Working with Group Purchasing Organizations

This article was originally published on Industry Today.

Supply chain issues are getting increasingly complex. Not only because of the everyday complications—freight, supply, customs, etc.—but because of the number of players in the field. More and more, particularly in fields like foodservice and healthcare, purchasing is being run through a third-party intermediary known as a “Group Purchasing Organization,” or a “GPO.”

A GPO makes money by grouping together smaller purchasers and negotiating pricing on their behalf. By grouping together purchasers, the GPO increases the volume they can bring to manufacturers and is thus able to obtain better pricing. To make money, the GPO generally takes a cut of the savings they have created for their buyers.

For example, if a case of broccoli is $10 on the open market, a GPO might negotiate a purchase price of $8 for its members. Generally, the end-user customer will nonetheless purchase the case of broccoli through normal channels (like a food distributor) for $10. The manufacturer then pays the $2 difference directly to the GPO. The GPO, in turn, remits some portion—say, $1—to the buyer. The buyer’s net price is thus $9—a dollar cheaper than it can do on the open market—and the GPO earns $1. Everybody wins. Sometimes.

Everybody wins when the system works like it is supposed to. But it doesn’t always. For example, the GPO may claim it sold more cases of broccoli than it did. Or the GPO may seek its rebate for cases that were not purchased through the GPO. For example, if the distributor holds a sale and the broccoli is offered at $7.50 a case, the buyer may purchase directly through that deal—yet the GPO may still try to claim its $2. At that point, the manufacturer is probably losing money on the sale by netting only $5.50 on a case that usually sells for $10.

The problem is manufacturers often don’t know which purchases were made through the GPO and which were not. They get an aggregate bill from the GPO with very little detail. And most manufacturers have few options but to pay the invoice – otherwise, that GPO’s volume will not only be lost, but will likely go to the manufacturer’s competitor.  

Recently, juice manufacturer Gregory Packaging stood up to Foodbuy, the largest GPO in the foodservice industry (and owned by Compass Group, the largest foodservice company in the world). First, Gregory Packaging refused to pay about $1 million in invoices to Foodbuy, claiming the invoices did not accurately reflect purchases by Foodbuy’s members. Gregory Packaging did not renew its contract with Foodbuy and let Foodbuy’s purchases go to a competitor.

Foodbuy sued Gregory Packaging for that $1 million in unpaid invoices. The court, however, found that Foodbuy had been charging Gregory Packaging for products it did not sell for years and awarded $9.2 million in damages and another $14 million as a penalty for Foodbuy’s unfair and deceptive trade practices. In other words, after getting sued for $1 million, Gregory Packaging recovered more than $23 million from Foodbuy.

That case goes to show that GPO invoices must be validated by manufacturers. They cannot be accepted at face value.

Validating GPO invoices, however, requires data. Foodbuy, it turns out, received data from food distributors on all of its members’ purchases. It then charged Gregory Packaging whether the customer was buying through Foodbuy or through another channel.

The lesson learned here is two-fold. First, when negotiating deals with GPOs, manufacturers should avoid being distracted by the large volume (and associated dollars) and ensure the deal includes transparency. One must consider what data is necessary to ensure that sales are actually new business brought by the GPO and not the GPO claiming sales the manufacturer would have made anyway. Then, with that data in hand, manufacturers must go through the laborious process of validating those invoices. There is a cost involved in doing so, and that cost should be factored into any GPO deal to ensure it’s profitable. There is software that can help, but some issues will always require human analysis.

The Gregory Packaging case can be used as a guide to show what manufacturers need to consider and to convince GPOs why it’s important. GPOs acting honestly should have no problem turning over the data so that their invoices can be properly validated. That way, all parties are sure that the GPO system is working—the GPOs are bringing new business to manufacturers and manufacturers are giving a discount in return. If the GPO is refusing to turn over the data necessary to validate their invoices—there is likely a problem.