Summary: Below an excerpt from “Dirty Medicine” which appears in the July/August 2010 issue of Washington Monthly. The article reveals how “group purchasing organizations”( GPOs) have taken control of the medical supply and  device market.

Originally, GPOs were non-profit collectives formed by medical facilities that hoped to keep a lid on prices by banding together to make bulk purchases of supplies and devices at a discount. But in the mid-1970s, reporter Mariah Blake explains, “the model began to shift. Some large hospital chains started to spin off for-profit GPO subsidiaries, which other hospitals could join by paying membership dues, much the way members of buying clubs like Costco pay dues to get bulk-buying discounts. By decade’s end, virtually every hospital in America belonged to a GPO.

“Then, in 1986 Congress passed a bill exempting GPOs from the anti-kickback provisions embedded in Medicare law. This meant that instead of collecting membership dues, GPOs could collect ‘fees’—in other industries they might be called kickbacks– from suppliers in the form of a share of sales revenue. (For example, in exchange for signing a contract with a given gauze maker, a GPO might get a percentage of whatever the company made selling gauze to members.) The idea was to help struggling hospitals by shifting the burden of funding GPOs’ operations to vendors. To prevent abuse, ‘fees’ of more than 3 percent of sales were supposed to be reported to member hospitals and (upon request) the secretary of health and human services.

"Suddenly a GPO’s revenues were tied to the profits of the suppliers that they were supposed to be negotiating with for discounts. Rather than representing their member hospitals, GPOs began to favor sellers, big companies like Becton Dickinson. No surprise, prices of medical supplies and devices spiraled. As a former GPO executive told Blake: “. . . if you get a percentage of sales, going with a lower bid from a little company just loses you money and pisses off the big vendors with multiple contracts.”

Blake tells the stories of two small suppliers who offered a better product at a lower price.

                              From The Washington Monthly
                                      Dirty Medicine

                                      by Mariah Blake

When Thomas Shaw gets worked up, he twists in his chair and kneads his hand. Or he paces about in his tube socks grumbling, “They’re trying to destroy us,” and “The whole thing is a giant scam.” And Shaw, the founder of a medical device maker called Retractable Technologies, spends a lot of time being agitated.

One of the topics that gets him most riled up these days is bloodstream infections. And with good reason—while most people rarely think about them, these are the most dangerous of the hospital-acquired bugs that afflict one in ten patients in the United States. Their spread has helped to make contact with our health care system the fifth leading cause of death in this country.

A few years ago, Shaw, an engineer by training, decided he wanted to do something to help solve this problem and quickly homed in on the mechanics of needle-less IV catheters. Rather than using needles to inject drugs into IV systems, most hospitals have moved to a new design, which involves screwing the threaded tip of a needle-less syringe into a specially designed port. The problem is that if the tip brushes against a nurse’s scrubs, or a counter, or the railing of a hospital bed, it can pick up bacteria. And the rugged threaded surface makes it difficult to get rid of the germs once they’re there. Often, the bacteria go straight into the patients’ bloodstream—which explains why, according to some studies, the rate of bloodstream infections is three times higher with needle-less systems than with their needle-based counterparts.

After months of trial and error, Shaw hit on the idea of surrounding the tip of the syringe with six petal-like flanges, which could flare open to make way for the catheter port. Unlike some of the solutions floated by big medical device makers, such as coating the ports with silver, Shaw’s innovation added only a few pennies to the cost of production. And it seemed to be remarkably effective: a 2007 clinical study funded by Shaw’s company and conducted by the independent SGS Laboratories found the device prevented germs from being transferred to catheters nearly 100 percent of the time.

Given these facts, you might expect that hospitals would be lining up to buy Shaw’s product. But that is not the case, even though his company is offering to match whatever price medical facilities are paying for their current, infection-prone IV catheter syringes. In fact, since the device hit the market two years ago, Retractable has sold fewer than 20,000 units, mostly to one New York hospital. Often, the company’s sales team can’t even get in the door to show their wares to purchasing agents. “The product does exactly what it is supposed to do,” Shaw says. “But it has one fatal flaw. Right there at the bottom of the handle it says Retractable Technologies.”

This is hardly the first time Shaw has found his path to market blocked. In fact, he has spent the last fifteen years watching his potentially game-changing inventions collect dust on warehouse shelves. And the same is true of countless other small medical suppliers. Their plight is just the most visible outgrowth of the tangled system hospitals use to purchase their supplies—a system built on a seemingly minor provision in Medicare law that few people even know about. It’s a system that has stifled innovation and kept lifesaving medical devices off the market. And while it’s supposed to curb prices, it may actually be driving up the cost of medical supplies, the second largest expenditure for our nation’s hospitals and clinics and a major contributor to the ballooning cost of health care, which consumes nearly a fifth of our gross domestic product.

Thomas Shaw is a lanky fifty-nine-year-old man with dark eyes and a shock of gray hair that gives him a bit of a mad scientist air. Growing up, he lived in Mexico and Arizona, where his father worked as a chemist (among other things, the elder Shaw invented the first nitrogen test for plants). Shaw describes his childhood home as a kind of frenetic laboratory where science and math problems were worked out on a chalkboard that hung over the dinner table.

After high school, Shaw went on to study engineering at the University of Arizona, and eventually launched his own engineering firm in a former bicycle-repair shop on a rundown strip in Lewisville, Texas. His core business was small-town building projects, like road repairs and structural inspections, but he also dabbled in medical devices. At one point, a friend’s grandmother underwent gallbladder surgery and came out addled and confused. Believing a medication mix-up was to blame, Shaw invented an automated pill dispenser.

Then, one night in the late 1980s, Shaw saw a news program about a doctor in California who had been infected with HIV after being stuck with a contaminated needle. This got Shaw’s attention. One of his oldest friends had recently been diagnosed with AIDS, and Shaw was all too aware of the ravages of the disease. “I thought, I can’t do anything to save my friends,” he recalls. “But maybe I could do something to save other people.”

The next day, Shaw set to work trying to invent a safer syringe. He began buying pigs’ feet from the local butcher and using them to simulate injections. He outfitted every room in his engineering firm with chalkboards so he could draw design ideas whenever they popped into his head. To make time for the syringe venture alongside his regular work, he started pulling ninety-five-hour weeks. And even when he was on vacation, he rarely stopped obsessing. “I remember being in South Padre Island with my wife and kids,” Shaw recalls. “Everyone wanted to go out and play. I wouldn’t go anywhere until I figured out what to do with the back corner of the syringe. I told my wife, ‘I have to work on
it all the time until I get it or I’m dead.’”

It took four years and more than 150 design permutations, but Shaw finally came up with a crude prototype and found a local physician to test it on him—an event Shaw’s wife documented with a shaky handheld camcorder. In the video, the doctor holds up a saline-filled syringe about the size of a kielbasa sausage. Then he jabs the needle into Shaw’s arm and pauses for a second before pushing in the plunger. First the saline empties, and then the needle snaps back into the barrel with a pop.

Shaw had just invented the first retractable syringe, a fact that drew the attention of public health officials. In 1993, the National Institutes of Health gave him a $600,000 grant to shrink it down to the size of an ordinary hypodermic and produce 50,000 of them for clinical trials. Shaw was now able to bring on a team of engineers and product designers, and turn a cinderblock bay adjoining the old bicycle shop into a clean room. By the mid-1990s, he had the final design in hand.

Around this time, Shaw launched Retractable Technologies and began searching for funds to build a factory in Little Elm, Texas. Eventually, he raised $42 million, much of it from doctors at Presbyterian Hospital in Dallas. “Everyone was eager to invest,” recalls Lawrence Mills, who was then chief of thoracic surgery at the hospital and invested $95,000 in Shaw’s company. “We all thought it was just a matter of time before it became the standard in the industry.”

In 1996, Shaw returned to Presbyterian to conduct a final round of clinical trials. The nurses who took part gave his syringe uniformly high marks (though some complained in the follow-up survey that the packaging was hard to open and that the air bubbles were difficult to get out), and Presbyterian’s top medical brass was clamoring to get it into the supply rooms. Edward Goodman, the hospital’s director of infection control, wrote a letter to the purchasing department, saying Shaw’s product was “essential to the safety and health of our employees, staff and patients.” But Shaw soon learned that the enthusiasm of health care workers was not enough to gain him entrée; the hospital initially promised him a contract, only to back out three months later. Though he didn’t realize it at the time, Shaw had just stumbled into the path of a juggernaut.

Breaking into the medical supply market has always been tough, in part because for decades the business has been dominated by a handful of behemoth suppliers. In the case of syringes, the incumbent heavyweight has long been Becton Dickinson, or BD, a New Jersey–based company that controls 70 percent of the syringe market and has a lengthy history of trampling competitors. As early as 1960, BD was brought up on Justice Department charges for its anticompetitive practices—among them price fixing, buying up patents to kill its rivals’ innovations, and forcing hospitals to buy its syringes to get other essential supplies, some of which were only produced by BD.

Often, these large companies used their clout to squeeze hospitals on prices. To keep costs in check, in the 1970s many medical facilities began banding together to form group purchasing organizations, or GPOs. The underlying idea was simple: because suppliers generally give price breaks to customers who buy large quantities, hospitals could get better deals on, say, gauze or gloves, if a group of them came together and bargained for ten cases, rather than each hospital buying a case on its own.

Originally, these purchasing groups were nonprofit collectives and were managed and funded by the hospitals themselves. But in the mid-1970s, the model began to shift. Some large hospital chains started to spin off for-profit GPO subsidiaries, which other hospitals could join by paying membership dues, much the way members of buying clubs like Costco pay dues to get bulk-buying discounts. By decade’s end, virtually every hospital in America belonged to a GPO.

Then, in 1986 Congress passed a bill exempting GPOs from the anti-kickback provisions embedded in Medicare law. This meant that instead of collecting membership dues, GPOs could collect “fees”—in other industries they might be called kickbacks or bribes—from suppliers in the form of a share of sales revenue. (For example, in exchange for signing a contract with a given gauze maker, a GPO might get a percentage of whatever the company made selling gauze to members.) The idea was to help struggling hospitals by shifting the burden of funding GPOs’ operations to vendors. To prevent abuse, “fees” of more than 3 percent of sales were supposed to be reported to member hospitals and (upon request) the secretary of health and human services.

But, as with many well-intended laws, the shift had some ground-shaking unintended consequences. Most importantly, it turned the incentives for GPOs upside down. Instead of being tied to the dues paid by members, GPOs’ revenues were now tied to the profits of the suppliers they were supposed to be pressing for lower prices. This created an incentive to cater to the sellers rather than to the buyers—to big companies like Becton Dickinson rather than to member hospitals. Before long, large suppliers began using “fees”—sometimes very generous ones—along with tiered pricing to secure deals that locked GPO members into buying their products. In many cases, hospitals were obliged to buy virtually all of their bandages or scalpels or heart monitors from one company. GPOs also began offering package deals that bundled products together. To get the best price on stethoscopes, a hospital might have to agree to buy everything from pacemakers to cotton balls from the GPO’s preferred vendors. Hospitals went along because they got price breaks, usually in the form of rebates if they met buying quotas.

This situation only grew thornier in 1996, when the Justice Department and the Federal Trade Commission overhauled antitrust rules and granted the organizations protection from antitrust actions, except under “extraordinary circumstances.” Once again, the idea was to help struggling hospitals, this time by allowing the buying groups to grow big enough to negotiate the best deals for their members. But the decision led to a frenzy of consolidation. Within a few years, five GPOs controlled purchasing for 90 percent of the nation’s hospitals, which only amplified the clout of big suppliers.

As it turns out, Shaw’s retractable syringe hit just as these trends were converging. In fact, the year his product came onto the market, three of the nation’s largest GPOs merged to form a company called Premier, which managed buying for 1,700 hospitals, or about a third of all hospitals in the United States. Shortly thereafter, Premier signed a $1.8 billion, seven-and-a-half-year deal with Becton Dickinson. Under the agreement, member hospitals—among them Dallas-based Presbyterian, where Shaw would hit a brick wall—had to buy 90 percent of their syringes and blood collection tubes from the company. Over the next two years, BD landed similar deals with all but one major GPO. As a result, almost everywhere Shaw turned, he found hospital doors were closed to him.

Nevertheless, Shaw soldiered on and managed to score a few victories. He landed a number of contracts with government agencies, including the VA, that negotiate directly with vendors for supplies. Or he sold his wares to systems so small and poor that they weren’t on the GPOs’ radar—prisons, nursing homes, Indian reservations, and the like. He also teamed up with the SEIU, the nation’s largest union of health care workers, which was lobbying for legislation to curb the needle sticks that were afflicting more than 600,000 health care workers each year. Shaw ended up helping craft a California bill that required hospitals to keep a log indicating which syringes were causing needle sticks and take regular steps to transition to the safer ones. Twenty-one states later passed laws patterned after California’s, an
d in 2000 the federal government followed suit. That winter, Shaw traveled from Little Elm for the signing ceremony in the Oval Office, and President Bill Clinton gave him a pen he had used to sign the measure into law.

This bumper crop of legislation should have been a boon to Shaw’s company—after all, there was nothing else like his product on the market. BD had released its own safety syringes some years earlier. But the ECRI Institute, the Consumer Reports of the health care industry, had rated its best-selling model “unacceptable” (it was later upgraded to “not recommended”), whereas Shaw’s product received the top rating. And some medical facilities had found that, rather than drive down needle sticks, BD products caused their numbers to rise. After the federal needle safety law passed, Cook Children’s, a Fort Worth–based chain of pediatric clinics, first moved to BD safety needles. But after dropping initially, the number of needle sticks more than doubled, from nine to nineteen a year. So in 2004 Cooks began transitioning to Retractable syringes, and over the next four years the number of sticks fell to zero.

But Shaw’s company continued to have trouble breaking into hospitals. In mid-1999, Kaiser Permanente of California signed a one-year contract to buy Retractable syringes, which seemed like an enormous coup. But a month later, Becton Dickinson announced a “unique” three-year, $30 million deal with Kaiser nationwide. After that, Shaw struggled to get his syringes into Kaiser supply rooms—often, he says, they sat locked in warehouses or trucks in distributors’ parking lots. Kaiser spokesman Jim Anderson argues that if Shaw’s products didn’t make their way to hospitals it was because of  “significant supply issues” on Retractable’s end. He also says they were prone to malfunction and that, in several cases, needles detached and were left “stuck in the arms of patients.” Whatever the reasons, Kaiser broke off the deal early.

Meanwhile, as Shaw was fighting his battles hospital to hospital, Becton Dickinson was working to extend its hold on the nation’s GPOs. According to confidential documents filed as part of a whistleblower lawsuit, in 1999 BD paid $1 million to Novation, the only major GPO with which it hadn’t yet signed a sole-source contract, in return for a three-year sole-source deal for syringes and needles. This payment, which it dubbed a “special marketing fee,” was on top of more than 3 percent of its sales revenue and other perks valued at hundreds of thousands of dollars. Becton Dickinson’s grip on hospitals was now even tighter than it had been before.

By this point, the struggle was starting to take its toll on Shaw. Now when he came home after long days in the office, he would shut himself in a room and not let anyone in except his children. His marriage was unraveling (he later divorced) and his increasingly confrontational style was starting to put off potential allies. When he was invited to speak at a luncheon of the Medical Device Manufacturers Association, an alliance of small medical suppliers, no one would sit near him; he ate alone, surrounded by twelve empty chairs, and was booed when he stepped to the podium. “They were afraid if we took on the GPOs they would be destroyed,” Shaw recalls. Meanwhile, Retractable Technologies’ stock had lost nearly two-thirds of its value, and its operating capital was dwindling rapidly. After weighing his options, in 2001 Shaw finally filed an antitrust suit against Becton Dickinson, Novation, and Premier. . .

To find out what happened to Shaw, and why reform legislation didn’t address the incestuous relationship between GPOs and suppliers, click here to read the rest of the article.