your statements to five minutes.
    Before we commence, I would like to ask the chairman of our 
committee, Senator Leahy, if he has an opening statement.

  STATEMENT OF HON. PATRICK J. LEAHY, A U.S. SENATOR FROM THE 
                        STATE OF VERMONT

    Chairman Leahy. Mr. Chairman, just hearing your comment 
about keeping it brief, I just want to compliment both you and 
Senator DeWine. As I have said on many occasions, the two of 
you, the subcommittee should be a model for the rest of the 
Senate in the way you handle it.
    One, we all agree that we worry about escalating health 
care costs, whether you are a legislator or a provider or you 
are a consumer or anything else. I am concerned on this one 
issue: Do the GPO's contracts and other practices with large 
established medical and pharmaceutical supply companies keep 
newer and smaller companies from bringing innovative items in? 
Do the fees paid by suppliers to the GPOs who act as go-
betweens for the hospitals exceed statutory limits? Do some 
GPOs have officers and employees with inappropriate connections 
to large medical suppliers? Should they be funded by the 
suppliers at all, rather than by the member hospitals?
    So these are the issues. I will, because of our other 
hearing, I will leave most of these for the record, but I do 
want to compliment you, Mr. Chairman and Senator DeWine, and 
thank you for holding this hearing. If I could put my whole 
statement and my questions in the record.
    Chairman Kohl. It will be done and we thank you for your 
appearing here, Senator Leahy.
    [The prepared statement of Senator Leahy follows:]
   Statement of Hon. Patrick Leahy, a U.S. Senator from the State of 
                                Arizona
    Escalating health care costs are a source of concern to all of us, 
as legislators and as health care consumers. The struggle to keep 
health care costs as low as possible, while ensuring that the quality 
of care remains high, is the Herculean task confronting our nation's 
health care providers and hospital administrators. In recent years, the 
development of Group Purchasing Organizations, or GPOs, has been 
heralded as an effective tool to meet this pressing need. The New York 
Times reported today that the General Accounting Office has just 
released a study concluding that hospitals do not necessarily benefit 
from participating in GPOs.
    GPOs allow hospitals to aggregate their buying power in making 
purchases from suppliers of medical equipment, pharmaceuticals, and the 
many ordinary products necessary for the daily functions of any 
hospital. By purchasing in bulk, the hospitals ostensibly would save 
money, and because the GPOs handle much of the administrative burden of 
dealing with the suppliers, the hospitals would then be relieved of 
those tasks.
    However, recent media reports and industry commentaries suggest 
there are issues we need to address in the context of GPO purchasing. I 
see this hearing as an opportunity for the Judiciary Committee and for 
the public to learn more about how GPOs operate, how they benefit 
hospitals, and whether there are any changes that could improve their 
operations.
    Serious questions on several topics should be answered, including:
     Do the fees paid by suppliers to the GPOs who act as the 
go-betweens with the hospitals exceed the statutory limits?
     Do some GPOs have officers and employees with 
inappropriate connections to large medical suppliers?
     Should the GPOs be funded by the suppliers at all, rather 
than by their member hospitals?
     Do the GPOs' contracts and other practices with large, 
established medical and pharmaceutical supply companies keep newer and 
smaller companies from bringing innovative and high-quality products 
into our nation's hospitals?
     In light of the new GAO report, do GPOs actually save 
hospitals money?
    I look forward to exploring these questions with the panel today, 
and I thank Senators Kohl and DeWine for their laudable and bipartisan 
efforts to ensure that these questions--and other important antitrust 
issues--are considered in this forum. I commend the chairman and the 
ranking member of this subcommittee for their productive working 
relationship. This level of cooperation should be the rule and not the 
exception in the Senate.
    Another significant effort to improve the quality and lower health 
care costs is the Drug Competition Act of 2001, S. 754, which was 
reported out of this Committee unanimously last October. Drafted in the 
wake of several Federal Trade Commission suits against large brand name 
drug makers who paid off their generic rivals to keep their lower cost 
drugs off the market, that bill would require that such deals be filed 
with the antitrust enforcement agencies. The FTC and the Justice 
Department would then have the tools they need--tools they have asked 
us for--to combat these pernicious practices which keep prescription 
drug costs unnecessarily high by blocking generic entry into the 
marketplace. But that bill has been awaiting Senate action for 6 
months, the victim of a partisan anonymous hold. Such politically 
motivated efforts only hurt consumers, and I would hope that this body 
could focus on the best interests of the American people, rather than 
on short-term political gain.
    I thank the witnesses for coming before us today and I look forward 
to hearing their testimony.

    Chairman Kohl. We start with your testimony first, Mr. 
Norling.

   STATEMENT OF RICHARD A. NORLING, CHIEF EXECUTIVE OFFICER, 
              PREMIER, INC., SAN DIEGO, CALIFORNIA

    Mr. Norling. Thank you, Chairman Kohl, Senator DeWine, and 
Senator Leahy. I am Richard Norling, Chairman and CEO of 
Premier. As a former hospital CEO who spent 28 years in not-
for-profit health care, I know that hospitals are under 
enormous pressure from Medicare, Medicaid, and other payers to 
deliver high quality care at the best possible price for their 
patients, and hospitals need all the help they can get. Premier 
provides them with a very important tool, namely group 
purchasing services. I would like to talk to the subcommittee 
on specifically how that works.
    Premier is an alliance of some 1,600 not-for-profit 
hospitals and health care systems, from major medical centers 
to small rural community hospitals. To put it simply, our 
mission is to do everything we can to help our not-for-profit 
hospital members provide the best patient care at the best 
possible price. We are a performance improvement organization.
    One important part of what we do is negotiate contracts 
with suppliers for our hospitals, but we are not a middleman 
for hospital purchasing. In addition to our contracting 
program, we offer many other valuable services to our 
hospitals. For example, Premier is the most significant health 
care database available in America today to help hospitals 
share information and implement best clinical practices. We 
estimate that we save our member hospitals over $1.5 billion 
per year through all our programs.
    Premier is a driving force for innovation. Premier hospital 
systems, like Aurora Health Care in Wisconsin, Cleveland Clinic 
in Ohio, demand immediate access to the newest and most 
effective technology. We work closely with our hospitals to 
identify and evaluate promising new products and processes. We 
have staff dedicated to tracking key medical developments to 
identify the very best products. Our technology assessment 
team's primary job is to evaluate promising new technologies 
with an eye towards bringing those advances into our hospitals. 
Our contracts give us flexibility to add breakthrough 
technologies regardless of the existence of existing contracts.
    If I can, a couple of examples with regard to our record on 
innovation. We regularly examine the marketplace and move 
rapidly to evaluate new technologies and make available under 
group contracts those that are real breakthrough advances. In 
January, shortly after the cutting-edge given imaging camera 
pill was launched--I have an example of that right here--our 
staff recognized the potential of this pill-sized device, 
which, after being swallowed by the patient, provides the most 
advanced images of the small intestine available. It is a very, 
very exciting technology. Within 30 days of learning that, we 
had a group contract with this company, the only group 
purchasing organization at this time with a contract of this 
revolutionary new product.
    Second point, even when a contract is already in place, we 
can add breakthrough products to our portfolio. In early 1999, 
well before Congress passed the Needle Stick Safety Act, which 
I might note we very strongly supported, Premier reached out to 
the industry for new safety products in this arena. Through our 
Technology Breakthroughs Program, we added three new syringes 
and four blood-drawing devices with safety features to expand 
our portfolio, all but one of these from small manufacturers. 
Currently, we have 96 sharps safety products categories on 
contract with 772 individual products available to our members. 
These are manufactured by 15 different companies.
    The facts are clear. Our contracting process is open to all 
suppliers and we are always interested in and actively seek out 
more advanced and safer products. If this were not the case, 
there is no doubt our member hospitals would go elsewhere.
    Let me emphasize how we engage those hospitals. All product 
selections are made with substantial clinical input by 
committees of people who work at our hospitals. Once they, the 
committees, make their decisions, we negotiate the contracts. 
But Premier does not purchase products, hospitals do. Our group 
purchasing contracts do not require our hospitals to use a 
contract for all of their needs in any product category. Our 
members can and do buy items to meet their unique needs and 
preferences while still getting a negotiated discount for 
products under group contracts.
    Like all GPOs, we receive administrative fees in return for 
our services. Our fees average 2.1 percent, well within Federal 
guidelines. We have no fees in excess of 3 percent involving 
medical products or pharmaceuticals. We do not require up-front 
payments, and since 1997, 67.4 percent of all administrative 
fees we receive through group purchasing have been distributed 
as cash payments or credited to Premier hospitals as 
incremental equity in their retained earnings.
    After Premier's creation in late 1995 through a three-way 
merger, we inherited from our predecessor organizations some 
practices that have figured in recent criticisms of our 
organization. As Premier has matured and evolved, many of those 
practices have been discontinued.
    In conclusion, we are very proud of our accomplishments in 
pursuing excellence in health care. We are committed to 
operating openly, honestly, and transparently. We intend to 
cooperate with the subcommittee and the health care community 
to explore every avenue to make our work even more effective. 
If there is an opportunity to improve, Senators, we will take 
it, and may I say that I applaud you for your proposal on the 
idea of an industry-wide set of ethical practices and you have 
Premier's absolute full support in trying to seek that common 
ground that I think is so important. Thank you.
    Chairman Kohl. We thank you, Mr. Norling.
    Now from Novation, we have Mr. McKenna.

 STATEMENT OF MARK MCKENNA, PRESIDENT, NOVATION, LLC, IRVING, 
                             TEXAS

    Mr. McKenna. Good afternoon, Chairman Kohl, Ranking Member 
DeWine, and Senator Leahy. It is my pleasure to be with you 
today representing over 2,300 health care organizations. I am 
also compelled to relay this message from our members. The 
value, cost savings, and other benefits they receive through 
Novation are necessary and crucial to their survival and to 
their ability to provide quality patient care in their 
communities.
    Novation was formed in 1998 by combining the group 
purchasing programs of VHA and the University Health System 
Consortium, two national health care alliances with members in 
all 50 States. From major academic medical centers to rural 50-
bed facilities, these hospitals share a common mission of 
community service, a vision of continually improving the 
quality of care, and an imperative to operate more efficiently. 
These hospitals rely on us and the collective strength of their 
membership.
    Group purchasing saves hospitals hundreds of millions of 
dollars annually. By our estimate, last year alone, we saved 
our members over $1 billion by aggregating their buying power 
and by consequently avoiding other costs. Many hospitals, 
especially those serving rural communities, could not realize 
these savings on their own. Here is just one result of how 
these savings can directly improve community health and why our 
members value what we do.
    In Menomonee Falls, Wisconsin, Community Memorial Hospital 
saved $1.5 million over the last 2 years through purchases made 
by Novation contracts, and they report that these savings have 
helped them fund a free clinic for indigent care patients in 
their community.
    The benefits enjoyed by Community Memorial reflect a sound 
business model. It is a cooperative model, similar to others 
outside the health care sector, such as agriculture and 
electronics.
    Now, I would like to take a moment to briefly comment on 
Novation's business practices. I am proud of our organization 
and what we accomplish every day on behalf of our members. We 
are member-driven and rely heavily on member input in 
determining the needs, identifying and evaluating products, and 
by helping individuals share ideas and best practices.
    Novation provides many ways for physicians and other 
clinical professionals from our member organizations to guide 
us in administering an objective and open bid process, 
resulting in the selection of high-quality, low-cost products. 
We use over 20 member advisory councils. Our councils include 
more than 450 individuals from 300 health care organizations. 
These represent both large and small hospitals. Our contract 
decisions are supported by a matrix evaluation that considers 
safety, quality, availability, support, customer service, 
education, and, of course, cost.
    Some suppliers may provide a single product. Others provide 
more. But each product is chosen on its own merits through this 
fair, objective, and inclusive process. In fact, all our bids 
are posted on our public website so they are all available to 
all suppliers. This methodology results in low best bid, which 
in our definition means providing our members the highest 
quality products at the lowest possible costs.
    I should point out that many suppliers can and do take 
advantage of opportunities to provide contracts through 
Novation. In fact, approximately 25 percent of our suppliers 
meet the Small Business Administration's definition of a small 
business. One example, Triad Disposables, a small Upper Midwest 
company that makes alcohol preps, which won a bid over much 
larger competitors, proves this out.
    Our contracts are also flexible, allowing us to continually 
seek and offer new and alternative products and the latest 
technology. For example, our members told us that Possis 
Medical had an innovative device to more effectively treat 
blood clots, and after receiving input from members on our 
advisory councils, we promptly added it to our portfolio.
    Finally, our members can freely choose whether or not to 
purchase through Novation contracts, and we believe that this 
voluntary approach has been key to our success and greatly 
enhances the satisfaction of our members. They retain the 
freedom to choose the products that best meet their specific 
needs.
    In the time allotted, I hope I have been able to give you a 
sense of how group purchasing benefits hospitals and how 
Novation adheres to a strong, fair, and ethical process in 
contracting. As you know, hospitals across the country are 
under severe budget constraints and desperately need ways in 
which to reduce their costs and serve their communities. Thank 
you for this opportunity to tell our story.
    [The prepared statement of Mr. McKenna follows:]
          Statement of Mark McKenna, President, Novation, LLC
    Chairman Kohl, Ranking Member DeWine, and distinguished members of 
the Subcommittee, thank you for this opportunity to tell our story and 
share with you examples of the value we believe Novation delivers to 
the nation's patients and hospitals. My name is Mark McKenna. I am the 
president of Novation, the supply chain management company for VHA Inc. 
and University HealthSystem Consortium (UHC), two alliances comprised 
of community-owned not-for-profit hospitals and academic health systems 
throughout the United States.
    Our focus at Novation is to help the hospital members of VHA and 
UHC realize efficiencies and cost savings in their purchasing 
functions. As I'm sure you know, the environment of health care has 
changed dramatically in the last 10 years--through the Balanced Budget 
Act of 1997, staffing shortages, advances in technology, aging 
populations and managed care. Our nation's hospitals are facing these 
pressures and the rising costs of supplies, as well. At the same time, 
reimbursements from HMOs and Medicare continue shrinking, while many 
more patients are uninsured and are unable to pay at all. Hospitals are 
caught in the middle. Novation, as an extension of its owner alliances, 
works to lessen this financial pressure by helping those it serves 
create a more cost-efficient supply chain, while keeping quality the 
top priority.
    For example, Community Memorial Hospital, a VHA member and not-for-
profit health care organization in Menomonee Falls, Wisconsin, employs 
almost 1,300 people and provided care to more than 60,000 patients last 
year, including many indigent patients. By choosing to purchase quality 
products through Novation contracts they realized tangible costs 
savings of well over $700,000 in 2001, in addition to significant cost-
avoidance. These savings went directly to their bottom-line and helped 
them maintain their community outreach and indigent care services to 
their community, such as their free clinic. This hospital's story is 
only one of many around the country.
    At its very core, group purchasing benefits hospitals as well as 
the entire health care system. As it currently stands, group purchasing 
brings the most value to hospitals and maintains a fair market for 
suppliers. All of the hospitals Novation serves are under tight budget 
constraints. Thousands of free standing large, medium and small 
hospitals--especially smaller facilities in rural areas--would 
experience increased costs and struggle to survive if the system was 
changed.
    Health care group purchasing was created by groups of hospitals 
that came together to gain efficiencies. History traces the concept of 
group purchasing in the health care industry to as far back as the late 
1800's. However, it really didn't take hold until the late 1970's, when 
health care costs, specifically supply costs, were escalating at an 
alarming rate. Not-for-profit and academic hospitals, hurting 
financially, sought a way to aggregate purchasing strength to lower 
supply costs and to better compete with the for-profit hospital chains. 
By pooling their efforts, they were able to achieve more together than 
they could alone.
    VHA and UHC are organized as cooperatives and as such, return 100 
percent of their cooperative income to members in cash and equity. In 
2001, VHA returned approximately 32 percent of its revenue to members 
in cash payments. UHC distributed almost 40 percent of its revenue to 
members in cash payments. Members indicate that the combination of VHA 
and UHC's cash and equity returns, pricing, and value beyond price for 
products and services are superior to other alternatives. These 
cooperative payments and the clinical services that the alliances offer 
help hospitals carry out their missions.
    Fees also fund other services of the alliances and are utilized in 
board-approved initiatives such as information technology resources, 
research, benchmarking, educational programs, and other efforts to 
improve health care--things that would be too costly for hospitals to 
do on their own.
    We continue this vision of slowing rising health care costs, 
helping hospitals fulfill their mission of healing and saving lives. 
Novation serves the purchasing needs of more than 2,300 health care 
organizations--the members of VHA and UHC. Our company was formed in 
January 1998 when these two alliances created a new joint venture firm 
that would efficiently serve the purchasing needs of both alliances. 
VHA, is a nationwide network of more than 2,200 leading community-owned 
health care organizations and their physicians. It comprises 26 percent 
of the nation's community hospitals. UHC, representing most of the 
academic medical centers in the United States, is an alliance of 87 
academic medical centers and 110 associate members. In total, VHA and 
UHC represent health care organizations in all 50 states.
    Cooperative group purchasing, as well as Novation's overall 
approach, are commonly recognized business models. Novation's 
relationships with suppliers are similar to business-to-business 
relationships in other industries where agents broker services such as 
real estate, financial services, travel and hospitality and other 
buying agents in the electronics and food industries.
    Cooperatives have served this country well. They enable their 
members to reap the benefits of joint endeavors while still maintaining 
their independence. They allow the members to own and control the 
business and to operate it for their benefit. Our cooperative structure 
is similar to other cooperatives in the farming, building, hardware and 
restaurant industries. Supplier-paid fees are a means by which 
cooperatives operate. This is the most effective way to fund our 
operations, given the financial constraints that most hospitals operate 
under.
    Novation receives fees from suppliers just as other cooperatives 
do. The amount of the fee offered is generally based upon the value 
placed on Novation's services by the supplier and usually varies based 
upon the product category. Fees are paid based on a percentage of 
member purchases from the agreements accessed.
    Our average overall fee is 2.1 percent. Of those fees that are 
above 3 percent, the vast majority are for NOVAPLUS agreements--our 
private label brand owned by VHA and UHC members. These slightly higher 
fees involve trademark and licensing fees. Novation, VHA and UHC are 
fully accountable for the fees they collect from suppliers and 
manufacturers and disclose all fee information to the member hospitals.
    The Federal Government has previously reviewed the issue of 
administrative fees received by group purchasing organizations from 
suppliers and determined that based on the benefit of these 
organizations to the nation's health care system, the fees they 
generate on behalf of their memberships should be permitted. On April 
17, 1985, Richard P. Kusserow, HHS Inspector General said:

          ``We [HHS OIG] believe the current practice of reimbursement 
        by vendors to group purchasing agents should be permitted . . . 
        The use of volume purchasing through group purchasing agents 
        clearly reduces the cost of purchases by hospitals. Therefore, 
        we would encourage use of such arrangements regardless of the 
        reimbursement methodology.''

    Novation works as an agent on behalf of VHA and UHC hospitals, 
ultimately answering to them. Whereas publicly held manufacturers 
ultimately answer to stockholders for their financial performance, we 
answer to hospitals for financial performance as well as by how well we 
help them fulfill their missions of healing. Member satisfaction is 
extremely important to Novation. Half of our yearly incentive plan for 
all employees is based on member satisfaction. As stewards of the 
members' finances, the other half is based on achieving operating 
income goals.
    With significant involvement from, and on behalf of, VHA and UHC 
members, Novation works with medical supply companies to offer 
contracts for products of the highest quality at the most cost-
efficient price. When comparing Novation's product portfolio to member 
and prospective member hospitals' supply purchasing Novation has saved 
VHA and UHC member hospitals approximately $2.1 billion since its 
inception in 1998.
    Dennis Barry, President and CEO of Moses Cone Health System in 
Greensboro, NC and chairman-elect for the board of the American 
Hospital Association, probably sums it up best:

          ``[They] bring significant value to us as an organization: 
        better pricing for consumables and equipment than we could 
        arrange on our own; a range of other services . . . helpful to 
        our organization; the ability to network with other similar 
        sized organizations throughout the country on a whole range of 
        questions or issues.''

    You will hear many benefits and aspects of group purchasing and 
Novation mentioned today, but the primary one to remember can be summed 
up in our mission statement: In partnership with VHA and UHC, Novation 
will deliver industry-leading supply chain management solutions that 
assist community-based, not-for-profit and academic hospitals in 
improving financial, operational and clinical performance.
    Novation, and group purchasing as a whole, brings tremendous value 
to health care. In this regard, my testimony will focus on five topics:
     The philosophy and ethics of Novation's overall business 
practices
     The value created by Novation's competitive ``low best 
bid'' process
     The fair, open and competitive nature of Novation's 
bidding process for suppliers of all sizes
     The flexibility of participation in our product and 
program offerings
     The clinical & operational benefits beyond group 
purchasing of the VHA and UHC alliances
    Now, I would like to tell you about the way Novation delivers value 
to member hospitals:
                 Novation's Overall Business Philosophy
    Our overall philosophy is to deliver the greatest possible value to 
hospitals, keeping both quality and cost squarely in focus. This is 
accomplished in large part through our open competitive bid process and 
through extensive member input.
    On a more practical level, our day-to-day purpose is to offer and 
manage contracts with a variety of companies that provide VHA and UHC 
hospitals with the ability to access high quality products in a cost-
efficient manner. Much of what we contract for is commodity-oriented 
products.
    Our contracting objective is to provide members with the highest 
quality products at the lowest total delivered cost. Recognizing the 
diversity of the hospitals we serve, all participation in our product 
agreements is purely voluntary. We seek to provide additional value to 
hospitals based upon their purchasing volume, commitment and ability to 
drive purchasing efficiencies across their respective systems. To that 
end, considerable attention has been given to the following elements:
     Involvement of VHA and UHC member representatives in the 
process
     Development of a structured process with ``high 
integrity'' to accommodate the competitive bid requirements of public 
institutions
     Reliance upon the business acumen and facilitation skills 
of staff to guide the process
    Because of our eight-step contract process--what we believe to be 
the most extensive in the industry--hospitals can have confidence that 
Novation ensures consistent, high-value agreements. This process is 
used across all departments and program areas of the company to achieve 
a consistent, high-value outcome.
    Novation's contracting process includes the following steps:
    1. Identifying VHA and UHC member contract needs
    2. Conducting member and market research
    3. Developing and analyzing bids with councils
    4. Deciding awards
    5. Resolving and clarifying contract issues
    6. Finalizing the award
    7. Launching the agreement
    8. Retaining records
    To determine contracting priorities, Novation relies on member 
input and member purchasing behavior. Through the direction of member 
councils, made up of clinical and procurement professionals, as well as 
surveys and other research, we distribute Invitations to Bid for 
specific product categories. These include specific questions related 
to member-determined specifications.
    Additionally, we post and maintain a bid calendar of products that 
are up for bid on our public web site, inviting all suppliers, large 
and small, to request an invitation to bid. While many manufacturers 
offer multiple product lines, they must submit separate bids for each 
product category based upon the bid calendar. Novation's supplier 
agreements are generally 3-year agreements with two 1-year optional 
extension years, exercised at the discretion of Novation and the 
hospital members. Member councils also help determine if an agreement 
is sole (one supplier) or multi-sourced (multiple suppliers.) 
Generally, when there is little difference in the overall award 
decision criteria matrix results, a multi-source award is recommended 
to give members more choice.
                  ``Low Best Bid'' Contracting Process
    Novation is proud of its innovative ``low best bid'' approach to 
contracting. In fact, it is one of the first things new Novation 
employees learn as they are oriented into the company. Understanding 
the low best bid process is the key to understanding Novation's overall 
strategy. The concept centers around the view that hospitals derive the 
most value from supply agreements when other qualitative (non-
financial) factors are considered rather than just the lowest price. 
The product with the best value for hospital members is not necessarily 
the product with the lowest price. The low best bid takes into account 
both financial and non-financial criteria. All decision criteria are 
established by member councils and through research and vary from 
product category to product category. For example, non-financial 
requirements might include: patient and care provider safety, customer 
service, product quality, clinical knowledge of company 
representatives, educational offerings and cost in use. Financial 
criteria can include price, fees and other value measures such as free 
goods for trial, which are deducted from the cost of the product. These 
criteria are entered into a matrix--what we call a Decision Criteria 
Award Matrix--standardizing the way decisions are made. To calculate 
the low best bid, the financial scores are divided by the non-financial 
scores for each bidder. This fair and equitable process, created with 
significant member involvement, ensures a mix of both high quality and 
cost effectiveness.
    Our contracting process is thorough and exhaustive. The average 
contract decision takes 9 months, and some take as long as 1\1/2\ years 
from start to finish. In addition to member-based criteria and input, 
the decisions take into account such things as: interviews, field 
trials and published literature, as well as the opinions of multiple 
member clinicians. Imagine the time, resources and cost associated with 
these activities if more than 2,000 hospitals did them individually.
    The entire contracting process is member-driven. As the contracting 
arm for the members of VHA and UHC, Novation works with prestigious 
hospitals around the country that employ some of the most well-
respected clinical professionals. Novation seeks member input in many 
ways including through surveys, councils, task forces and focus groups. 
In fact, Novation sponsors 23 standing member councils and several 
other ad hoc task forces, representing more than 300 hospitals, that 
help shape Novation's product portfolio.
    Novation keeps its member-centered focus throughout its award 
selection process. Physicians, nurses, pharmacists, directors of 
operating rooms, other clinicians and materials managers from around 
the country are included on councils. These member councils help decide 
the bid criteria before the invitations to bid are even sent to 
suppliers.
    It's also important to note that Novation's highly objective and 
fair contracting process makes the concept of ``inherent conflicts'' 
practically impossible. Fees are one small part of a host of quality, 
non-financial and pricing criteria, which is also set by members. 
Mathematically alone, fees alone never drive decisions. Quality plays 
too important a role--as it should.
                  Working with Suppliers of all Sizes
    Novation's public competitive bid process allows all eligible 
suppliers to participate in a fair manner. Novation welcomes 
competition from manufacturers as it allows us to gain better value for 
the members we serve. The competitive bid process and our low best bid 
approach, provide a level playing field for manufacturers large and 
small. Our bid calendar is continuously posted on our public web site 
to ensure the bid is open to all interested parties and those 
interested in receiving a bid are encouraged to request one.
    Of the approximately 500 suppliers contracted with Novation, 25 
percent of them are small businesses, as defined by the Small Business 
Administration. A shining example of Novation working with a small 
company is our relationship with Triad Disposables, a small business 
based in Wisconsin. Through the contracting process, they were awarded 
the contract for alcohol wipes, a low-tech but vital supply for all 
hospitals. During the contract process, they won over other larger 
suppliers, including one of the largest in health care, simply because 
they brought the most value to the members per the decision criteria 
established by the members.
    Innovative technology suppliers, in addition to small suppliers, 
are found throughout our portfolio of supplier contracts. One 
innovator, Possis Medical, is a leader in creating a significant new 
medical market for the mechanical removal of blood clots with a 
procedure known as ``rheolytic thrombectomy.'' Soon after the FDA 
approved this new technology, Novation placed it on contract in 
September 1999, following input from members. The members involved in 
the decision consisted of interventional radiologists, radiology 
technologists, interventional cardiologists and cardiovascular 
administrators and nurses. Additional input was obtained through market 
research studies to VHA and UHC members.
    It is important to note the distinction between ``new'' (something 
not available anywhere else) and ``different'' (something similar that 
accomplishes the same outcome) technology. Novation is committed to 
providing agreements containing the latest technology to members--the 
competitive bid process and provisions in our contracts ensure it.
    Novation strives to be sensitive to continually evolving health 
care technology, to remain relevant to those we serve. Through our 
contracting process, we ensure that we contract for the technology that 
is most acceptable to VHA and UHC hospitals at the time of the bid 
award. Should technology change during the term of the agreement and 
the current supply partner not provide the latest technology, Novation 
can add other suppliers or terminate the existing agreement and put out 
a bid for a new agreement if the members find the technology change so 
substantive to deem the current agreement's offerings outdated. All 
agreements contain termination clauses that allow Novation to terminate 
the agreement with the existing supplier with 90 days written notice 
when necessary.
    An example of a supplier with a new technology being added to the 
portfolio is Megadyne, a small company that makes an innovative 
product--reusable grounding pads--used to protect patients from 
electrical shock. Novation already had disposable grounding pads on 
contract with 3M and Valley Lab. Megadyne's reusable pads employed a 
new technology that VHA and UHC members wanted added to the portfolio. 
These reusable pads are and example of ``new'' technology.
    An example of technology that is simply ``different'' is in the 
field of pulse oximetry. The selection of Nellcor over Masimo is a good 
example of how Novation's bid process works fairly. During the 
contracting process, which took almost 18 months to complete, we used 
enormous amounts of clinical input from members, including the active 
involvement of five separate member councils made up of more than 40 
hospital professionals as well as survey results involving more than 
850 member hospitals. Regarding the non-financial criteria, our process 
revealed that Masimo's technology is based on ``rhythmic and 
repetitive'' patient motion while Nellcor's technology is based on 
``random and chaotic'' patient motion. Masimo's product was deemed to 
be a different technology, but not a new technology. Our clinicians 
gave us input that random and chaotic patient motion is a more 
realistic measure, especially when the patients are children and 
babies. Overall, in the non-financial categories, Nellcor received 
higher marks from clinicians than any other competitor in every single 
category. In the end, the results were overwhelmingly in favor of 
Nellcor, far above all other bid participants. Ultimately, the member 
councils recommended the bid award go to Nellcor.
    Besides meeting member standards, suppliers with new technologies 
also face additional challenges. Some truly ``new'' technologies must 
wait for FDA approval.
    Others are available, but must wait long periods for reimbursement 
approval, making them cost-prohibitive to many health care 
institutions. Finally, many companies with ``new'' technologies are not 
always interested in contracts with group purchasing organizations, 
believing that with no competition they can command higher pricing for 
their product on their own.
    Possibly even more telling regarding clinical input in decisions, 
is the support of many clinicians at VHA and UHC member hospitals 
following bid awards. Because participation in our contracts is 
voluntary, hospitals often conduct their own clinical trials on some 
contracted products, even after the rigorous review the Novation 
contracting process gives to the products. By conducting their own 
clinical trials, members ensure they are choosing to access the 
products that best meet their needs. This not only underscores the 
clinical decision of our member councils, but also underscores the 
inherent freedom of choice that member hospitals enjoy in the Novation 
relationship.
    In addition to relying on member input to keep us updated on health 
care technology changes, Novation's contracting staff--with significant 
input from Novation's field-based service delivery team--is responsible 
for monitoring their respective product's markets for technological 
advances. These staff members typically have a high degree of 
experience, training and expertise related to their area of 
responsibility--often having direct experience in these areas at 
provider organizations. Should a Novation staff member learn of changes 
in product technology, the staff member can review the impact of the 
technology changes with one of Novation's member councils.
    As a member-driven organization, it is always in the members' best 
interest to make sure that our agreements meet the needs of the VHA and 
UHC members--clinically, financially and operationally.
                  Flexibility of Member Participation
    Hospital participation in Novation agreements is totally voluntary. 
Novation strives to offer VHA and UHC hospitals the most competitive 
value on the highest quality products based upon members' purchase 
patterns and ability to deliver volume, commitment and purchasing 
efficiencies.
    However, we also recognize that each hospital's ability to commit 
varies. In response, Novation offers a portfolio of agreements and 
programs in which organizations can freely choose to participate in, 
without disadvantaging those that cannot.
    For example, Novation offers a committed purchasing program we call 
OPPORTUNITY. Novation's approach to commitment is a self-selecting 
philosophy in which members are free to choose whether they wish to 
participate. We believe the voluntary nature of OPPORTUNITY has helped 
make it the industry's leading and most successful committed purchasing 
program. In addition to offering best pricing, the program helps 
organizations focus their efforts on further improving efficiencies 
through standardization and utilization. OPPORTUNITY delivers cash 
rewards for commitment and the potential to increase VHA's and UHC's 
cooperative returns. OPPORTUNITY rewards VHA and UHC hospitals that 
voluntarily meet previously agreed-upon commitments in designated 
product categories. There are no Novation programs that require 100 
percent participation.
    Our contracts offer product coverage of about 75 percent of the 
total supplies the average hospital uses. So, there is 25 percent we 
don't have on contract at all--these products could represent fast-
changing technology areas, local or regional products or large capital 
expenditures. Of the 75 percent product coverage we offer, VHA and UHC 
hospitals typically use our contracts for about 55 percent of their 
purchases. So, overall, VHA and UHC hospitals use Novation's services 
to purchase about 40 percent or less of their product needs, all of 
which is accessed on a voluntary basis. Hospitals choose what works 
best for them.
    The significant involvement of the councils and hospitals as a 
whole, play an important role in the aggregated purchasing strength of 
the VHA and UHC facilities. We actually see ourselves as a champion for 
the small rural or community hospital that would have a difficult time 
providing these services on their own. Through our aggregated approach, 
small rural and community hospitals enjoy the buying strength of large 
health systems. More than 700 VHA and UHC member hospitals have fewer 
than 100 licensed beds. According to the March 2000 Muse & Associates 
study, The Role of Group Purchasing Organization in the U.S. Health 
Care System, without Novation to contract on their behalf, these small 
health institutions could be spending up to 15 percent more on hospital 
supplies. Additionally, of our 23 member councils and task forces, 
about 30 percent of the participants are representatives from small 
hospitals with 100 beds or less.
    To better illustrate this, if I may quote Susan Park, Purchasing 
Agent of VHA member Sarah D. Culbertson Memorial Hospital in Rushville, 
IL, she says,

          ``We have limited resources, as a 58-bed facility, and 
        Novation is always willing to work with us to meet our needs. 
        With Novation's help, we gain the benefits of a bigger hospital 
        that we couldn't get on our own. Through Novation, we are not 
        little, but mighty.''
      Clinical & Operational Benefits of the VHA and UHC Alliances
    It's important to note that health care organizations affiliate 
with VHA and UHC and gain access to Novation's services for a number of 
benefits beyond simply supply chain management. These include: 
nationwide collaboration on clinical improvement initiatives; high-
quality educational opportunities; groundbreaking research on emerging 
technologies; consulting services that improve operational 
efficiencies; research on consumer trends; advocacy on public policy 
issues; and innovative services provided by VHA and UHC that might not 
otherwise be affordable for individual organizations or available from 
other sources. Alliances represent the coming together of their member 
organizations in areas other than purchasing. More can be done to 
improve the country's health through collaboration and scales of 
efficiency.
    For example, VHA recently launched the nationwide program, Women's 
HeartAdvantage, as part of a national initiative to change how women 
are treated for heart disease and to educate women about their own 
risks for heart disease. VHA is collaborating with hospitals across the 
Nation to implement the first hospital-based program to address heart 
disease, which is the greatest health threat to women. To address this 
largely unrecognized health crisis, VHA conducted nationwide and 
market-specific benchmarking research on the attitudes and awareness 
among women about heart disease. Interval results from the Yale-New 
Haven Hospital demonstration program revealed that after 10 months of 
the Women's HeartAdvantage program, awareness significantly increased 
from 26 percent to 39 percent. In fact, already we know it's helped 
save at least one life. After experiencing chest pain, a patient 
mentioned to her doctor that she had read about Yale-New Haven's 
participation in Women's HeartAdvantage. The symptoms she read about 
reminded her of her own discomfort. She was sent to the hospital, where 
doctors performed an emergency balloon angioplasty, and she's doing 
fine.
    Likewise, UHC helps members identify standards of excellence among 
academic health centers and community providers so that members can 
achieve optimal quality and productivity.
    UHC's improvement and effectiveness services focus on enhancing 
practice management, improving members' clinical and operational 
performance, and providing the support and resources for effective 
clinical decisionmaking. UHC's benchmarking projects use data-driven 
processes to identify models of efficiency and best practice, share up-
to-date information, and initiate effective, long-term clinical and 
operational improvements. A recent benchmarking study focused on 
ischemic strokes. Participating hospitals reported current patient care 
protocols for treating stroke victims. UHC compiled and reviewed the 
information and produced a report that identified best practices in 
patient care. The University of Utah Hospitals and Clinics was one of 
the stroke project participants. Using the findings from the UHC study, 
the hospital's staff formed a clinical ``brain attack team'' of 
physicians, nurses and pharmacists. The team reviewed the findings and 
modeled their response and treatment patterns on better performers' 
practices. Since implementing their new response protocols, they have 
experienced improved outcomes with many of their stroke patients.
    Attention to safety is also a vital initiative. Novation's 
comprehensive safety initiative promotes and enhances patient, care 
provider and environmental safety. Through this initiative, Novation 
increases member awareness of its safety-related contracted products; 
promotes and tracks supplier-sponsored safety initiatives; obtain 
member input on safety projects through councils; and incorporates 
safety specifications into the contract process. Our quality assurance/
regulatory affairs team ensures the delivery of safe and effective 
products by conducting manufacturing inspections and audits of supply 
partners, monitoring customer complaints and enforcing all regulatory 
guidelines.
    During 1999 and 2000, 25 VHA and UHC member organizations 
participated in the Novation Education in Anesthesia Techniques 
program. This program is an anesthesia clinical simulation training 
program offered by Novation's anesthesia business unit. The initiative 
was presented, reviewed and supported by the Novation Anesthesia 
Advisory Council which consists of clinicians such as nurses and 
pharmacists. This program allows organizations to receive a free, 
cutting-edge and accredited training program for anesthesiologists, 
nurses and pharmacists. Nine out of ten participants felt that their 
clinical staff gained enhanced clinical knowledge from the program. 
Multiple clinical participants wrote to us following the program. One 
letter from a physician and professor at the University of Minnesota 
said the program was ``tremendously successful educationally for 
medical students, residents, fellows, anesthetists and staff.''
    Additionally a fourth-year medical student that attended the 
program wrote to us saying:

          ``I attended a training session on the identification and 
        treatment of a tension pneumothorax. The very next morning, one 
        of our patients developed a tension pneumothorax in the PACU. 
        After the incident, when the resident began asking questions 
        about how to treat this condition, I was able to answer 
        correctly.''

    Additionally, VHA and UHC, operational efficiency solutions are 
offered to hospitals through [email protected], Novation's Internet 
information solution containing a members-only Web site and e-commerce 
services for hospitals and suppliers. Hospitals can access contract and 
program information, publications and other Novation supply chain 
tools. In the late 1990s, VHA and UHC members strongly indicated a need 
and a desire for electronic health care procurement. VHA and UHC's 
strategic investment in Neoforma to build [email protected] ensures 
that members have easier access to innovative technologies and reduces 
members' development costs for these services.
    The health care industry is large, fragmented and surprisingly 
behind in the information arena. Easily accessible information 
available to all parties in the supply chain is non-existent. In 1995, 
the industry-wide study, ``Efficient Healthcare Consumer Response'' 
stated that by addressing current inefficiencies in the supply chain, 
$11 billion of additional savings could be realized by America's 
hospitals. Despite the industry's best efforts to try to address these 
issues, very little was accomplished. The evolution of the Internet and 
the 2001 study, ``The Value of e-Commerce in the Healthcare Supply 
Chain'' identified specific steps we can take to achieve potentially 2-
10 percent savings and help hospitals accelerate the technology 
timeline to reach supply chain efficiencies enjoyed by other 
industries. Those steps are the guiding development principles behind 
the [email protected]
    [email protected] is an evolution of our core competency of 
aggregating purchases to reduce supply costs. The Internet makes it 
possible to streamline the process, create new efficiencies and connect 
existing information systems to perform productive new activities. 
[email protected] will enable members to purchase virtually all 
their supplies through our e-commerce services. In fact, any supplier--
both those with and without Novation agreements--can post all of their 
product information on [email protected] just those products on 
contract--to allow greater visibility. These services will allow 
members and suppliers to automate current manual purchasing processes.
    It will reduce administrative costs by aggregating purchasing 
information across all health care organization sites. 
[email protected] is a logical extension of what we already do for 
VHA and UHC members--deliver value.
    As it grows and develops, [email protected] is proving to be 
successful. In just over a year since its first member hospital went 
online, [email protected] has seen dramatic increases in the 
transaction volume and rapid hospital and supplier adoption. Currently, 
more than 700 VHA and UHC hospitals and almost 240 supply and 
distribution companies have signed on to participate in 
[email protected] e-commerce services. This leading supply chain 
solution facilitates the efficient exchange of information with 
hospitals and their suppliers for the procurement of goods and 
services, resulting in streamlined processes, reductions in 
administrative costs and more efficient healthcare purchasing.
                               Conclusion
    Safety, quality patient care and good stewardship of resources are 
the top priorities of the hospitals and health care professionals we 
serve. Their passion, commitment, and insight are transferred to us 
through their involvement in everything we do as a company. We are 
dedicated to helping hospitals around the country realize significant 
efficiencies and cost-savings--the underlying reason for the existence 
of group purchasing organizations. In today's health care environment 
of tight budgets, these savings are invaluable in allowing hospitals 
the breathing room to have resources for safe and quality patient care, 
providing indigent care, hiring practitioners, providing community 
outreach programs and offering the best services most effective to 
better the health of our nation.
    On behalf of Novation, VHA, UHC, their hospitals and their 
patients, I deeply appreciate the opportunity to share with you of the 
value and benefits we bring to public and community-owned hospitals 
around the United States.

    Chairman Kohl. Before we proceed further, I would like to 
ask Senator Schumer, who is on a very tight schedule, to make 
his always very brief and concise statement.
    [Laughter.]

         OPENING STATEMENT OF HON. CHARLES E. SCHUMER, 
           A U.S. SENATOR FROM THE STATE OF NEW YORK

    Senator Schumer. Thank you, Mr. Chairman, and I want to 
thank you for squeezing me in right now and, more importantly, 
for your leadership, and I thank Ranking Member DeWine, as 
well.
    What I want to do is just ask that my statement be added 
into the record, my whole statement, to make the point, of 
course, that health care costs are out of control. We have to 
find solutions to this. I think it is very important that all 
of us keep in mind that GPOs, in concept, are not all a bad 
thing. They perform a valuable service by permitting hospitals 
to buy supplies more effectively, and when hospitals can 
purchase quality equipment at cheaper prices, consumers save 
money.
    Now, health care bills are soaring. We know that. Savings 
cannot come at the cost of the quality of care. So the balance 
we need to strike at this hearing today is important. We have 
to not throw out the baby with the bathwater, look at the 
concept of GPOs and understand why they are needed, see if how 
business has been conducted works--there have been some serious 
allegations that it has not--and I look forward to, Mr. 
Chairman, not only to your hearing, but knowing your thoughtful 
diligence and persistence at these issues, to help you come up 
with whatever solutions might make things a little better.
    Chairman Kohl. Thank you, Senator Schumer.
    Senator Schumer. Thank you. I apologize. This committee 
always has a lot of things going and we have the bankruptcy 
conference, as well, but I wanted to come in here, so thank 
you. I appreciate it.
    Chairman Kohl. Thank you for coming.
    [The prepared statement of Senator Schumer follows:]
     Statement of Hon. Charles E. Schumer, a U.S. Senator from the 
                           State of New York
    Mr. Chairman, thank you for squeezing me in to make a few brief 
remarks. As you know because of all the work you've done on the bill, 
we're trying to work out the final details in the bankruptcy 
legislation that's in conference. But I did want to take a couple of 
moments out of that process to say a few words here.
    It's no secret that health care costs in this country are spiraling 
way out of control. An ever increasing percentage of Americans' monthly 
income is going to pay absurdly high health care bills. We need to find 
solutions to this problem that will only get more serious as the baby 
boomers move into their later years.
    One area that I've been looking at is prescription drugs. Senator 
McCain and I have a bill that would make generic drugs more broadly 
available and reduce patients' reliance on high-priced drugs from the 
big pharmaceutical companies. Passing that bill would be a start, but 
only a start.
    In the past few months there's been a lot of debate about the role 
of group purchasing organizations in the health care system. As you 
mentioned in your statement, the New York Times ran a front page 
article raising some serious questions about the practices of certain 
GPOs and I'm pleased to see that they're here today to give some 
answers to those questions.
    As we examine the problems, it's important for all of us to keep in 
mind that GPOs, in and of themselves, are not a bad thing. They perform 
a valuable service by permitting hospitals to buy supplies more 
affordably. When hospitals can purchase quality equipment at cheaper 
prices, consumers save money.
    Not to put too fine a point on it, but lower operating costs lead 
to lower-cost operations.
    With health care bills soaring through the roof, every dollar 
counts. But savings can't come at the cost of quality care. That's the 
balance we need to strike and this hearing today is important because 
it will examine both the problems with and the advantages of using 
GPOs.
    Government shouldn't jump in with fixes to problems that industry 
can clean up on its own. That's why I'm so pleased to hear that the 
GPOs have committed to creating their own code of conduct which, we 
trust, will resolve the concerns that have been raised about the ways 
GPOs operate.
    Mr. Chairman, I know that you share my view on that issue and I 
believe that holding this hearing, focusing attention on these issues, 
and taking a constructive approach to solving the problems you're 
highlighting here is just the kind of limited government intervention 
that serves our constituents well.
    I look forward to reading the testimony of everyone here and to 
reviewing your answers to the questions posed. I apologize for not 
being able to stay to participate, but duty on the bankruptcy bill 
calls.

    Chairman Kohl. Now, we proceed to Ms. Trisha Barrett.

STATEMENT OF TRISHA BARRETT, BSN, ASSISTANT DIRECTOR, MATERIEL 
SERVICES, VALUE ANALYSIS FACILITATOR, UNIVERSITY OF CALIFORNIA, 
    SAN FRANCISCO MEDICAL CENTER, SAN FRANCISCO, CALIFORNIA

    Ms. Barrett. Chairman Kohl and Senator DeWine, it is a 
pleasure to be with you this afternoon to share my perception 
of how our hospital benefits from its association with 
Novation. My name is Trisha Barrett. I am the Value Analysis 
Facilitator for the University of California-San Francisco 
Medical Center, a member of UHC, where my responsibilities 
include the clinical coordination for product selection and 
standardization.
    I have been a nurse for 25 years. Previous to joining UCSF, 
I served in a similar capacity at a VHA facility. I have thus 
served on the Novation Nursing Council as both a VHA and a UHC 
member representative. I am proud to serve an organization like 
UCSF Medical Center, where our mission focuses on caring, 
healing, teaching, and discovering.
    UCSF Medical Center is a 500-bed academic hospital. 
Annually, we perform over 20,000 surgical procedures and 
provide literally tens of thousands of days of care. To meet 
this demand, we maintain a product and device inventory 
anywhere from 20,000 to 30,000 items. Recently, we were named 
one of the top ten hospitals by U.S. News and World Report.
    Beyond the daily challenges of providing care and saving 
lives, America's hospitals face nursing shortages, constraints 
imposed by managed care, and important patient and health care 
worker safety issues. Overshadowing these challenges is 
financial pressure due to ever-rising costs of pharamceuticals, 
supplies, devices, and equipment. While Medicare, Medicaid, and 
private payer reimbursements go down, the cost of health care 
continues to rise.
    Novation helps our organization remain financially viable, 
allowing us to place our energies where they belong, on patient 
care. We spend about $120 million each year for supplies, 50 
percent of that through Novation contracts. The remaining 50 
percent is spent on products that are not on contract or on 
products that may compete with Novation contracts, but our 
clinicians choose to use them. That is one of the good things 
about Novation. Use of their services and product contracts are 
voluntary. However, we do use Novation agreements whenever we 
can because they bring value to UCSF Medical Center.
    The Medical Center benefits from my participation in 
councils and task forces because it provides a forum where I am 
able to provide clinical expertise and product experience in 
the formation and analysis of Novation contracts. Clinicians 
like me from across the country gather and collaborate to share 
our experience, reach consensus, and advise Novation in 
structuring and awarding contracts that we know will best meet 
the needs of our patients and our staff.
    For example, I am currently working with fellow clinicians 
throughout the country to establish quality criteria for the 
upcoming IV catheter bid. We clinicians share our experiences 
and opinions to formulate catheter quality and supplier service 
criteria. For instance, many hospitals have lost on-site nurse 
educators, either to national nursing shortage or to financial 
constraints. Therefore, educational support will be a high 
priority for the supplier we choose, that the supplier will be 
able to provide 24-hour-a-day, seven-day-a-week training during 
conversion from old product to new. These discussions lead to 
consensus and advice that make the final bid award a good one.
    It is important to note that as clinicians who actually use 
medical products to treat, heal, and save lives, we place a 
high priority on product quality and performance in our 
discussions and our decisions. I take my role as a health care 
professional very seriously, so when I was invited to 
participate on the Novation Nursing Council in 1999, I welcomed 
the opportunity. Being a council member is something I do above 
and beyond my day-to-day responsibilities at UCSF and often 
involves being away from my family. However, having the 
opportunity to assist Novation in contracting for the highest 
quality, most clinically acceptable products available on 
behalf of our patients makes it all worthwhile. More 
importantly, I can trust in other Novation contracts because I 
know there are hundreds of others like myself working on other 
member councils.
    I have the privilege of assisting some of the best doctors 
and nurses in the country at UCSF. With that privilege comes 
the moral and legal responsibility to invest the hospital's 
funds wisely. When selecting products, I ask my fellow 
clinicians to think of these funds as they would their own 
family budget.
    There has been a perception that member hospitals are a 
passive third party when these awards are made. Nothing could 
be further from the truth. At each individual facility, the 
hospital must evaluate Novation's offering, committed or not, 
on its clinical and financial merits.
    In closing, I would suggest that the members of the 
committee proceed very carefully in considering any new laws 
that could potentially place additional financial pressure on 
an already fragile health care system. Without companies like 
Novation, I am concerned that hospitals, and ultimately 
patients, would pay more for health care. In addition, we in 
hospitals would be forced to dedicate significant additional 
resources to contracting, diverting those precious resources 
away from care at the bedside. Thank you.
    Chairman Kohl. Thank you for your statement, Ms. Barrett.
    [The prepared statement of Ms. Barrett follows:]
Statement of Trisha Barrett, Value Analysis Facilitator, University of 
                California, San Francisco Medical Center
    Chairman Kohl, Senator DeWine, and distinguished members of the 
Subcommittee, it is a pleasure to be with you this afternoon to share 
my perspective of how our health care organization benefits from its 
association with Novation.
    My name is Trisha Barrett and I am the Value Analysis Facilitator 
for the University of California, San Francisco Medical Center--a 
member of University HealthSystem Consortium (UHC)--where my 
responsibilities include the clinical coordination for product 
selection and standardization. I have been a nurse for 25 years. 
Previous to joining UCSF, I served in similar capacity for Alta Bates 
Summit Medical Center in Berkeley and Oakland California, a member of 
VHA. I have thus served on the Novation Nursing and Clinical Practice 
Council as both a VHA and UHC member representative.
    I am proud to serve in an organization like UCSF Medical Center 
where our mission focuses on caring, healing, teaching and discovering. 
UCSF Medical Center is a 500-bed academic hospital, located in northern 
California that employs 5,500 health care professionals. Annually, we 
perform 20,000 surgical procedures, and provide tens of thousands of 
inpatient and outpatient days of care. To meet this demand, we maintain 
a product and device inventory of anywhere from 20,000 to 30,000 
different items. Recently, we were named one of the top ten hospitals 
in the Nation by U.S. News and World Report.
    Beyond the daily challenges of providing care and saving lives, 
America's healthcare organizations face shortages of nurses, 
constraints imposed by managed care, patient and healthcare worker 
safety issues, the aging of the baby boomer generation and more. 
Overshadowing these challenges is financial pressure due to the ever-
rising costs of pharmaceuticals, supplies, devices and equipment. While 
Medicare, Medicaid and private payer reimbursements go down, the cost 
of health care continues to rise. Novation helps our organization 
remain financially viable, allowing us to place our energies where they 
belong--on patient care. We spend about $120 million each year for 
supplies--50 percent of that through Novation contracts. We at UCSF 
choose to access just over 50 percent of the Novation contracts 
available to UHC hospitals. The remaining 50 percent is spent on 
products that are not on contract, or on products that may compete with 
Novation's contracts that our clinicians choose to use instead. That's 
one of the good things about Novation--use of their services and 
product contracts are voluntary. However, we do use Novation agreements 
whenever we can because they bring value to UCSF Medical Center.
    The Medical Center benefits from my participation on councils and 
task forces because it provides a forum where I am able to provide 
clinical expertise and experience in the formation and analysis of 
Novation contracts. Clinicians like me from hospitals across the 
country gather and collaborate to share our experience, reach 
consensus, and advise Novation in structuring and awarding contracts 
that we know will best meet the needs of our patients and staff.
    For example, I am currently working with fellow clinicians 
throughout the country to establish quality criteria for the IV 
catheters bid. Clinical council members share our experiences and 
opinions during meetings and conference calls where we discuss IV 
catheter quality criteria and supplier service criteria. We recently 
discussed the need for the supplier to support hospitals with education 
and training. Many hospitals have lost onsite nurse educators either to 
the national nursing shortage or to financial constraints. Educational 
support is a high priority for the supplier we choose--that they be 
able to provide training 24 hours a day 7 days a week during conversion 
from old product to new. These meetings and discussions lead to 
consensus and advice that makes the final bid a good one and also makes 
it satisfying to participate on the councils and task forces.
    It is important to note that as clinicians--who actually use 
medical products to treat, heal and save lives--we place a high 
priority on product quality and performance in our discussions and 
decisions. I take my role as a health care professional very seriously, 
so when I was invited to become a part of Novation's Nursing and 
Clinical Practice Council in 1999, I welcomed the opportunity. Being a 
member of a council is something I do above and beyond my current 
responsibilities at UCSF and involves being away from my family 
periodically. However, having the opportunity to assist Novation in 
contracting for the highest quality, most clinically acceptable 
products available on behalf of patients makes it all worth it. More 
importantly I can trust in other contracts because I know there are 
hundreds of others like myself working on the other member councils.
    I have the privilege of assisting some of the best doctors, nurses 
and other healthcare professionals in the country. With that privilege 
comes the moral and legal responsibility to invest the organization's 
funds wisely. I ask fellow clinicians to think of these funds as they 
would their own family budget. When possible, we use Novation 
contracts. Beyond that, we concentrate our own hospital resources at 
searching and bidding for those items our care providers need that are 
not on contracts or offered by suppliers who choose not to participate 
in Novation bids.
    In closing, I would suggest that the members of the committee 
proceed very carefully in considering any new laws that could 
potentially place additional financial pressure on an already fragile 
health care system. Without companies like Novation, I am concerned 
that health care organizations, and ultimately patients, would pay more 
for health care. In addition, we would be forced to dedicate 
significant additional resources toward contracting, diverting precious 
resources away from the delivery of care.
    Thank you.

    Chairman Kohl. Now, we are going to hear from Joe Kiani, 
who is a co-founder and CEO of a privately-held medical 
technology company. Thank you for being here.

   STATEMENT OF JOE E. KIANI, PRESIDENT AND CHIEF EXECUTIVE 
        OFFICER, MASIMO CORPORATION, IRVINE, CALIFORNIA

    Mr. Kiani. Thank you, Chairman Kohl and Ranking Member 
DeWine. Good afternoon. We are happy to be here to testify. We 
thank you.
    Masimo is a typical American start-up company. Our goal was 
to make a contribution to humanity by improving care and 
reducing cost of care. We also wanted to become financially 
independent and reward investors who invested in our dream.
    Masimo actually started very humbly in our garage. I took a 
loan, a second loan on my home, and since then, $90 million has 
been invested in Masimo by some of the leading health care 
investors in this country.
    Masimo has developed the next-generation pulse oximetry. 
Pulse oximetry, in case you do not know--we have lived this for 
14 years--is the non-invasive monitor to measure oxygen in the 
blood, and it is important, because if your blood oxygen drops 
below normal, within three minutes, you can get brain damage, 
and within five minutes, you can die. On neonates, there is an 
additional problem. If they get too much oxygen, they can get 
eye damage.
    Masimo is the innovator in the industry. The problems that 
were thought to be inherent limitations with pulse oximetry, we 
solved. These were problems of motion artifact, like you would 
see with babies moving or agitated patients in the intensive 
care unit or recovery room, and maybe just as importantly, very 
sick patients have very low perfusion, which means very low 
blood flow.
    In fact, there have been over 50 clinical studies over the 
last several years by independent researchers across the 
country that have proved that Masimo SET is indeed superior and 
it has improved care and reduced costs. But you gentlemen do 
not need to decide that here. We understand your role as policy 
makers is to not favor any company, but to foster a free 
market. We are not asking for special treatment. We are just 
asking for you to show oversight on this and help us compete in 
a free market.
    We believe there needs to be reform because there is a 
system here that precludes innovative devices to get to the 
hands of the clinicians who are the best to know what is best 
for the patients, and this is happening at the expense of not 
only manufacturers like ours, but expense of clinicians, 
patients, and payers.
    The fact that our primary competitor, who owns more than 90 
percent of the pulse oximetry market, can pay group purchasing 
organizations to exclude Masimo from the market is dead wrong. 
It is not good for Masimo and it is not good for the society.
    The title of the hearing is, ``Hospital Group Purchasing: 
Lowering Costs at the Expense of Patient Health and Medical 
Improvements?'' I presume this title assumes that GPOs are 
saving money. I do not understand how they can save money when 
they exclude competition in most instances.
    My dad used to say to me, to keep your honest neighbors 
honest, lock your front door. Well, with very good intentions, 
Congress left the door open in 1986 and allowed kickbacks to be 
paid by suppliers to group purchasing organizations. I guess in 
a polite world, those are not called kickbacks, they are called 
administration fees, marketing fees, other types of fees.
    GPOs, and when I mean GPOs, I am talking about the most 
powerful group purchasing organizations like Novation and 
Premier, are using this policy to enrich themselves and a few 
companies by selling them exclusivity and market share, to 
these powerful companies. Their strategy is to maximize the 
group purchasing organizations' and these companies' revenues 
at the expense of vendors, hospitals, patients, and payers, and 
as you very well know, government is one of those payers and 
pays over 40 percent of health care expenditures.
    Why have we concluded this? For 4 years, we have had direct 
experience dealing with Premier and Novation, who we believe 
actually control over 70 percent of U.S. hospitals' purchasing. 
There has been a systematic pattern of exclusion of competition 
by sole-source contracting, by bundling, by questionable 
tactics, which include threatening manufacturers of Masimo-type 
devices, the same manufacturers that actually are current, or 
some of them are still current GPO contractees, with expulsion 
if they show Masimo technology to their member hospitals. We 
discovered the hard way that the breakthrough process, the 
breakthrough technology process, or the technology assessment 
process, is a sham. I have specific examples that I will be 
happy to share with you here today and I welcome your questions 
on that.
    Is this all sour grapes? There is an exhibit I would like 
to show you. I think it is important, if you will allow us, 
Chairman Kohl, to show it.
    Let us look at this exhibit. Masimo has 100 percent success 
rate in the free markets. In the magenta, you see the sole-
source GPOs. In the yellow, you see the free markets. Last 
year, we did not lose one deal, we did not lose one opportunity 
at a hospital that was in a free market. AmeriNet is actually 
one GPO who has allowed Masimo in contract, and we are grateful 
of that. They are acting differently. They do believe members 
should have choice and voice and they do believe in bringing 
value. Then also, independent hospitals, zero. I did not expect 
to see the statistics, Chairman Kohl, but we lost zero.
    At the same time, we lost 48 contracts, 22 at Premier, 24 
at Novation, and 22 at Consorta. These are all sole-source 
contractees with Tyco-Nellcor, who is the 90 percent market 
share competitor of ours. As you can see, in hospital-wide 
conversions, what that means, these are hospitals that chose 
that every one of their patients should have access to Masimo 
SET, in the free markets, over 50 percent of those hospitals 
chose to have every patient there be monitored with our 
technology. As you can see, the sole-source environment, in 
Novation, we did have some success, 10 percent, but those 
happen to be the most famous institutions, like Massachusetts 
General Hospital, where they are not easily bullied by such 
tactics. Thank you.
    We are not just an anecdote. I know some would like you to 
believe that, but Masimo's story is just one of many, just one 
example. Chairman Kohl, there are numerous other companies--I 
can go from A to Z, companies like Applied Medical, Biotronics, 
Retractable Technologies, St. Jude Medical, and Utah Medical--
that suffer the same problems that I am talking about today.
    The current system for group purchasing organizations like 
Premier and Novation sell markets and exclusivity to group 
selling organizations, these big companies I big call them, has 
a negative impact on health care. Many companies are exploiting 
the system to exclude competition. Competition and innovation 
is, therefore, stifled. Prices are artificially kept high. 
Patient care is being harmed. Today, it is the best pulse 
oximetry, the best pacemaker, the best safety needle, but 
tomorrow, it could be the best cancer treating medication that 
is kept out.
    We need a solution. The solution should restore free 
market. I have my own. I would be happy to share with you what 
my recommendations for those solutions are. But we believe 
competition is not only the key to innovation and improved 
health care, but as one hospital purchasing manager has put on 
his walls, he put, ``Competition is the mother of lower 
prices.''
    So I would be happy to answer your questions and I thank 
you for this opportunity.
    Chairman Kohl. Thank you for your testimony today, Mr. 
Kiani.
    Now, we move on to Dr. Mitchell Goldstein, a physician at 
the Citrus Valley Medical Center at the University of 
California, Irvine Medical Center. He specializes in neonatal 
medicine.
    Dr. Goldstein.

        STATEMENT OF MITCHELL GOLDSTEIN, M.D., NEONATOL-
  OGIST, CITRUS VALLEY MEDICAL CENTER, WEST COVINA, CALIFORNIA

    Dr. Goldstein. Good afternoon. Thank you for inviting me to 
testify today. I am Dr. Mitchell Goldstein. I am a practicing 
neonatologist and clinical researcher in southern California.
    I am here because I have become concerned that products 
offering improved care and potentially decreased costs are 
being kept from reaching patients due to purchasing 
constraints. GPOs operate in the middle ground, selectively 
contracting with manufacturers and supposedly providing 
discounted pricing to hospitals.
    Pulse oximeters' incessant beeping and alarming were more 
of a distraction than a useful clinical tool when I started 
practice. During one outbreak of retinopathy prematurity, a 
disease caused by too much oxygen given to premature infants, 
an associate of mine went through the neonatal intensive care 
unit, shutting off every oximeter in the room. The devices were 
the cause of inappropriate oxygen administration. This was the 
beginning of my interest in improving this technology.
    Since 1994, I have conducted several studies on pulse 
oximetry. I found a 90 percent reduction in false alarms in 
neonatal patients using Masimo technology. Looking at the 
independent studies, Masimo SET has been shown to be 
overwhelmingly superior to its competition.
    Masimo SET has not been placed on the GPO's availability 
list. Those of us physicians who have tried to lobby for 
purchase of Masimo SET in GPO-dominated hospitals have dealt 
with the incessant smoke and mirrors techniques. One former 
associate of mine in an area children's hospital has indicated 
in a national neonatal forum that his hospital's GPO contract 
prevents them from acquiring more than a certain percentage of 
Masimo pulse oximeters. His hospital has also requested that he 
not speak publicly about these constraints.
    Several years ago, I was involved in the care of a newborn 
several weeks of age. The baby came to the emergency room in 
extreme condition. The skin was blue. Resuscitation was begun. 
The conventional monitors gave no indication of improvement. 
The pulse oximeter could not measure the infant's oxygen 
saturation. No amount of effort appeared to improve the 
situation. The nurses and respiratory therapists questioned the 
wisdom of continuing the resuscitation. I attached a novel new 
oximeter that we had only because of our research. We finally 
had a number to work with.
    If not for the presence of the Masimo pulse oximeter, life-
sustaining efforts would have been discontinued. At this 
hospital, the same pulse oximeters that did not work are still 
in use. GPO-related incentives prevented the introduction of a 
better product. Another oximeter's failure nearly cost several 
small premature babies' lives. In one case, this device 
reported a near-perfect saturation when the baby had no oxygen 
in the blood at all.
    While these occurrences have been reported to the 
manufacturer and subsequently to the FDA, these oximeters are 
still in clinical use in this particular hospital. Why? Because 
despite the manufacturer's admission that the oximeter was not 
designed to work in this type of situation, a GPO-mandated 
contract stipulates that this hospital cannot engage in 
contracting to purchase another manufacturer's pulse oximeters.
    Bunnel Incorporated produces a state-of-the-art newborn 
ventilator that prevents chronic lung disease by delivering 
very fast but very small ventilator breaths. An innovative 
device with improved ventilation and better monitoring has been 
put on the shelf because of lack of funding. The reason? 
Venture capitalists will not advance the funds necessary to 
continue the development of the ventilator because the 
manufacturer does not have an existing relationship with any of 
the GPOs. Efforts to produce a ventilator for adults have met 
with similar outcome. The GPOs have not only restricted market 
access, but have discouraged and prevented research and 
development of newer innovative technologies.
    Another ventilator company, Infrasonics Corporation, with 
an innovative line of ventilators with promising clinical 
results, was unable to capture sufficient market share to 
remain viable due to GPO contracting.
    Utah Medical Products makes special newborn central line 
catheters designed to reduce complications. In some hospitals, 
these catheters are smuggled in or kept under lock and key 
because they are prohibited under the GPO contract. Physicians 
are discouraged from officially approaching the vendor for in-
hospital competitive trials.
    Who is it, after all, that decides which equipment is 
covered by the GPO contracts? What criteria are used? What 
happens to the research and development process? If the proper 
equipment is not made available, how does the individual 
patient suffer?
    In my field, the answer is clear. Take away the incentive 
to develop newborn-appropriate devices, pulse oximeters, 
ventilators, catheters, and other equipment, develop only for 
the highly profitable product lines, cater to the lowest common 
denominator, and patient care will be compromised, the point 
that babies go blind from being exposed to inappropriate 
amounts of oxygen, flail helplessly while convulsing on 
ventilators designed principally for adults, and once again, 
lose their lives to the ravages of premature lung disease.
    As physicians, we weigh thoroughly our choices for care and 
medical therapeutics. Where medical care has become subservient 
to contracting demands, our ability to practice medicine is 
curtailed. Innovation deferred, health care denied. Give us the 
option, the freedom of choice to select the medical equipment 
that will most adequately meet our patients' needs at the best 
possible price. Thank you very much.
    Chairman Kohl. We thank you very much, Dr. Goldstein.
    [The prepared statement of Dr. Goldstein follows:]
  Statement of Mitchell Goldstein, M.D., Neonatologist, Citrus Valley 
                             Medical Center
    Patient care is dependent on the availability of equipment designed 
specifically to meet patient needs. The individual needs of patient 
care are often subservient to the contracting demands of institutions. 
Without doubt, the need to decrease cost is a powerful drive to 
achieving better access to health care. A better balance sheet allows a 
hospital to more efficiently meet its needs. Group Purchasing 
Organizations operate in the middle ground selectively contracting with 
manufacturers and supposedly providing discounted pricing to hospitals. 
However if the equipment available doesn't provide for the individual 
needs of the patient, at what price is cost savings achieved?
    During my training and early practice as a Neonatologist, pulse 
oximeters (devices designed to measure the amount of oxygen in the 
blood) had been more than a casual annoyance. The incessant beeping and 
alarming of the non-functional devices were more of a distraction than 
a useful clinical tool. During one outbreak of retinopathy of 
prematurity (blindness caused by too much oxygen given to premature 
infants) an associate of mine went through the neonatal intensive care 
unit, shutting off every oximeter in the room. These devices were the 
cause of inappropriate oxygen administration. Several weeks later I was 
discussing our frustration with a manufacturer of newborn hospital 
equipment and expressed my concern that no one in the field was working 
to enhance the State of the art. He gave me contact numbers for Masimo. 
This was the beginning of my interest in their technology.
    Since 1994, I have been involved in clinical studies with Masimo 
Signal Extraction Technology (SET) pulse oximeters. My early studies 
demonstrated the practicality of a ``Novel Pulse Oximeter Technology 
Resistant to Noise Artifact and Low Perfusion'' and that this 
technology was . . . ``Capable of Reliable Bradycardia (low heart rate) 
Monitoring in the Neonate''. Subsequently, I was able to demonstrate a 
90 percent reduction in false alarms in neonatal patients using Masimo 
technology. I showed that ``Conventional Pulse Oximetry Can Give 
Spurious Data in a Neonatal Population at Risk for Retinopathy of 
Prematurity (ROP),'' demonstrated the feasibility of reliable pulse 
oximetry operation during neonatal transport, and revealed that Masimo 
SET reliably tracks neonatal heart rate variability. We investigated 
and concluded that ``Selective Inattention to Pulse Oximetry Alarms is 
Unsafe in Infants at Risk for Apnea of Prematurity''. In studying 
Nellcor alarm management technology, SatSeconds, we showed that in an 
effort to limit ``nuisance'' alarms, the Nellcor N-395 misses relevant 
desaturations and jeopardized the detection of the infant at risk for 
sudden infant death syndrome.
    Other groups have looked critically at the emerging pulse oximeter 
technologies. Dr. Barker has shown significantly fewer missed true 
events and false alarms using Masimo SET technology in adults. He has 
demonstrated that Masimo SET is on the top of the curve relative to 
performance when compared to other oximeter technologies using a model 
of motion and low perfusion. Dr. Torres's group has shown the failure 
rate of the Nellcor 395 to be four times that of Masimo SET. Dr. 
Brouillete has shown that Masimo SET is more accurate for monitoring 
breathing obstruction during sleep in children and that the Nellcor 395 
is not adequate for a sleep laboratory setting. Dr. Hay has shown 
decreased false alarms, missed true events, and measurement failures by 
Masimo SET relative to other technologies. Dr. Sola has demonstrated a 
significant decrease in retinopathy of prematurity. Overall looking at 
major independent studies, Masimo SET has been shown to be 
overwhelmingly superior to its competition.
    Despite this plethora of evidence, Masimo SET has not been placed 
on the GPO's availability list. Those of us physicians who have tried 
to lobby for purchase of Masimo SET in GPO dominated hospitals have 
dealt with the incessant ``smoke and mirror'' techniques. One former 
associate of mine at an area Childrens Hospital has indicated in a 
national neonatal forum that his hospital's GPO contract prevents them 
from acquiring more than a certain percentage of the ``superior'' 
Masimo SET oximeters. His hospital has also requested that he not speak 
publicly about these constraints. Dr. Sola's experience, as reported in 
the New York Times article, caused him to question the entire buying 
process. ``In country with freedom of choice, this was the hardest 
thing for me to understand,'' said Dr. Sola. ``If the baby was choosing 
consciously, we know what the baby would choose.''
    Several years ago, I was involved in the care of a newborn several 
weeks of age. The baby presented to the emergency room in extreme 
condition. The skin was poorly perfused and blue. The blood pressure 
was not measurable. The baby was brought to the newborn intensive care 
unit immediately. Artificial ventilation was provided, central lines 
were placed, and fluids and cardiac medications were given. The 
conventional monitors gave no indication of improvement. I had 
approached the parents about the seriousness of the situation after 
working on the baby for over a half hour. The nurses and respiratory 
therapists questioned the wisdom of continuing the resuscitation. The 
pulse oximeter could not measure the infant's oxygen saturation. The 
baby still appeared blue and poorly perfused. No amount of effort 
appeared to improve the situation. Out of desperation, I attached a 
novel new oximeter (which only available to me on a research protocol) 
designed to work through poor perfusion. Finally, we had a number to 
work with. Despite the fact that the other oximeter was attached, for 
the next several hours, until the blood pressure was in the normal 
range, there was no saturation readout. If not for the presence of the 
Masimo pulse oximeter, life-sustaining efforts would have been 
discontinued. The baby, who was subsequently diagnosed with a complex 
heart defect, would have died instead of receiving a life sustaining 
heart transplantation. At this hospital, the same pulse oximeters that 
failed to measure this baby's vital signs are still in use despite my 
years of research demonstrating the superiority of Masimo's technology. 
GPO related incentives prevented the introduction of a better product.
    Is this an isolated case? No, there are numerous other clinical 
examples of oximetry failure. Within the past several months at yet 
another hospital, I have had the displeasure to witness another 
device's failure nearly costing several small premature babies' lives. 
In one case, this device reported a near perfect saturation, when the 
baby had no oxygen in her blood. While these occurrences have been 
reported to the manufacturer and subsequently to the FDA, these 
oximeters are still in clinical use in this particular hospital. Why? 
Because despite the manufacturer's admission that the oximeter was not 
designed to work in this type of situation, a GPO mandated contract 
stipulates that this hospital cannot engage in contracting to purchase 
another manufacturer's pulse oximeters.
    There are additional examples. In the area of assisted ventilation, 
GPO mandated contracts have restricted innovation. Bunnel Incorporated 
has for many years produced a State of the art newborn ventilator that 
helps prevent chronic lung disease by delivering very fast but very 
small ventilator breaths. An innovative device under development that 
would have produced improved ventilation with better monitoring has 
been put on the shelf for lack of funding. The reason? Venture 
capitalists will not advance the funds necessary to continue the 
development of the ventilator because the manufacturer does not have a 
relationship with any of the GPO's. Efforts to produce a ventilator for 
adults have met with similar outcome. Because of predatory tactics, the 
GPO's have not only restricted market access to only a select few 
companies but have discouraged and prevented research and development 
of newer innovative technologies.
    Infrasonics Corporation manufactured one of the more popular 
neonatal and pediatric ventilators. The InfantStar and InfantStar 950 
were in widespread use in neonatal units across the country. These 
ventilators distinguished themselves in being the ``workhorses'' of 
neonatal ventilation. With the rise of GPO related contracting, 
Infrasonics had decreased ability to sell to its market. Despite the 
fact that the 950+ was under development and provided many new and 
innovative modes of neonatal and pediatric ventilation, further sales 
and development of the product line were ultimately scuttled. These new 
``market pressures'' decrease the number of options available to 
provide patient care.
    Utah Medical Products makes special newborn central line catheters 
designed to ease insertion, reduce the risk of perforating blood 
vessels, and prevent complications such as catheter breakage, clotting, 
or adhesion to the wall of these blood vessels. In some hospitals, 
these catheters are smuggled in or kept under lock and key so that they 
can be available for ``only the sickest'' patients. Physicians are 
discouraged from ``officially'' approaching the vendor for in hospital 
competitive trials. Hospitals are falsely led to believe that they can 
rely on a consistent pricing schedule offered through the GPO's to meet 
physician expectations for choice and quality. Hospital costs can 
increase secondary to related complications, and again patient care 
suffers.
    The argument that the GPO's offer for standardization of patient 
equipment across a hospital or across a hospital network is persuasive. 
Put the same equipment in numerous centers across the country, 
standardize the equipment in the hospital so that you decrease the cost 
of training nurses and respiratory therapists, achieve the efficiencies 
of being able to order in large quantities, and increase the amount of 
money supposedly available for research and to ``improve patient 
care''. But, there is a significant downside. Who is it after all that 
decides which equipment is carried by the GPO contract? What criteria 
are used? What happens to the research and development process? If the 
proper equipment is not made available, how does the individual patient 
suffer? In the case of my field, the answer is clear. Take away the 
incentive to develop newborn appropriate devices, pulse oximeters, 
ventilators, catheters, and other equipment, develop only for the 
highly profitable product lines, cater to the lowest common dominator; 
and patient care will be compromised to the point that babies go blind 
from being exposed to inappropriate amounts of oxygen, flail helplessly 
while convulsing on ventilators designed principally for adults, and 
once again lose their lives to the ravages of premature lung disease.
    As physicians, we learn to weigh thoroughly our choices for care 
and medical therapeutics. Where medical care has become subservient to 
contracting demands, our ability to practice medicine is curtailed. 
Give us the option, the freedom of choice, to select the medical 
equipment that will most adequately meet our patient's needs at the 
best possible price.


[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]


    Chairman Kohl. Now, we turn to Mr. Lynn Detlor. He is the 
principal of GPO Concepts, Inc.

STATEMENT OF LYNN R. DETLOR, PRINCIPAL, GPO CONCEPTS, INC., SAN 
                       DIEGO, CALIFORNIA

    Mr. Detlor. Senator Kohl, thank you, Senator DeWine. My 
professional career in health care began in 1972. Group 
purchasing in health care at that time was in its infancy. 
Hospital medical supply costs averaged 6 to 7 percent of our 
annual expense budget, as compared to today in a hospital, 
where the expense for medical supplies could range anywhere 
between 23 to 28 percent, depending on the acuity of care 
delivered. The growth in new technology has helped to expand 
the growth in the supply cost arena.
    The political impact of Medicare legislation in the mid-
1970s on operating expenses had a direct impact on hospital 
executives targeting areas to lower expenses. Salary impact as 
a potential target caused adjustments in nurse staff-patient 
ratios, and supply cost reductions through materials management 
was the major targets. This drove the rapid growth of State and 
local group purchasing organizations.
    In 1974, I was hired by the Adventist Health System to 
organize and establish a collective purchasing program for 17 
hospitals in the Western United States. This shortly led to the 
expansion of the program to all 84 Adventist institutions in 
North America.
    In 1986, I was hired by American Healthcare Systems to 
organize and develop a national group purchasing organization, 
which ultimately grew to 40 multi-hospital systems representing 
approximately 1,400 institutions. This growth and expansion was 
directly related to the continued pressure to lower operating 
costs. Also in response to competition from for-profit health 
systems in select markets throughout North America, American 
Healthcare Systems operated with approximately 60 employees and 
an annual operating budget of $10 to $12 million.
    Income was derived from annual dues from its members. Over 
time, dues were replaced by fees charged to a select group of 
manufacturers, at that time which we called corporate partners. 
Fees were not taken on all contracts. Instead, management time 
was spent on helping the select manufacturers reduce their 
costs of selling and passing it along to the hospitals. The 
elimination of dues was seen as an additional cost-cutting 
strategy. Other group purchasing organizations were already 
solely fee-funded from the medical manufacturing industry.
    Pricing of products was implied by medical manufacturers to 
be linked to the largest compliant customers. This, in turn, 
led to the consolidation of the marketplace. Local and State 
group purchasing organizations began to consolidate with larger 
national organizations in the quest for lower prices for their 
members. Today, less than a dozen group purchasing 
organizations represent the majority of the nation's hospitals. 
Two, Novation and Premier, represent over 60 percent of the 
nation's institutions.
    In 1995, American Healthcare Systems and Premier, a group 
purchasing organization out of Chicago, merged, and six months 
later, Sun Health merged to form what today is the new Premier. 
Novation was formed by the linking of the University Hospital 
Consortium and the Voluntary Hospitals of America.
    The outcome of mergers has led to large organizations with 
operating budgets in excess of $300 to $400 million. Diversity 
to be more than just a group purchasing organization has led to 
program expansions in e-commerce, data mining, business 
development, physician practice management, et cetera.
    Today, working as a consultant in GPO Concepts, we hear the 
same question from two sides of the marketplace, the medical 
manufacturers and the hospitals. The medical manufacturers are 
concerned about the value they receive from the fees paid. How 
much of it makes its way down to the hospitals is also a major 
concern. The hospitals are questioning where and how the fees 
are spent, and yet hospitals face even more pressure to 
continue to lower their costs.
    Probably the remaining question in today's marketplace, are 
hospitals not competing for the same dollars that today go to 
the GPOs? It is a question the committees and GPOs have to face 
in the future. The solution rests in their management and with 
the marketplace demands upon how they function and how they 
behave. Thank you.
    Chairman Kohl. We thank you, Mr. Detlor.
    [The prepared statement of Mr. Detlor follows:]
       Statement of Lynn R. Detlor, Principal, GPO Concepts, Inc.
    My professional career in health care began in 1972. Group 
purchasing in hospital health care was in its infancy.
    Hospital medical supply costs averaged 6 to 7 percent of annual 
expense budget as compared to today in a hospital where the expense for 
medical supplies could range anywhere between 23 to 28 percent 
depending on the acuity of care delivered. The growth in new technology 
has helped to expand the growth in supply costs.
    The political impact of Medicare legislation in the mid-70's on 
operating expenses had a direct impact on hospital executives targeting 
areas to lower expenses. Salary impact as a potential target caused 
adjustments in nurse-patient staffing ratios and supply costs reduction 
through material management were the major targets. This drove the 
rapid growth of State and local group purchasing organizations to 
emerge.
    In 1974 I was hired by Adventist Health System West to organize and 
establish a collective purchasing program for 17 Adventist hospitals in 
the Western United States. This shortly led to the expansion of the 
program to all 84 Adventists throughout North America. In 1986 I was 
hired by American Healthcare Systems to organize and develop a national 
group purchasing organization which ultimately grew to 40 multi-
hospital systems representing approximately 1400 hospitals. This growth 
and expansion was directly related to the continued pressure to lower 
operating costs. Also in response to competition from the for-profit 
health systems in select markets through North America, American 
Healthcare Systems operated with approximately 60 employees and annual 
operating budget of 10-12 million dollars. Income was derived from 
dollars. Income was derived from annual dues. Over time dues were 
replaced by fees charged to select group of manufacturers called 
corporate partners. Fees were not taken on all contracts. Instead, 
management's time was spent on helping the selected manufacturers 
reduce their costs of selling and passing it along to the hospitals. 
The elimination of dues was seen as an additional cost cutting 
strategy. Other group purchasing organizations were already solely fee 
funded from the medical manufacture industry.
    Pricing of products was implied by medical manufacturers to be 
linked to the largest compliant customers. This in turn led to 
consolidation of the market place. Local and State group purchasing 
organizations began consolidating with larger national organizations in 
the quest for lower prices for their members. Today, less than a dozen 
group purchasing organizations represent the majority of the nations 
hospitals. Two, Novation and Premier represent over 60 percent of the 
nations hospitals.
    In 1995 American Healthcare Systems and Premier (A group purchasing 
organization out of Chicago) merged and 6 months later Sun Health 
merged to form what today is the new Premier. Novation was formed by a 
linking of the University Hospital Consortium and the Voluntary 
Hospitals of America.
    The outcome of the mergers has led to larger organizations with 
operating budgets in excess of $300-$400 million dollars. Diversity, to 
be more than just a group purchasing organization, has led to program 
expansions in e-commerce and data mining, business development, 
physician practice management, etc.
    Today, working as a consultant at ``GPO Concepts'' we hear the same 
questions from two sides of the market place, the medical manufacturers 
and the hospitals.
    The medical manufacturers are concerned about the value they 
receive from the fees paid. How much makes its way down to the 
hospitals is also a major concern. The hospitals are questioning where 
and how the fees are spent and yet hospitals face even more pressure to 
continue to lower costs. Are the hospitals now competing for the same 
dollars that today goes to the group purchasing organizations?

    Chairman Kohl. Finally, we come to Elizabeth Weatherman, 
who is the Managing Director of Warburg Pincus, where she has 
been a member of the health care group since 1988.

   STATEMENT OF ELIZABETH A. WEATHERMAN, VICE CHAIR, MEDICAL 
   GROUP, NATIONAL VENTURE CAPITAL ASSOCIATION AND MANAGING 
       DIRECTOR, WARBURG PINCUS, LLC, NEW YORK, NEW YORK

    Ms. Weatherman. Thank you, Senator Kohl, Senator DeWine. 
Yes, Warburg Pincus is one of the largest venture capital firms 
in the United States and, therefore, in the world, since the 
United States is the most vital community for venture capital. 
We have also been a leader in health care investing for over 30 
years. I have been with the firm for 14 years, and for the last 
13 of those have been actively investing in medical technology 
companies.
    I am also the Vice Chair of the medical group within the 
National Venture Capital Association and am here today on 
behalf of the more than 475 professional venture capital firms 
dedicated to stimulating the flow of equity capital to emerging 
growth and developing companies. Our members currently invest 
more than $36 billion per year in such companies and have 
invested nearly $210 billion in aggregate over the past 20 
years, funding many of the most important technological and 
medical breakthroughs of that period across the fields of 
biotechnology, drug development, medical devices, and health 
care services.
    First, I would like to thank you, Senator Kohl, and your 
committee and your staff for bringing forth and taking the 
initiative to examine this very critical issue to the venture 
capital medical device industry and the medical community at 
large and patients and Americans at large.
    During the past 30 years, the venture community has 
financed over 1,300 innovative medical companies with more than 
$20 billion in start-up capital, including more than $4.2 
billion last year alone. These companies now have sales of tens 
of billions of dollars and employ more than two million people, 
and most importantly, have revolutionized medical care for 
nearly all Americans.
    In fact, it is fair to say that virtually every U.S. 
citizen born during the last 30 years will benefit personally 
and significantly from one or more of the drugs or medical 
devices developed with venture capital. These include MR 
imaging, ultrasound, coronary angioplasty and stints, 
implantable cardiac defibrillators, spinal implants, pulse 
oximetry, and drugs for cancer, heart attacks, and anemia, to 
name a very few. Clearly, what these companies do is critically 
important to the well-being of the American public and the 
world at large.
    A second point is that bringing medical innovation to 
market is very hard. It entails taking enormous risks. These 
include refining and perfecting the technology itself, proving 
the safety and efficacy via well-conceived and executed human 
clinical trials, obtaining the FDA approval to market the 
technology, developing the means to assure high-quality 
manufacture of the technology, and obtaining an efficient means 
to sell and distribute it to the market. Like any market, it 
also entails for new entrants contending with established 
competitors who already have significant share with the 
customer base.
    Any one of these risks alone may lead to a venture-backed 
company's failure, and many companies focused on medical 
innovation actually do fail. Venture capitalists accept these 
legitimate risks every day, while traditional financial 
institutions and government-supported programs cannot. It is 
the function of the venture capital community to take risks 
like this.
    However, it is our view that the anti-competitive practices 
of the GPO community as currently configured disrupts the 
already highly fragile and risky process of bringing medical 
innovation to market. The new reality is that GPOs are now 
financed, and therefore too controlled by, large medical 
products companies rather than by the hospitals they are 
intended to represent.
    GPO practices such as long-term contract exclusivity, 
substantial fee structures, and product bundling, if allowed to 
continue, will so constrict potential markets that product 
segments where these practices are widely adopted will simply 
not be considered for venture capital backing. This investment 
drain will result in a stagnation of product innovation and 
stymie improved patient care in these product segments.
    It is hard enough for a small company to overcome the power 
of a large entrenched competitor even in an open and 
competitive marketplace. It is nearly impossible when 
monopolistic producers collude with monopsonistic buyers, such 
as GPOs to suppress competition.
    While the government would not tolerate such practices in 
any other sector of the economy, for it to tolerate or even 
encourage the situation in medicine is very disturbing, because 
one of the clear effects is to impede innovation, certainly not 
the government's intent. In medicine, as much if not more than 
any other sector, in contrast to any other sector, reduced 
innovation ultimately affects patients' lives and health, and 
there is no doubt that patients' health have suffered as a 
result of GPO activities. In light of this, the anti-
competitive activities of the GPOs should be viewed with even 
more, not less, skepticism.
    Finally, the idea that GPOs save money for hospitals by 
extracting larger price discounts from manufacturers than 
manufacturers could achieve themselves is unprovable and most 
likely wrong, unprovable because no one knows what the real 
market price would be in a truly competitive market among 
producers in the absence of GPO gatekeeping. In fact, the 
product areas where GPOs collude with producers who already 
have virtual monopolies, the ``discounted'' price, quote-
unquote, that the GPOs claim to achieve, is almost certainly 
well above what the market price would be in an open and 
competitive marketplace.
    In summary, the venture capital community believes there 
are enormous opportunities to continue to improve the health of 
the American public through the development and application of 
new technology. These efforts are already very expensive and 
risky. Despite this, my community is committed to further 
investments in U.S. health care technology. However, the 
increasing powers of GPOs and their collusive and anti-
competitive activities with larger entrenched medical companies 
threatens to undermine the open and competitive markets that 
have served the American public well by stimulating fair prices 
and vast technological innovation. We would strongly encourage 
the committee to correct these abuses and again open these 
markets to fair and vigorous competition.
    Chairman Kohl. We thank you, Ms. Weatherman.
    [The prepared statement of Ms. Weatherman follows:]
   Statement of Elizabeth A. Weatherman, Vice Chair, Medical Group, 
  National Venture Capital Association and Managing Director, Warburg 
                              Pincus, LLC
    Good Morning. My name is Bess Weatherman and I am Vice Chair of the 
Medical Group of the National Venture Capital Association. I am here 
today on behalf of the more than 475 professional venture capital and 
private equity firms dedicated to stimulating the flow of equity 
capital to emerging growth and developing companies. Our members 
currently invest more than $36 billion per year in such companies and 
have invested nearly $210 billion in aggregate over the past 20 years, 
funding nearly all of the most important technological breakthroughs of 
that period. A substantial number of these firms invest heavily in the 
life sciences field that includes biotechnology, drug development, 
medical devices and therapeutics and health care services. In 2001, the 
venture capital community invested more than $4.2 billion, or more than 
10 percent of all venture investing last year, in these medical 
industries.
    Venture investment in the life sciences has given new hope to 
people who suffer maladies across virtually the entire spectrum of 
diseases and afflictions. In fact, without patient investment from 
venture capitalists, the biotechnology and medical technology industry, 
for example, would be virtually nonexistent. Almost every biotechnology 
product that has been approved for sale by the Food and Drug 
Administration has been financed by the venture capital community. The 
venture community also provided financing for many of the medical 
devices and therapeutics we take for granted today, including the 
entire interventional cardiology or stent industry. These now standard 
medical treatments allow patients to lead longer and healthier lives. 
The venture community's dedication to the medical technology industry 
exists despite heavy government regulation and the longer-term 
investing strategy required for successful development of new medical 
technology, even when compared to other emerging market investments.
    Few can argue that what these companies do is critically important 
to the well being of the American public and the world at large. 
However, the results of the debate we are holding today on reforming 
group purchasing organizations to ensure a competitive and open market 
for all medical industry producers will directly affect the future of 
emerging life science companies and in turn impact the availability of 
the important medical products these companies are developing.
    Let me be clear, companies subject to, or potentially subject to, 
anti-competitive practices by GPOs will not be funded by venture 
capital. As a result, many of these companies and their innovations 
will die, even if they offer a dramatic improvement over an existing 
solution. Permitting this innovation stifling practice is unnecessary 
and counter to what we believe should be a fundamental role of the 
government: enhancing health by making new or improved products widely 
available as quickly and efficiently as possible.
       the role of venture capital in improving america's health
    Venture capital plays an integral, often-unsung role in the 
development of medical technology. In fact, venture capital is the 
single most important source of early stage financing to new and 
emerging health-focused companies. During the past 30 years, the 
venture community financed 1,324 innovative medical companies with more 
than $20 billion in startup capital. These companies now have sales of 
tens of billions of dollars, employ more than 2 million people and most 
importantly, have revolutionized medical care for nearly all Americans. 
It is fair to say that virtually every U.S. citizen born during the 
last thirty years has benefited or will benefit, in his or her 
lifetime, personally and significantly from one or more of the drugs or 
medical devices developed with U.S. venture capital. These include MR 
imaging, ultrasound, angioplasty/stents, implantable defibrillators, 
spinal implants, pulse oximetry and drugs for cancer, heart attacks, 
and anemia, to name a very few. It is also important to note that the 
real medical impact of venture investments is also significantly 
greater than even these numbers would suggest, since our investments 
are normally focused only on ground breaking or revolutionary 
technology by the very nature of our investment selection process. Many 
of these companies' names are now synonymous with progressive medical 
technology including Guidant, Amgen, and Genentech.
  why medical device and biotechnology companies need venture capital
    Medical device and biotechnology companies need venture capital 
because their capital needs are so large, their time to market so 
long--due in large part to regulatory compliance--and their risks so 
high. There are enormous entrepreneurial risks in bringing medical 
products to market--risks that include proving product safety and 
efficacy, securing patent protection, securing a good distribution 
channel, facing entrenched competition, and possibly running out of 
money before the product can reach a significant portion of the 
market--to name just a few. Such characteristics make these young 
companies ineligible for bank financing or other sources of private 
capital.
    It is important to note that venture capitalists will accept these 
legitimate risks that traditional financial institutions and government 
supported programs cannot--it's part of our function. But, VCs do not, 
cannot, and will not accept unnecessary and unfair risks. We need to 
provide our investors with justification that substantial capital 
investment can result in successful product development and financial 
gain. Thus, we have no interest in products that can be blocked from 
fairly competing for a share of a market, even after a long, expensive 
and risky product development cycle. Simply put, venture capitalists 
will increasingly stay away from many investments in long-term, high-
risk medical breakthroughs if the government continues to allow 
anticompetitive business practices to artificially limit access to 
medical market.
 standard business practices by group purchasing organizations affect 
venture capital investment emerging medical companies, and patient care
    GPO roadblocks have greatly diminished the attractiveness of 
medical device and biotechnology investments because they reduce the 
confidence of venture capitalists that they will have fair access to 
medical markets and thereby will achieve a return on very risky 
investments. To put this in perspective, between 1990 and 1994 at least 
22 percent of all companies financed by venture capitalists were 
medical device or biotechnology companies, with medical device 
companies accounting for approximately 9 percent and biotechnology 
companies accounting for 13 percent of the 22 percent. By comparison, 
during the period 1999 to 2001 these companies made up only 8.9 percent 
of all companies receiving venture capital financing. Of this 8.9 
percent, device companies received 5.0 percent and biotechnology 
companies receive 3.9 percent.
    These numbers dropped dramatically from 1999--2001 when 9.8 
percent, 7.1 percent and 11 percent respectively of the companies 
funded were medical device or biotechnology companies. For these years, 
medical device companies dropped more, making up only 5.5 percent, 3.9 
percent and 6.2 percent of the combined totals.
    One of the reasons for this relative decline new investment is a 
lack of market access brought about by the business practices and the 
increasing power of GPOs. GPO practices such as contract exclusivity, 
substantial fee structures, and product bundling, if allowed to 
continue, will so constrict potential markets that product segments 
where these practices are widely adopted will simply not be considered 
for venture capital backing. This investment drain will result in a 
stagnation of product innovation and stymie improved patient care 
across these product sectors.
    The arguments made by GPOs about the ``administrative'' savings 
they provide to members could be applied to every single sector of the 
economy and are virtually identical to the arguments made by the 
anticompetitive ``trusts'' of the early 1900's, which led to the 
landmark Sherman Antitrust laws. The idea that the GPOs ``save'' money 
for hospitals by extracting larger price discounts from producers than 
they could achieve by themselves, is unprovable and most likely wrong--
unprovable because no one knows what the ``real'' market price would be 
in a truly competitive market among producers (in the absence of GPO 
gatekeeping). In fact, 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. The 
impact of the GPOs in healthcare is equally anticompetitive and 
stifling of innovation, and there is no special reason why the 
healthcare system should be the only sector of the economy where such 
practices are tolerated.
    The venture capital industry exists, in part, because the antitrust 
philosophy of the United States prevents entrenched, unmoveable 
competitors from abusing their market power to unfairly restrain 
competition. By their very nature, virtually every company we finance 
is a ``revolutionary'' and a threat to the established order. The 
technological innovations they develop, whether in computers, 
electronics, software, telecommunications or medicine, are inevitably 
threats to some existing larger competitor who will use all means at 
its disposal to defend itself. It is hard enough to overcome that kind 
of power in an open and competitive market place. It is nearly 
impossible when monopolistic producers collude with monopsonistic 
buyers such as GPO to suppress competition. This is precisely what is 
now happening in healthcare.
    As the GPOs become more powerful and add more technologically 
sophisticated products to their portfolios (instead of the more 
commodity-like products such as rubber gloves, syringes and cotton 
swabs that they originally focused on) the adverse impact on innovation 
will increase. There will be fewer and fewer areas in which venture 
capital will invest. The current trend is not encouraging.
    The venture capital community believes that collusion between GPOs 
and providers of medical products to limit market access to competitors 
is extremely anticompetitive and not justified by any peculiarities of 
the medical sector. On the contrary, while the government would not 
tolerate such practices in any other sector of the economy, for it to 
tolerate (and even encourage) this situation in medicine is disturbing, 
because one of the clear effects of these practices is to impede 
innovation. In medicine, in contrast to any other sector, reduced 
innovation ultimately affects patients' lives and health. There is no 
doubt that patients' lives have been lost and other harm done as a 
result of GPO's activities. In light of this, the special exemptions 
from the normal operation of the antitrust laws granted to the GPOs 
should be viewed with even greater, not less skepticism.
                               Conclusion
    The venture capital community believes that there are enormous 
opportunities to continue to improve the health of the American public 
through the development and application of new technology. These 
efforts are already very time consuming, expensive and risky, 
particularly given recent increases and uncertainties in the U.S. 
regulatory environment.
    Despite this, the venture capital community is committed to further 
investment in U.S. healthcare technology. We welcome open and 
competitive marketplaces, and we believe that competition has served 
the American public well by stimulating fair prices and vast 
technological innovation. The increasing power of GPOs, and their 
collusive and anticompetitive activities with larger medical companies, 
threatens to undermine the open and competitive markets that have 
produced such obvious benefits for the American public, not only in 
healthcare, but also across the entire economy. We would strongly 
encourage the committee to consider legislation to correct these abuses 
and again open these markets to fair and vigorous competition.
    Thank you.


[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]
    
    Chairman Kohl. Before I begin my questioning, Senator 
DeWine, who has to leave for another unavoidable commitment, 
has asked to make a comment.
    Senator DeWine. Thank you, Mr. Chairman. I do apologize to 
the panel and to you for having to leave. Our voting schedule 
has thrown off my schedule a little bit today, but I look 
forward to hearing your comments and reading your comments, and 
I will, Mr. Chairman, be submitting questions for the record 
for the different panelists.
    I have found, Mr. Chairman, that the testimony of Mr. 
Kiani, Dr. Goldstein, and Ms. Weatherman to be extremely 
troubling, and I am anxious for Mr. Norling and Mr. McKenna, to 
hear their answers, because each one of us has benefitted from 
technology, medical technology. There is not a person in this 
room who has not, and the older we get, the more we benefit, 
but we also see it in our children and our grandchildren.
    So I am always alarmed if there is any possibility that any 
kind of practice that this Congress is permitting, which we 
have with the law that we passed a few years ago, that might 
impede that kind of research, might impede people taking 
changes with their money, might impede smaller start-up 
businesses that have an idea from getting a fair hearing, and 
more importantly to get a fair hearing, to get the opportunity 
to make that sale.
    So, again, I apologize to you, Mr. Chairman and the members 
of the committee. I think the testimony has been very good and 
I will take a look at the answers to your questions and the 
rest of the hearing and I will be submitting questions for the 
record. Thank you.
    Chairman Kohl. We thank you very much, Senator DeWine.
    Ladies and gentlemen, it is good to have you here. We think 
there is some opportunity to accomplish some significant 
things, not just today, but tomorrow, next week, and next 
month, and this whole area of GPOs and their impact on health 
care in our country.
    I was interested and satisfied, very pleased to hear you, 
Mr. Norling, say that you were willing and more than willing to 
be part of a group that is put together to study how we can 
improve, if possible, improve the practices of GPOs. I assume, 
or I would like to hope, Mr. McKenna, that you would be equally 
willing to be part of a group that would include not only your 
two companies, but perhaps some manufacturers, device 
manufacturers from hospitals, a small group, but a 
representative group of this entire industry, to do what we can 
collectively do to improve something that you would like to 
improve yourself, if possible, is that correct?
    Mr. McKenna. That is more than a fair statement, Senator. 
In fact, if you looked at my chicken-scratched notes, it said 
to add something at the end to acknowledge that----
    Chairman Kohl. Right.
    Mr. McKenna [continuing]. In the crush of the schedule, I 
did not do that. But I overwhelmingly would be in favor of 
principles of operation, things that would make us better. We 
always have room for improvement.
    Chairman Kohl. Mr. Norling.
    Mr. Norling. I reiterate my comments, Senator. Anything 
that is ultimately going to benefit patients, you are going to 
find us thoroughly supportive of.
    Chairman Kohl. So we will be able to discuss whatever the 
law permits us to discuss. I think that would be significant 
and I believe that that will result, and I say this not just 
optimistically, but I believe that it is your intention and 
your sincerity in wanting to run a business as well as you can, 
as clean as you can, and as efficiently and effectively as you 
can and you would be happy to discuss it. So I think that is a 
good start.
    Now, we would like to ask the two of you this question of 
financial interest in companies, either individually or 
corporately, that you do business with. I am sure you could 
understand how, at least on the surface if not far deeper, 
there is a concern on how, theoretically or in fact, you serve 
more than one master. So in advance of asking you to desist, we 
would like you to respond to our concern about financial 
interests, either as individuals or corporately, in companies 
with which you do business.
    Mr. McKenna, would you like to speak first, and then Mr. 
Norling?
    Mr. McKenna. Certainly, Senator. Thank you. We have a very 
specific conflict of interest policy and a code of ethics that 
we have provided and put into the testimony. So we have 
employees in our company that, like many companies, can own up 
to 1 percent of a public company. In regard to that matter, and 
what I personally own, as the only member of the senior 
management team that has individual stock holdings, I own at 
this point in time five stocks that would be medically 
related--actually, four medically related and one other, and 
the total holdings are 1,371 shares, with the highest holding 
being 249 shares.
    So what I would suggest in that regard, Senator, is that 
with good clinicians like Ms. Barrett next to me and the over 
23 advisory councils that we have, they have no knowledge of my 
holdings nor would they have a need to. But they do not come 
into play relative to the decisions that our clinicians and 
others make relative to our contract process, which separates 
both the non-financial or quality criteria from the financial 
criteria.
    Chairman Kohl. Wait, wait, wait. You are saying you do hold 
stock in companies with which your company does business?
    Mr. McKenna. Yes, sir.
    Chairman Kohl. You are saying this is OK?
    Mr. McKenna. We have a code of conduct, an ethics policy 
for our company, and that policy allows for ownership in public 
companies of up to 1 percent.
    Chairman Kohl. Well, that may be your company's policy. 
That is what we are discussing.
    Mr. McKenna. Yes, sir.
    Chairman Kohl. I would like to hope you could understand 
how people like myself and others would be skeptical about such 
ownership. In fact, if you want to be as clean as clean can be, 
then you might consider having a policy--after all, there are 
many stocks to own in this world----
    Mr. McKenna. Certainly.
    Chairman Kohl [continuing]. You could own a plethora of bad 
stocks or good stocks.
    Mr. McKenna. That is true.
    Chairman Kohl. So why not just say, look, it is a bad idea. 
Some people who are reputable consider it to be questionable, 
so I and all of those with whom I am associated in my company 
will not do business stock-wise with companies that we buy 
from, or who buy from us.
    Mr. McKenna. Certainly, Senator. I think it is worth a 
review. We are in the process of looking at our code of 
conduct. It has served us well, we believe, up to now. We do 
not believe there is any conflict of interest. Even our 
advisors are asked to abide by the same conflict of interest as 
they make decisions for us. But I think taking a look at it 
certainly would be in order.
    Chairman Kohl. OK. Mr. Norling.
    Mr. Norling. Senator, we also have a code of conduct/
conflict of interest policy. It speaks to individuals, and we 
also have a practice with regard to corporate conflict of 
interest.
    As regards individuals, first of all, to clarify that 
policy, in any cases where an individual is appointed by 
Premier to any kind of an outside board, it is against our 
policy for those individuals to financially benefit. Very 
specifically, the policy suggests that any income earned 
through that sort of process, be they director's options, 
director's fees, or anything else, would accrue to Premier and 
thus accrue to Premier's hospitals. So we are very specific on 
that.
    Cases have been reported in the media that suggest that 
practices have occurred otherwise. That dates back to the early 
history of the new Premier. There are no such cases at this 
time. Those cases that were reported are under investigation by 
our outside counsel. We are awaiting a comprehensive 
recommendation case-by-case as to what we ought to do in the 
four specifics that were noted. We have also been advised to 
maintain confidentiality of the individuals involved until we 
conclude our action.
    So specifically in that regard, as regards holdings by 
members of management in this area, our policy is clear. Some 
exceptions to that have been noticed. They are historic, but 
that does not mean that they are not significant. They are 
being dealt with in, I think, an appropriate way that once we 
learn about the conflict or the inconsistency of disclosure, 
we, in turn, pursue it. So with regard to that point, I think 
it is pretty clear.
    Regarding investments by employees in companies that we do 
business with or might do business with, our policy currently 
calls for disclosure, number one, and recusal, number two. I 
get a sense of where you are going here, and we are in the 
process of reviewing this policy. I can tell you that I 
personally, as regards employees in our company and having 
shares in companies we do business with, I am in personal 
support of a prohibition of that. So as we review our policies, 
we, indeed, will do that.
    Now, regarding board members, for example, who may have a 
relationship with a company in the medical area, our policy 
also calls for disclosure and recusal and I happen to believe 
that is appropriate. Board members serve a defined time period. 
More often than not, they come to the board with a set of 
experience, et cetera, and to say that to join this board, you 
must change your retirement account that might perhaps have X 
shares of some medical products company does not, to me, make 
sense.
    We think the policy of disclosure, and we do have a 
conflict of interest policy that requires full disclosure and 
the policy-related recusal should any issue come to the board 
regarding that, is an appropriate one, but as in all things, we 
are open to improving and we are open for dialogue in that 
arena.
    Chairman Kohl. Great. I think that is great. All right.
    Mr. Kiani, I am sure you would say, made some very strong 
testimony here today. He says he has an outstanding product. He 
says that he has sold that product to independent hospitals all 
across this country very successfully and the product is 
recognized as a legitimate, legitimate, very legitimate tool.
    Now, why would you not have him on your list? I mean, the 
man has tried to get on your list. He has clearly got a product 
that is on the list of many hospitals. He is not able to do 
business with you fellows. I would think that one of your 
sensitivities in your job is to recognize, as has been pointed 
out by people on this panel, how important innovation is, that 
one of your proclivities should be to bend over backwards to 
find ways to encourage innovation, which really means to get on 
your list. If they cannot get on your list, as they have 
pointed out, they are out of business.
    So here is one example of a man who has got a product which 
we would like you to comment on and perhaps tell us why, in 
your esteemed judgment, he doesn't belong on your list. Who 
wants to be first?
    [Laughter.]
    Mr. McKenna. In our case, Senator, Mr. Kiani's company did 
participate in our process. As I mentioned, it is open and fair 
and he went through the entire process along with two other 
companies that went through the bid process. This process 
involved an 18-month period where we utilized over 40 hospital 
professionals from five of our advisory councils and also got 
research returned to us from 850 of our member organizations.
    Utilizing the process that our members have helped us 
develop, which is called low best bid, we separate out the non-
financial criteria, very important, things to do with quality, 
safety, availability, education, and service, from the cost 
factors, and taking the entire submissions through that 
process, our clinicians overwhelmingly endorsed the company 
that we made an award to.
    Now, I would point out that 30 percent of our portfolio is 
offered on a dual or a multi-source basis, and so directly to 
your question, in this case, we found that this technology was 
different from the other technology that we selected. We did 
not find it at the time to be new or innovative, and, 
therefore, we looked at what value would we put on the table 
relative to the decision process, and once again, the task 
force that drove this decision, over 40 individuals strong, 
overwhelmingly came in favor of the company that we selected.
    We would, if we have not already submitted it into the 
record, would be happy to give a detailed report to you, 
Senator Kohl and all of the committee members, to review our 
process of cost divided by quality resulting in low best bid.
    Chairman Kohl. Before we ask Mr. Kiani and maybe Mr. 
Goldstein to respond to you, Mr. Norling, would you like to 
respond?
    Mr. Norling. Yes, indeed. Thank you. First of all, I am not 
a clinician, so obviously I listen to a presentation both by 
Mr. Kiani and by Dr. Goldstein and it sounds very, very 
compelling. I will tell you very frankly, in the role I am in, 
I get the benefit of multiple inputs from multiple 
manufacturers, frankly, all of whom suggest their product is 
unique and differentiated and I am not one to make that 
determination. My role is to see that there is a fair and 
effective process, so let me speak to that.
    First of all, Premier facilities are free to choose 
Masimo's product. Now, I would acknowledge that we do have a 
contract. It has a target commitment percentage, but there is 
plenty of room for the use of Masimo's product, and if I could, 
Senator, I have a couple of letters from some very key 
institutions that speak directly to this and I wonder if I 
might be able to quote from those letters.
    Chairman Kohl. Sure. Go ahead.
    Mr. Norling. Thank you very much. First of all, from St. 
Vincent Catholic Medical Centers in downtown Manhattan, an 
organization that really distinguished itself during the 9/11 
tragedy, David Campbell is the President and CEO of that 
organization. He writes in a letter to the editor of the New 
York Times in response to a New York Times article, he wanted 
to highlight the positive relationship he had with Premier. He 
indicated that they internally estimate that they have saved 7 
to 10 percent through that relationship.
    He highlights, ``the flexibility within Premier's contracts 
also allow us to choose those products that physicians require, 
whether or not Premier has arranged a group contract. There are 
instances when we have chosen to use products not on contract, 
such as Masimo's pulse oximeter, to support our caregiver's 
preference with no penalty from Premier. We currently,'' as Mr. 
Campbell says, ``use Masimo's technology in our hospitals, 
although,'' and the rest speaks to the Times and their article.
    Likewise, I have a similar letter here from the Henry Ford 
Health System in Detroit, a large organization serving all of 
Southeast Michigan. I, frankly, could come up with additional 
letters, but there is certainly the opportunity for the Masimo 
product to enter Premier hospitals, and so I would take 
exception to the suggestions that that is not the case. I have 
two letters here and, frankly, could produce others over time.
    If you are willing, sir, I would submit these for your 
consideration in the record, and that is up to you, if you 
would like to do so.
    Chairman Kohl. All right.
    So now I would like to go to Mr. Kiani. I think I am 
hearing at least Mr. McKenna say that your product is not all 
that good in comparison to its competitor and that it does not 
belong on their list. Incidentally, Mr. McKenna, is the other 
product sole source?
    Mr. McKenna. In this case, it is a sole-source contract, 
Senator----
    Chairman Kohl. Sole source, all right.
    Mr. McKenna [continuing]. It may have been as good, but 
just not--we did not find it to be--clinicians did not find it 
to be innovative, but just different technology.
    Chairman Kohl. Then the question that I would also like to 
keep on the table here is, recognizing your responsibility to 
be sensitive to innovation, I still wonder why the pulse 
oximeter, is that what it is?
    Mr. McKenna. Yes, sir.
    Chairman Kohl [continuing]. Should be a sole-source 
commodity, unless you can make the case, not only with respect 
to this product but many other products, that the alternative 
does not belong on anybody's list.
    Mr. McKenna. Not at all, Senator.
    Chairman Kohl. Then why sole source? Before I get to Mr. 
Kiani, why sole source?
    Mr. McKenna. In this case, the differential in value is 
such, offered both in pricing as well as, more importantly, 
non-financial criteria, the clinicians overwhelmingly endorsed 
this product and found the technologies to be different, but 
not new and innovative. So when looking at then making an 
award, we went through our low best bid process and the greater 
value accrued to our membership by the decision that we had 
made.
    Mr. Kiani has a fine product, and as Mr. Norling has 
stated, in our organization, our members are free to choose. We 
have members that use us to a great degree. We have members 
that use us very little. Of the 70 percent of the products that 
we cover that members use, that means 30 percent we do not have 
contracts for, we probably have in the vicinity of a little 
over 50 percent, 50 to 60 percent of their business. So about 
60 percent is bought off-contract to begin with and 40 percent 
is bought on-contract, and then that level will vary.
    If I could, I sense Ms. Barrett has some information that 
could be helpful relative to----
    Chairman Kohl. All right, and then we will hear from Mr. 
Kiani and Mr. Goldstein.
    Ms. Barrett. If I could, I would like to take Mr. McKenna 
off the hot seat a little bit in that we who participate on the 
panels often discuss that issue as we see a marketplace of 
items. I have to again ask the committee to consider the fact 
that we, as individual professionals who serve on these 
councils, take that duty to look at innovation, look at the 
marketplace, consider patient safety, very heavily in our 
deliberations.
    In many cases, we will be advising the Novation staff 
whether we think what we have seen and reviewed warrants a sole 
source or dual source or, in some cases, triple source. We as 
individual members have to realize that when we make that 
advice to Novation, we probably will be giving up on some 
financial value, but those are decisions that we, as clinicians 
on these panels and councils, take very seriously.
    Chairman Kohl. OK. Mr. Kiani, then Dr. Goldstein and Ms. 
Weatherman?
    Mr. Kiani. Senator Kohl, if you do not mind, I would like 
to just make a few points. Number one, we do not disagree with 
Ms. Trisha Barrett that the advisory group that Novation has 
put together does meet and does diligently try to come up with 
the best solution, but we have reasons to believe that the 
advisory groups, when the votes are taken, they are not 
listened to and they are taking another way or format where 
people really know what all the people on the advisory group 
really want to do.
    Now that I have made that point, because I do respect UCSF, 
I do respect the advisory groups and the members. I have met 
with a lot of them. They are very good people. It is just not 
being listened to.
    I would like to address both Premier and Novation, if I 
may, of what has happened in those particular situations. First 
of all, Premier's technology assessment team, which supposedly 
does technical evaluations for Premier and the hospitals, did 
come out with a report that said Masimo is a breakthrough and 
should be allowed and is necessary for certain types of 
patients. After completing this report, Premier stalled us for 
2 years. In the meantime, Premier extended the sole-source 
contract with Tyco-Nellcor to 2007 without even asking us for a 
price. Now, I do not understand how they could be saving their 
members----
    Chairman Kohl. Let me say this again, because I want to be 
sure. You are saying they came up with a conclusion that your 
product does represent a breakthrough technology?
    Mr. Kiani. Yes, sir.
    Chairman Kohl. Yet, at the same time, they extended the 
contract with their other supplier sole source?
    Mr. Kiani. Yes, sir.
    Chairman Kohl. To 2007?
    Mr. Kiani. To 2007. This contract has been in place since 
1996 and it was extended to 2007 and not once did they even ask 
us, what is our competitive bid, so they could use that to 
hopefully get a better price from Tyco-Nellcor. In fact, I have 
a chart that is in the back of your book that I could also put 
up. That price has been constant since 1996.
    Chairman Kohl. You are talking about independent hospitals 
where you have made a sale. How many hospitals are there? I 
think you said 44 percent, but I did not get the number. Did I 
miss the number of independent hospitals where your pulse 
oximeter is----
    Mr. Kiani. Yes. I do have the exact number. It is probably 
in the area of about 60 to 70 hospitals where we were able to 
make sales, and the testament that Premier and Novation 
hospitals wish to have our product is that they buy our 
product, but they stay below the 5 percent compliance level, or 
the 5 percent exclusion level that Novation has and the 10 
percent level that Premier has.
    Chairman Kohl. OK.
    Mr. Kiani. But if I may just take you through the Premier 
process, once they renewed it, then later Premier pronounced 
that because Tyco-Nellcor had purportedly a competitive 
product, it would not further consider Masimo as a breakthrough 
technology. Now, I do not want to take you through 50 clinical 
studies. I have charts. I do not think it is your--you are not 
here to decide if we are better or not. They are not capable of 
deciding that. It should be clinicians that decide what is best 
for the patient.
    I also mentioned that they also said we can get into 
hospitals. We know the Premier hospitals continue to petition 
Premier for exemptions to permit them to purchase Masimo 
technology. To date, all of these have been denied or not 
responded to. During the same period, at least two of our 
licensees who manufacture patient monitors with our technology 
were threatened by Premier to not even show Masimo to Premier 
hospitals. In fact, one of them refused and, maybe 
coincidentally, their contract was not renewed.
    Now, Senator Kohl, over 40 companies, companies like GE 
Medical Systems, Dataskove, Zoehl, they did their own 
evaluation. They decided Masimo SET was a breakthrough and they 
made it their standard product, but they cannot sell it into 
Premier and Novation hospitals because of these impediments.
    I would like to just briefly tell you about the Novation 
experience. Novation initially said it was not going to grant a 
sole-source contract for pulse oximetry. They said they were 
going to do a dual source. Masimo was told that many of 
Novation's hospitals wanted our technology and had listed 
accuracy, motion performance, which is what we pioneered, and 
price as key to any decision. Now, not only did our product 
beat Tyco-Nellcor's, respectfully, even though Mr. McKenna says 
we are just different, on accuracy and motion performance by 2- 
to 10-fold to 20-fold to 30-fold, depending on which study you 
look at--independent studies, not ours--but we have since 
learned that our bid price to Novation was 30 percent lower 
than Tyco-Nellcor, who got the contract.
    Now, here is a group purchasing organization that granted a 
sole-source contract, so frankly, Senator Kohl, we assumed 
Nellcor must have given a better price, but we gave a price 
that was 30 percent lower, and I have a chart that I could show 
you if you would like me to.
    Chairman Kohl. All right.
    Mr. Kiani. One last thing. I am sorry. You asked a very 
important question. You asked, why was Masimo excluded?
    Chairman Kohl. Yes.
    Mr. Kiani. You asked why Masimo was excluded. We have been 
told that up until the sixth week of the 18-month process, this 
was going to be a dual source, and Tyco-Nellcor went in in the 
11th hour and offered a kicker, more than $6 million more per 
year to Novation through an extra 10 percent fee for Novation 
to put their brand name on Nellcor-Tyco sensors and sell it.
    So if you ask why we get excluded, it is because of the 
payments that are being paid by these big suppliers who have 
learned how to manipulate the system to keep their competitors 
out. In fact, we actually believe they are paying between 12 to 
23 percent kickbacks to Novation in order to get this 
exclusion, and if you would like, I even have letters from 
UCSF, I have letters from St. Francis Hospitals, and I would 
just like to read maybe even UCSF's letter.

          ``Dear Mr. Wilson.''

    Mr. Wilson is one of our clinical specialists,

        ``We have evaluated the new Masimo Corporation pulse oximetry 
        and found them superior to existing Nellcor monitors. I 
        strongly recommend them for the pediatric intensive care unit 
        as well as the operating room.''

    This is by Dr. Mohan Reddy from UCSF, which Ms. Trisha 
Barrett is at.
    Another letter from UCSF, Dr. Scott Soifer, who is the 
Professor of Pediatrics and Vice Chair of Clinical Affairs. He 
writes,

          ``Dear Mr. Wilson, I would like to thank you''

and this is October 12, 2001.

        ``for the support Masimo provided during our evaluation of 
        pulse oximetry and inquire about when we might be receiving new 
        oximeters. After comparing the Masimo to the new Nellcor''

this is the device they say is as good as ours and we are just 
different

        ``and HP on dozens of patients, I am eager to see a Masimo at 
        every bedside in the pediatric intensive care unit. I was 
        impressed with the performance of your monitor on patients that 
        presented challenges for the other monitors and feel that 
        Masimo will help improve our ability to assess and treat our 
        patients. Please provide me with an update on your progress 
        toward supplying the pediatric intensive care unit at UCSF with 
        Masimo monitors. If I can help the process, please tell me what 
        is needed to move this along.''

    Ms. Barrett. May I respond to that? I did not know that was 
going to be coming up today. As a result of some of the new 
technology coming our way, regardless of our contract 
situation, we invited both Nellcor and Masimo back into the 
institution just recently, as Mr. Kiani suggests. Both the 
pediatric intensivists as well as the adult intensivists as 
well as all of our respiratory therapists who have a stake in 
this hearing were invited to those presentations. There was 
about an hour-and-45-minutes allotted. Both manufacturers were 
provided the opportunity to make another presentation and come 
back for questions and answers.
    To that extent, that is still under consideration at our 
institution at this very moment. I think it speaks to the 
opportunity that we can make an individual decision. Should all 
of the stakeholders, not just the two that were mentioned, 
reach a consensus, we can do that, and if we choose to do that, 
we will take into account whatever value we are giving up in 
doing that, as well as I think one thing the committee has to 
consider in looking at what we are facing every single day in 
constrained costs, and that is considerable capital equipment 
to balance with rewiring the whole place. We had just 
instituted all new critical care units for the adult side. So 
that is not an inconsequential consideration for us as we move 
forward to try to standardize.
    I would also like to take this opportunity to make the 
point about standardization. A lot has been discussed here 
about innovation, and again, I am a health care provider who 
has worked in no other industry, waiting for new innovation 
every year of my nursing career, and so I am excited about 
innovation. I am worried about innovation and it getting to our 
patients for a lot of reasons.
    But I also have to consider the constant churn of new 
product and technology as it faces our clinicians, because with 
every new device, especially more complex devices, we face an 
enormous education, patient safety, and in some cases health 
care worker safety, and we have to make that balance.
    You, Senator Kohl, spoke very eloquently about some balance 
in decisions, and that is a balance that we are looking at 
continually as we meet that innovative part of our mission and 
discovery, as well as trying to standardize and make care for 
our providers as quick and efficient as possible, in the safest 
possible manner.
    Chairman Kohl. I want to just pose this question and maybe 
get some input from some of the other panelists, which hits on 
what we are talking about here. Why do we have so many GPO 
contracts that require hospitals to purchase the vast majority 
of their supplies in a product category from the manufacturer 
with the GPO contract in order to gain the GPO negotiated 
discount price? Sometimes this commitment, as you know, is as 
high as 90 percent. In fact, it may be in Mr. Kiani's case. Why 
not give the hospital a choice?
    I do not understand this sole source, unless there is so 
little innovation, so few products that compare to the one you 
choose. I do not understand this business of sole source unless 
it is very rare, it almost never occurs, it only occurs where 
there clearly is no alternative. We are very sensitive to 
innovation. We bend over backwards to encourage innovation. 
That is why sole source never occurs or rarely occurs.
    But that is not our understanding here, that sole source is 
not an extremely rare occurrence. You hear all the other people 
on the panel say you have got to have, they have got to have 
access to you fellows or they are out of business or they are 
not even in business. Recognizing that, what is with this sole 
source?
    Mr. McKenna. First of all, Senator, all of these gentlemen 
do have access. I just would comment, the last meeting I had 
with Mr. Kiani was on an invite to come in when he did not get 
the contract award. We sat down and reviewed the process. Since 
that time, I have not heard from Mr. Kiani, and so I would be 
always open-minded in our business practice to sit and meet 
with innovative companies. Seldom, if ever, do I ever get a 
call from a venture capitalist. I do not think my staff does, 
either.
    In regard to your direct question about sole source versus 
dual source, we have many multi source, which is more than two, 
and dual source arrangements where the value and the 
innovation, or the combination of both, is perceived, and, in 
fact, laid out by our clinicians and others that evaluate our 
products to bring them the best value. But in many of our 
contracts, after evaluation of the submitted bids on criteria 
that the clinician set prior to the bid going out and putting a 
weighting on it, in the evaluation coming back, looking at cost 
factors and quality factors and dividing cost by quality and 
looking at the differential that would be left, from one 
decision to standardize on a sole-source product that more than 
meets the clinical requirements, and going to two sources of 
supply, which would leave value on the table that would not be 
able to inure to people like Ms. Barrett and her organization, 
we go with a sole source.
    So we have a blend of both. Our members who we are here to 
serve and whose bidding that we do really drive those 
decisions.
    Chairman Kohl. Ms. Weatherman, do you want to make a 
comment?
    Ms. Weatherman. Yes, I would make a couple comments. I 
think it is very important, as I have highlighted here, and I 
think everyone in this room would agree that medical innovation 
is important. But I think it is also important that innovation 
for innovation's sake is not what we should be focused on. What 
we need to focus on is, is a new product or an existing product 
truly serving a clinical need? Is it delivering value to the 
marketplace? Maybe it is because it is cheaper. Maybe it is 
because it is better, it is more accurate, it is easier to use. 
I mean, there are a lot of criteria for value that hospitals 
would perceive in a new or existing product.
    I think it is important for the committee, and my 
suggestion would be to investigate or gather the information to 
try to understand what the total revenues are and the prices 
that Tyco-Mallinckrodt-Nellcor charge for their sensors, how 
significant is that market and how much of a share do they own, 
and really look at, regardless of whether Mr. Kiani's 
technology is the same or better--I think no one has said it is 
worse in terms of delivering or serving a clinical need--I 
think it is very important to look at the context of how big is 
Nellcor-Tyco's position and what are their total fees that they 
have been paying over the years to Premier and Novation. It is 
a very important fact that needs to be looked at.
    I would contrast that, if you also wanted to investigate 
the situation with the given technology that was also 
highlighted, that in that particular situation, there is no 
significant incumbent that is being threatened by the entrance 
of that new technology. In fact, I would even ask you to look 
at what the true market potential is for that product. Where 
are the clinicians out there crying out for that technology to 
solve an unmet clinical need? I do not think you are going to 
find nearly the outcry or the market potential that you will 
see that Nellcor's sensors currently enjoy in the U.S. market.
    Chairman Kohl. OK.
    Mr. Detlor.
    Mr. Detlor. Yes. One of the things that several parties 
have said here, and it is one of the things that is a challenge 
to a GPO in general, the first thing is that incumbent 
clinicians in the sense of their historical experience deal 
with adult products. The products in this pulse oximetry were 
not, to Dr. Goldstein's conversation, were not originally 
focused nor did they have the sensitivity or the capability to 
deal with the neonatal. So you have got a segmented market that 
has developed in the pulse oximetry issue. So the demands of 
what was used in an adult marketplace, there was very little 
product available that had any sense of accuracy in the 
neonatal arena. Masimo's product bridges that type of issue, 
the change in technology.
    So if you go and survey in committees, which we used to 
spend months and hours with, what you would normally get out of 
a committee's feedback, unless they are focused solely on new 
technology, is their historical experience with the existing 
market incumbents, their satisfaction, the shortcomings, the 
things they like, et cetera.
    It takes an extremely expensive proposition for a start-up 
company to put in a sales force that is going to equal what a 
Nellcor has established over decades, so to develop the same 
clinician exposure to new technology, which means somebody as a 
clinician has to stop what they are doing in patient care and 
spend a certain amount of time with new technology, it is a 
very difficult task in today's health care environment.
    So all things being equal, from a process perspective, it 
does not surprise me that you wind up with these types of 
scenarios. People who sit on committees donate their time, et 
cetera. So many days out of a given year is all they can put 
in, at best. A good portion of that is going to be the 
historical experience, not the issue on future technology. They 
have not seen a salesperson. The companies do not have the kind 
of resources to make that type of intro and, therefore, it is 
very hard to have that be a 50/50 proposition, an equal 
footing, and I think you heard Dr. Goldstein kind of refer to 
that.
    The changes that are going to have to take place is the 
fact that in the breakout, if there is a neonatal niche for 
this technology, which has an undefined market--who knows the 
size of it, I think that is still one of the issues in the 
marketplace--then that has to be treated separately than the 
issue of what we do with adult pulse oximetry. Right now, it is 
lumped into one contract, and historically, the GPOs would do 
that, not because they meant to do any harm to anybody, but 
because of the commission input they have had historically, 
based on what they have used over years in the past. It has a 
tendency to favor the incumbent manufacturers.
    It is a process adjustment that has to take place. It is an 
issue that if we are going to look at more and more future 
technology, everyone has to guard against, the management team 
that chairs those committees of clinicians, et cetera, has to 
constantly challenge them not to take the shortcut, not to talk 
about what they have historically done, but take a look at what 
is new and current on the marketplace. It is not the clinicians 
are not willing, but they are also competing for their own day-
to-day jobs and time and what they can give to the GPO.
    So, hopefully, out of this process, maybe both GPOs, and I 
have heard the comments and the commitments, which is 
understandable, you know, you have to go back and reengineer 
your processes to make sure these things do not happen in the 
future as you move forward.
    Chairman Kohl. All right. Dr. Goldstein, do you want to 
make a comment?
    Dr. Goldstein. Thank you. I certain can appreciate cost and 
cost savings incentives and I understand what GPOs are all 
about and I can appreciate efforts involved to save money, but 
I would really at this point like to let some of the clinical 
studies talk. If you would not mind, I would like to bring out 
some of the placards that we have prepared.
    This first one shows a study that was done in an NICU 
looking at false alarms, missed true events, that is where the 
saturation, the amount of oxygen in the blood went down and the 
oximeter did not appreciate it, and measurement failures of the 
oximeter. As I mentioned, this took place in a neonatal 
intensive care unit, which is certainly my focus population. 
But you can see clearly the demonstrable improvement that 
Masimo SET has relative to its competition in these particular 
areas.
    The next example I would like to bring up specifically 
looks at one institution's experience with the Masimo SET 
oximeter with respect to retinopathy of prematurity, and in 
this, Dr. Sola, in a letter to Masimo, detailed his experiences 
with and without Masimo technology, looking at eye damage, that 
is, retinopathy of prematurity, as I alluded to in my 
statement, in this target presentation. As you can see, in the 
group that received pulse oximetry through Masimo SET, there 
was no evidence of retinopathy of prematurity, and this is a 
very significant finding.
    The next study I would like to refer to is one--the Barker 
study. This is a study that I performed, as well, in my 
institution, again looking at Masimo SET, specifically with 
respect to heart rate variability and heart rate changes. In 
this, we found that at no point, more than 1 percent of the 
time, Masimo had problems with respect to heart rate 
variability tracking. Now, granted, this is in a target 
population, neonates, where you have a great deal of heart rate 
variability and, in general, in adults, you do not see as much. 
But again, it points out my focus, that the target population 
here is being ignored.
    Looking at the objective studies that have been done 
heretofore, notwithstanding studies that have been supported 
outright by grants from either Nellcor or Masimo, 
overwhelmingly, Masimo SET is superior to its competition.
    To that, I would like to kind of ask, I mean, in terms of 
talking to people who make these decisions to the GPOs, which 
of you have been in an NICU for more than an hour within the 
past 5 years?
    Ms. Barrett. I have.
    Dr. Goldstein. You have?
    Ms. Barrett. Yes.
    Dr. Goldstein. Have either of you been in the NICU for more 
than an hour within the past 5 years?
    Mr. McKenna. The clinicians that make our decisions 
certainly have.
    Dr. Goldstein. Personally, I am asking if you have been in 
the NICU for more than an hour in the past 5 years.
    Mr. McKenna. No, I have not.
    Dr. Goldstein. You at the end, as well?
    Mr. Norling. I have not.
    Dr. Goldstein. OK. This is an important question, because 
in the interest of looking at cost and cost containment, we 
have to ask the question, what is the cost of a dead baby? What 
is the cost of a baby who has gone blind from retinopathy of 
prematurity? How do you explain this? What do you say to the 
parents in defense of this action? After all, we do have these 
overwhelming studies.
    Ms. Barrett. Could I take the opportunity here to make an 
observation and ask a question to capitalize on your expertise 
in the field. One is that the studies that I just now saw 
before us were published, I think, in the peer reviewed 
literature either late 2001 or one said 2002. So what we are 
aiming to do on many of the councils that I am involved with is 
look at evidence-based decision making, and in that, our best 
way of doing that is looking to the peer-reviewed literature 
database, which admittedly it takes a long time for the studies 
to work their way through, peer-reviewed studies, but we do try 
to have that guide us wherever that is possible and where we 
can.
    If I am not mistaken, the studies that are presented here 
may not have been available in a peer-reviewed manner at the 
time that this particular decision was made. I was not on that 
council.
    The other question that I have has to do with the fact that 
we were trying to relook at--many of your studies talk about a 
neonatal patient population. We also, in reconsidering this 
technology, wanted to see, was it applicable in adult 
population for the reasons that I am sure you are aware of. In 
hospitals, we do our best to standardize out of patient safety, 
because we have a cross-training that goes on for many of our 
physicians as well as our therapists, and having one 
standardized system they can use can become a patient safety 
issue.
    So my question is, to what extent do you think this 
technology is applicable to the adult ICUs, where it was also 
recently reconsidered by our adult therapists in that regard?
    Dr. Goldstein. With respect to the adult ICUs?
    Ms. Barrett. Yes.
    Dr. Goldstein. Again, I am a neonatologist and I do not 
profess to practice adult medicine. I am addressing a segment 
of the population that is often ignored and often not, I guess 
you could say, recognized in terms of the significance that 
newer technologies bring to care of these individual patients.
    Mr. Kiani. Senator Kohl, if I could say something, although 
as the CEO of Masimo and the person who founded it, I am 
enjoying all this conversation about Masimo pulse oximetry, how 
it is better, this is not what this meeting is about, of 
course.
    We have a systematic problem where large companies like 
Tyco-Nellcor have figured out how to use the, excuse the 
expression, almighty dollar to get large GPOs like Premier and 
Novation to exclude their competition. That is the problem, and 
we are just one example. There are adult examples right in the 
back of your hospitals you guys usually go to, unfortunately, 
where patients are being saved because of our technology and 
other stuff did not work, but that is not what it is about.
    I hope that there can be changes by the two groups sitting 
down and solving it, but I have to say that this is going to 
cause delay and delay means harm to patients and there needs to 
be something quick. It is not just about Masimo and this 
situation.
    Chairman Kohl. As you know, what we have concluded here 
this afternoon is that we are going to have an immediate forum 
composed of these two companies plus people like yourselves and 
we are going to get together on opening up this system, if we 
can, on eliminating all conflicts of interest, if we can, on 
trying to eliminate, if it is true, as you are suggesting, 
companies buying market share. They deny it, but if it is 
there, they are prepared to work on that problem, and getting 
this done in three months and reporting back in a public manner 
as to what we accomplish.
    So this, I hope, is not a hearing which, as so often on 
Capitol Hill hearings, there are hearings and then they vanish 
into history. I am very hopeful that this hearing will result 
in something that is a new and improved GPO system, and I do 
not find the principals who are here today, the two major 
principals in the industry, unwilling to engage in that process 
to see what improvements can be made.
    Mr. Norling. Senator, can I speak to the question you 
asked, as I believe it has not been answered yet. You were 
speaking about sole-source contracts, and I do have some data 
for you that might be useful.
    Chairman Kohl. All right.
    Mr. Norling. I would also like to, if I could, speak to a 
few of the other points that have been raised. Specifically, I 
think I mentioned earlier that Premier has contracts with about 
450 different manufacturers and a total of 750 contracts. Of 
them, 377 are what you would call clinical. They essentially 
relate to products where there are a clinical use and, in 
effect, where physicians may have various degrees of 
preference.
    I think the issues we are talking about here are 
specifically in areas of high physician preference, where you 
do not have a commodity, in effect, you have got something 
where there are some of the agreements that, frankly, have 
surfaced here. So I think it is important to get at this issue, 
and I think Mr. Detlor, in some ways, was trying to get at that 
also, this issue of high clinical preference and what is to be 
done.
    Premier's data is as follows. Of 377 clinical contracts, we 
have 20 sole-source contracts. I can tell you that as we have 
looked at this process and as we have come to think about it 
more fully, and frankly, as the terms of some of our longer-
term contracts have now reached the expiration dates, our 
conclusion is that in some of these areas, the idea of sole-
source contracts in high clinical preference areas do not make 
a lot of sense.
    So in terms of a practice going forward from Premier, I 
expect what you will see in these areas is as existing in-force 
contracts reach their expiration date, and prior to that, as we 
begin to renegotiate them, and even prior to that, as 
successful applications of our breakthrough technology clause 
are pursued, what you are going to see is a movement away from 
any sole source in high clinical preference to dual source or, 
in some cases, not even a commitment target of any kind but a 
preferred contract. So that is a leaning in a direction that I 
think makes sense and is a good solid learning here.
    I would make a couple of points, and just for factual 
accuracy, Premier's Nellcor contract expires in December of 
2004. I do not believe that is 7 years from now, nor was it 7 
years from the time that was quoted.
    Premier's administrative fee with regard to this is 3 
percent, no more. Very frankly, since there is some inference 
of decision making based on fees, we get greater administrative 
fees, because I do not believe the Nellcor 3 percent fee would 
change, if we contracted with Masimo, and if product flowed 
through that contract, we would actually get more 
administrative fees than we do now, and that is just a true 
economic fact of how this all works.
    Specific to the comment of being threatened by Premier 
members, I, frankly, have no knowledge of that. I have had no 
reports of that. If that were possibly true, I would agree that 
it was totally inappropriate. I seriously question whether it 
is true, but I will tell you that if, indeed, there is any 
inference of that, it would be totally inappropriate.
    I would also like to deal with this issue of the inference 
that Premier delayed the process for 2 years, and if I can, I 
would like to share with you a time line as I understand it. I 
have told you again, and I would acknowledge, Senator, that I 
have not been in a neonatal intensive care unit since I left 
active practicing as a hospital administrator about four-and-a-
half years ago, but I used to spend quite a bit of time prior 
to that.
    The time line, as I understand it, is this. In 1999, Masimo 
approached Premier and our technology assessment group with 
regard to the technology that they had in place. As it has been 
explained to me, and again, this is secondary, but again, I 
think it is accurate, is that what they had then was an 
algorithm, a calculation, if you will, and the related 
software. They did not have a stand-alone product at that time. 
Our technology assessment group said that this was an exciting 
looking technology and actually encouraged them to work with 
other manufacturers who have stand-alone products and encourage 
them to make that technology available to them, and it sounds 
like Masimo has been very successful in doing that, not with 
Nellcor, but certainly with others. As regards the time frame, 
that was the interaction with our technology assessment group.
    In January 2000, Premier received and was made aware of the 
Nellcor 395 pulse oximeter and contracted in January 2000 for 
that item. As I said, the contract goes with a term through 
2004.
    In March 2000, Nellcor approached Premier, indicating that 
they would--excuse me, Masimo approached Premier, indicating 
that they did have a product, a stand-alone product that they 
intended to bring to the market and data from Masimo suggests 
that product was first commercially available in August 2000. 
So in March 2000, we began the technology breakthrough process 
and the initial panel review suggested that this was worth 
further look, which is obviously you have to sort through all 
these requests to get to the absolute answer.
    We did bring together a panel, and at that time, based on 
the data that was available to our group and based on the 
comparison to the existing contract, namely the Nellcor 395, 
Premier made the distinction that this was not a significant 
breakthrough. Now, that does not mean that this is not a great 
product. I am sure it is. It does not mean that it is not 
particularly relevant in neonatology. Certainly, an expert here 
has suggested that it is.
    Our belief is that our contract leaves room for its use in 
that setting, and our other belief is, very frankly, that if, 
indeed, these additional studies suggest this kind of power as 
regards this particular product, particularly in neonatology, 
although I, indeed, want to explore its relevance elsewhere, 
that I would invite a resubmissions under the breakthrough 
technology program with that data, and I would tell Mr. Kiani 
that I personally will pay attention to this and make sure that 
process is expedited, because if, indeed, there is that kind of 
differential, there is no reason on earth that we would not 
want to have that kind of a product available for patients.
    Chairman Kohl. OK. We are going to wrap this up in a couple 
of minutes. I would like to just touch on two other areas.
    Is it true that some hospitals can go outside the GPO and 
get a better price on a particular commodity?
    Mr. Norling. That is a fairly complex question. The answer 
is, often, that is true. The question is whether they can do it 
consistently and sustained and create value.
    Chairman Kohl. So you have suppliers who will give a 
hospital of some size a better deal than they are giving you?
    Mr. Norling. In general, it would not be suppliers who work 
with us. It would be a situation where we would have a contract 
in place and a supplier who did not participate in that 
contract would come in and suggest that they would undercut the 
contract price.
    Chairman Kohl. So it----
    Mr. Norling. That, frankly, is the marketplace at work in a 
very productive way.
    Chairman Kohl. It is not the same product? It is not the 
same commodity?
    Mr. Norling. It may be the same product, essentially, but 
it may be different manufacturers. Now, in some cases, you may 
get the same manufacturer doing some of that. It is pretty 
infrequent in our experience. But, in general, and specific to 
the GAO report, there are a number of other reports that I 
believe were much more thorough and comprehensive in what they 
cover, such as the recent Lewin study that was submitted as 
part of the Health Industry Purchasing Group Association 
submission, studies out of Arizona State University, a study by 
Mr. Muse that suggests pretty significant benefits from GPO 
contracting, to the tune of 10 percent.
    Senator, just to give you one good example of--again, I 
have been trying to stick to factual data here--we have a 
process we call portfolio analysis. We have a team of supply 
chain folks who go out into the hospitals and collaboratively 
with them ask them for a computer dump of everything they have 
bought for a year. Now, we do about 200 of these assessments 
every single year and we get a sense of, here is everything 
that ultimately was purchased. We go through them and 
particularly highlight purchases for items in areas where we 
have a contract but that were not purchased through our 
contracts. We look at those not to penalize but to suggest what 
the benefit might have been for using our contracts.
    When we itemize these routinely, and it is a very 
significant amount of money, we have found consistently over 2 
years in more than 200 hospitals that they are leaving 9.5 
percent on the table by using contracts, or by buying product 
outside of our contracts in areas where a comparable product is 
under contract. That tells me that the marketplace, in general 
out there, is certainly not as competitive as the group 
purchasing prices that we have in place, and it is a very large 
number of hospitals and it is a very large number of dollars.
    Chairman Kohl. You are estimating to the tune of maybe nine 
to ten percent?
    Mr. Norling. Yes, I am.
    Chairman Kohl. Again, I want to ask this question. Is it 
possible that some hospitals go outside of the GPO and buy the 
same product with the same label for less?
    Mr. Norling. My answer is sometimes.
    Chairman Kohl. So that can happen and probably does? How 
can it happen?
    Ms. Barrett. I could shed some light on that. You are 
speaking about price. What we are looking for is a contract 
that offers us not just price, but some other value and quality 
criteria. So it is quite possible that a vendor may come in and 
give us a very low price, and yet when we ask, will they 
provide some educational support, will they provide some 
conversion support, then the price alone is not the only 
feature. So it is, indeed, possible for them to undercut us on 
item-by-item pricing, but indeed, we as the individual 
department materiel services managers have to look at the whole 
package that they might be offering, where price alone may not 
be the only thing that we need to look at.
    Chairman Kohl. Well, I want it to be just raw in my 
question. I am going to take Johnson and Johnson band-aids, 
which I do not know if it is on your list, but maybe it is.
    Mr. Norling. Probably.
    Chairman Kohl. Is it possible for a hospital to get a 
better price on that item than is on your list?
    Mr. McKenna. I think it is possible. In our industry, there 
is a practice that we would call cherry-picking, maybe it is 
used in other industries, where, for the work that we do, and I 
think our numbers would be consistent with what Mr. Norling has 
pointed out for what is being left on the table, but if a 
member of one of our organizations chooses to leverage what we 
have already done and apply pressure on a supplier, there may 
be a supplier that will buckle and provide a better deal.
    But in the majority of instances, it is usually one of our 
members that perhaps would leverage our contract price and go 
with a company that did not get the contract award, which I 
think proves the point relative to it is an open system and the 
hospitals will make the decisions on their own.
    Chairman Kohl. OK, last question. In the past, we have been 
informed that GPOs return about 80 percent of their 
administrative fees to their member hospitals, keeping the 
remaining 20 percent to cover their expenses. Data that Premier 
has provided to our subcommittee shows that for Premier's most 
recent fiscal year, Premier retained 63 percent of the 
administrative fee, instead of what we had understood to be 
about 20. It retained about 63 percent of the fee it collected 
from medical equipment suppliers, which was over $213 million.
    So we understand that GPOs--we assume, we are presuming 
GPOs are supposed to be merely nonprofit buying agents for 
hospitals and that they are supposed to return to their member 
hospitals the fees paid by suppliers less expenses. So where 
did all that money go, Mr. Norling?
    Mr. Norling. Thank you for your question, Senator. I think 
that I will do my best to simplify this, because this has been 
sort of an ongoing dialogue, both with your staff and with the 
media.
    There are two sets of points that have been made. First of 
all, Premier is not just a GPO. We are an enterprise that is 
about a $500 million a year enterprise. About $300 million of 
that relates to GPO administrative fees. We are also in the 
business of comparative clinical data, which charges fees. We 
have a business of well over $100 million that repairs and 
maintains clinical equipment. We also have a business that 
helps underwrite excess layer professional liability, 
professional and general liability. So we have a series of 
other businesses that comprise Premier, the enterprise. That is 
the organization that I run.
    The piece of it called Premier Group Purchasing Services is 
actually run by this gentleman here, Howard Sanders, who is 
Senior Vice President of Premier for Group Purchasing. So to 
the degree that I may not have had all the exact clinical data, 
that is, in part, because I am running the larger aggregate 
enterprise.
    The numbers are as follows. We have returned, historically 
since Premier began, 80 percent of the net income of Premier 
back to our hospital owners. So 80 percent of the net income 
generated across all of those businesses cumulatively since 
Premier started has gone back to those hospitals.
    Now, if you will take the administrative fee portion of our 
revenues, which last year were about $300 million, and if you 
look at a combination of the dollars that we send back to all 
of our members, the dollars that go back to our hospitals and 
our affiliates and the incremental value of the equity, just 
the incremental value, not the in-place value, but the 
incremental value earned per year, we have returned last year 
67.4 percent of the administrative fee dollar back to our 
members.
    So it is two different numbers. One is the percentage of 
net revenue in the aggregate and the other is a percentage of 
administrative fee revenue, which is a subset. I would be more 
than happy to document this clearly, to show you in our 
submissions to the committee exactly where those numbers come 
from, and those are, indeed, the numbers.
    Chairman Kohl. OK. Mr. McKenna?
    Mr. McKenna. Ours is a bit complex, but I will try to 
simplify it, Senator Kohl. We are owned by both VHA and UHC. 
After our expenses, everything that we have left goes to those 
organizations based on the way their members purchase, since 
they are set up as cooperatives. They, like as Mr. Norling has 
outlined, invest in other programs. There are benchmarking 
programs, clinical programs to assist local communities to 
reduce the risk of heart damage or stroke damage, and other 
services. After investing in those programs, which are board 
approved, they return--I am pretty sure this number is accurate 
for both alliances--100 percent of their net income.
    If you were to translate that into, going back to the GPO, 
I believe the numbers are, respectively, 32 cents and 40 cents 
on the dollar for both VHA and UHC, respectively.
    Chairman Kohl. OK. What I hope we have accomplished today 
is that we have seen on the part of the head of the two major 
GPOs a desire for a fairly extensive transparency with respect 
to your companies and how they function, a willingness to 
accept suggestions and comments from interested and sincere 
people who are here only to effect an improvement in the 
delivery of product and price and quality, and that we will get 
to work immediately on putting together this group of 
individuals, along with you all, who will work on achieving 
this end and expect to have a report with, hopefully, some 
positive results, inside of three months.
    If we can move forward on that, then I think we have 
achieved a lot and you will have demonstrated a sincere 
interest and willingness to work in the public interest, which 
is what this hearing was all about.
    So we thank you all for being here. You have made a real 
contribution.
    Before adjourning, I would like to insert in the record a 
number of documents. First, I would include statements from 
Senator Orrin Hatch and Senator Strom Thurmond.
    [The prepared statement of Senator Hatch follows:]
  Statement of Hon. Orrin Hatch, a U.S. Senator from the State of Utah
    Thank you, Mr. Chairman. I commend you and Senator DeWine for 
holding this hearing, as well as for your continuing efforts to get to 
the bottom of the important--and extremely complex--set of issues that 
we are addressing here today.
    I believe we need to examine how Group Purchasing Organizations--or 
``GPOs''--affect the cost and quality of health care in America. Recent 
studies and media reports have called into question whether the GPO 
system has been effective in reducing costs without sacrificing the 
quality of products available to hospitals. However, GPOs, various 
academics, and certain industry participants continue to argue that 
GPOs offer high quality products at significant savings.
    I have received and considered numerous opinions from parties on 
both sides of the GPO debate, including health care specialists, 
academics, and industry participants both from my home State of Utah 
and around the nation. To say that there is widespread disagreement 
among the participants of this debate would be a considerable 
understatement. News sources, commentators, and industry analysts offer 
diverse opinions regarding whether the GPO system helps or harms 
hospitals, consumers, and competition. Well respected academics 
similarly disagree.
    Although I believe that the concerns raised by those who are 
critical of GPOs certainly warrant further analysis and consideration, 
I do not feel that we have sufficient information to reach any solid 
conclusions on the issues that have been raised. Despite the need for 
further investigation, I want to emphasize that--based on the 
information and analysis currently available--I have several serious 
concerns regarding certain actions and practices of specific GPOs, as 
well as the structure of the GPO system in general. Without going into 
detail, I would like to summarize some of these in the hope that we 
might address them as we go forward on this issue.
    I am deeply disturbed by allegations that GPOs may prevent superior 
technologies and products from being adopted by the hospitals they 
serve.
    These claims have arisen in several distinct sets of circumstances, 
all of which raise significant questions. I am concerned about recent 
press reports that senior executives have received or obtained stock or 
stock options from product suppliers, creating serious conflicts of 
interest that may have improperly affected GPOs' purchasing decisions. 
Similarly, reports that large GPOs have favored products produced or 
supplied by entities in which they have invested raise serious 
questions as to conflicts of interest.
    I am also concerned about certain practices that may limit 
competition among small medical device manufacturers, leading to 
decreased competition and innovation. Allegations that large suppliers 
have effectively ``bought'' access to GPOs warrant further 
investigation to ascertain how widespread such activities are. 
Similarly worrisome are assertions that the products of favored 
suppliers are included in ``bundled'' or ``sole source'' contracts that 
create strong disincentives for hospitals to purchase competing 
products, effectively shutting smaller competitors out of the market.
    Finally, I note that many--perhaps even most--of the alleged harms 
and abuses raised by GPO critics have pertained disproportionately to 
the nation's two largest GPOs: Novation and Premier. The market shares 
of these two ``super GPOs'' dwarf those of the next eight largest GPOs. 
In fact, excluding Premier, Novation's estimated market share is 
roughly equal to the combined market shares of its four largest 
competitors. With the obvious exception of Novation, Premier's market 
share is almost three times that of its largest competitor. The 
enormous relative purchasing power of these two ``super GPOs''--
especially when coupled with allegations that this power has been used 
anticompetitively--raises obvious concerns. At this point, although it 
is unclear whether and to what extent the market power possessed by 
Novation and Premier has enabled allegedly anticompetitive practices, 
this question warrants further consideration.
    I look forward to hearing from the witnesses testifying here today, 
and hope that they will address these important issues. I commend the 
members of this committee for their efforts to date, and hope that--in 
conjunction with the appropriate government agencies and with the help 
of industry participants--this committee will continue its attempt to 
get to the bottom of these important issues.

    [The prepared statement of Senator Thurmond follows:]
  Statement of Hon. Strom Thurmond, a U.S. Senator from the State of 
                             South Carolina
    Mr. Chairman: Thank you for holding this important hearing today on 
hospital group purchasing and its effects on patient health and medical 
innovation. In particular, this committee should carefully examine the 
role that Group Purchasing Organizations (GPOs) play in bringing 
medical products to market. GPOs deserve antitrust scrutiny for two 
significant reasons.
    First, the organizations themselves are the result of hospitals 
banding together in order to increase buying power. Second, GPOs have 
merged and consolidated the industry significantly. The result is that 
two large corporations, Premier and Novation, control purchasing for 
approximately 60 percent of the Nation's hospitals. With these two 
concerns in mind, we must determine whether the consumers of medical 
care, the patients, are being well-served by GPOs.
    The fundamental premise of a GPO is to allow hospitals to aggregate 
their purchases and thereby negotiate lower prices. GPOs are generally 
immune from antitrust scrutiny for an array of policy reasons. When 
hospitals band together, they are better able to counteract the 
significant market power of large manufacturers of medical supplies and 
equipment. Additionally, the lower prices procured by the hospitals 
enable them to maintain financial stability in the Medicare prospective 
payment system. This prospective payment system replaced fee for 
service plans and essentially resulted in caps on Medicare payments, 
limiting what the Federal Government would pay hospitals for medical 
services.
    In addition to the relaxed antitrust scrutiny, GPOs have another 
useful tool in procuring lower costs for hospitals. They are immune 
from anti-kickback laws. This allows the payments for services provided 
by the GPOs to be shifted from the hospitals, the buyers of the goods, 
to the manufacturers of the goods. Therefore, manufacturers of goods 
pay kickbacks, often called administrative fees, to the GPOs. 
Administrative fees are commonly 3 percent of the value of goods sold 
to the hospitals, and may be higher if disclosed in writing. These fees 
go the GPO itself, and portions are remitted to the hospitals. Due to 
this arrangement, hospitals realize lower costs.
    At first glance, the lower costs attributed to group purchasing 
power may appear to benefit patients. Indeed, group purchasing keeps 
prices low, and that is certainly desirable in the medical marketplace. 
However, a closer look at current policies reveals some disturbing 
consequences.
    Many smaller device manufacturers have voiced concerns that they 
cannot break into the marketplace due to the power of GPOs. For 
example, GPOs negotiate long term contracts, thereby making it more 
difficult to bring new and innovative products to market. Long-term 
contracts themselves would not generally be a cause for concern. Two 
business entities may enter into these contracts if they wish. However, 
due to the fact that hospitals have all joined together in the GPOs, 
large numbers of hospitals are committed to these long-term contracts. 
This scenario warrants antitrust scrutiny.
    Smaller manufacturers may also have a more difficult time paying 
the kickbacks, or administrative fees, required to sell their products 
to the GPOs. Furthermore, the anti-kickback exception invites the kind 
of abuse that anti-kickback laws were designed to stop. Larger 
manufacturers have an incentive to pay higher administrative fees in 
order to dissuade the GPOs from purchasing the products of smaller 
competitors.
    It is my hope that this committee will closely examine the 
antitrust immunity and anti-kickback exception that GPOs enjoy. We 
should not support policies that inhibit the abilities of smaller 
manufacturers to introduce innovative products into the marketplace. If 
patients are not benefiting from current practices, we should seek to 
implement reforms that free the marketplace to function unhindered by 
anti-competitive practices.
    Another concern associated with the GPO system is the consolidation 
of the industry. In many areas, one of the two dominant GPOs, Premier 
or Novation, serves all of the hospitals while the other is almost 
nonexistent. The result is a dominant buyer in the market, which has 
been referred to as a monopsony, or a buyer monopoly. For antitrust 
purposes, a monopsony may be just as troubling as a monopoly due to the 
distortions that it creates in the market.
    The buying power of the GPOs raises questions about the common 
practice of ``bundling'' in contracts with medical manufacturers. A 
bundled contract provides for numerous products to be purchased in one 
order, benefiting the seller, who can sell more products, and allowing 
the GPO to negotiate lower prices. While this practice may lower 
hospital costs, it may also have the effect of keeping other 
manufacturers out of the market. Because hospitals must usually 
purchase a high percentage of their products through the GPO to take 
advantage of discounts, there is less of an incentive for hospitals to 
bypass the GPOs and negotiate with the manufacturers directly.
    Additionally, recent media reports have indicated that Premier 
invested in medical supplier companies, and then made contracts with 
them to provide supplies to Premier hospitals. I am greatly concerned 
about these allegations, and this committee should thoroughly study 
these potential conflicts of interest. If Premier has engaged in such 
activity, it has leveraged its buyer monopoly to procure goods from a 
company in which it has an interest, effectively blocking out 
legitimate competitors.
    Mr. Chairman, I appreciate your work on this matter, and I hope 
that we will learn more today about the role of GPOs in the health care 
industry. While GPOs have almost certainly led to decreased costs for 
hospitals, we should carefully examine whether patients benefit from 
the current system of group purchasing. If innovative and crucial 
technology is not reaching our Nation's hospitals, we should consider 
reforming current practices. We should ask whether GPO immunity from 
general principles of antitrust law and anti-kickback law best serves 
those in need of medical care. I hope that our witnesses will address 
these important questions, and I look forward to hearing from them 
today.

    Chairman Kohl. I would like to insert the GAO report that 
has been referred to several times during this hearing, 
entitled ``Group Purchasing Organizations: Pilot Study Suggests 
Large Buying Groups Do Not Always Offer Hospitals Lower 
Prices.''
    I would also like to insert a number of statements that 
have been submitted for the record. These are from Thomas J. 
Shaw, President and CEO of Retractable Technologies, Inc.; 
Larry Holden, President, Medical Device Manufacturers 
Association; Thomas V. Brown, Executive Vice President of 
Biotronik; Robert Betz, President and CEO of the Health 
Industry Group Purchasing Association; Paul Hazen, President 
and CEO of the National Cooperative Business Association; Einer 
Elhauge, Professor of Law at Harvard Law School; Jeffrey C. 
Lerner, President and Chief Executive Officer of ECRI; Dr. 
Augusto Sola, Professor of Pediatrics and Obstetrics and 
Gynecology, and Director, Division of Neonatal-Perinatal 
Medicine at Emory University School of Medicine; Frederick M. 
Valerino, Jr., President, Pevco Systems International, Inc.; 
and Julia Naunheim Hipps, a registered nurse from St. Louis, 
Missouri.
    This hearing is now adjourned.
    [Whereupon, at 5:00 p.m., the subcommittee was adjourned.]
    [Questions and Answers and Submissions for the record 
follow.]
    [Additional material is being retained in the Committee 
files.]





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