GPO Agreements - Good or Bad?
Question: We have joined our state Life Sciences group and we have access to a buying group contract pricing through a major national distributor. Since we have a contract, can I even do business with LPS? With all the prices negotiated at the national level, how could LPS do anything for me?
Answer: Many small and start-up lab managers think that a GPO agreement either obligates them to purchase from a particular vendor or they feel that by having this in place, there is no longer any need to worry about prices or where to buy products.
Working in management for a big distributor (i.e, on the other side of the negotiating table) gave me the opportunity to see how these agreements are “profitized” – while still abiding by the written terms of the agreement.
DID YOU SIGN A CONTRACT?
As a manager, it became clear that there were a few customers who read the fine print and far more who didn’t. The majority who sign a document in which the seller agrees to make concessions to the buyer that by signing the document they are contractually obliged to buy from the seller. We loved these customers! Lots of business, often for years, with little effort on our part!
Then there were customers who read the part where you pledged to use our company as a preferred supplier with a target of X% of your total business. Another statement that some customers keyed on was “[Seller] realizes you cannot obtain all of the needs from your lab from [Seller.]” These were the customers that kept us up at night. They were fully aware of the difference between a contract and an agreement and how they could use this to their advantage.
THE HOT LIST
The strategy behind how an item is priced is one of the most effective tools to increase profits. Here is a list of how items are priced in descending order of the profitability to the distributor:
1. Individually – on a “hot list.” Also called priced by SKU down to the unit of measure.
2. By Vendor – a set discount from “list” for a specified vendor
3. By Category – typically a category is a group of vendors grouped into “margin buckets .”
4. General – A global discount that applies under certain conditions.
In theory, Hot listed items are those items that represent the majority of your spend. So why don’t customers take advantage and load up most of what they buy on the hot list?
1. Restrict the number of items that can be put on the hot list. Most contracts have severe limitations on the number of items. It typically never exceeds 100 and is more typically 40. (This is negotiable!)
2. Limit the definition of an SKU. An item is defined by the catalog number PLUS the unit of measure. While you may get special pricing if you order by the CASE you will not if you order by the PACK unless you’ve burned two of your hot list positions.
3. Customer’s don’t know what should be on the hot list. If asked, most customers would say that they know what they spend a lot on. But there are many more that don’t. The suggested list that you may get from the distributor (if it is offered at all) should be carefully scrubbed!
4. The time when the hot list can be updated or modified is restricted. If you start buying a lot of something that isn’t on the hot list, it could be up to a year before you get the opportunity to modify the list. (This is negotiable!)
THE GGM RULE
Buried deep within the text of most agreements is a little gem called the GGM rule. GGM = Guaranteed Gross Margin. This means that if any item not on the hot list or on a specified cost plus basis has a profit margin less than the GGM rule, it will automatically be increased to attain that minimum profit margin stated in the rule.
For example, if your discount schedule says you get a 50% discount on all reusable glassware and you see a flask for $200 on the web site, you would expect to be charged $100. But the bill comes and it is $150. No, the distributor didn’t violate the terms of the agreement. It was the GGM rule kicking in and boosting the price.
What the GGM rule does is to make the discount schedule proposed look much better than it actually is. If you’ve got the GGM rule in place, why not advertise a 50% discount? It looks great and you will never suffer any harm by doing so because they have an insurance policy – the GGM rule. In my many years as a manager, I can recall only a couple of customers every questioning this!
COST PLUS PRICING
One of the more appealing clauses in a GPO agreement is the ability to buy expensive instruments and equipment at “Cost plus 10%.” How could you go wrong?
I will bet that you assumed that “cost” meant the price they pay to their vendor for that item, right? It’s very unlikely. Distributors have redefined “cost” to include things like their marketing expenses, inbound shipping charges, interest charges, and even the cost of their cafeteria!
What IS the cost? Ask them. See if you get an answer. If you do, go to the vendor and makes the product and ask them if that even resembles the price they charge. You are far better off bidding any capital item than buying it off one of these agreements!
LIST PRICE vs. MSRP
For all but a very small number of major vendors the price the distributor shows as ‘list’ bears no resemblance to the price the manufacturer shows as MSRP. In many cases, the big distributors insist that the manufacturer NOT even set a list price.
This is commonly known as the “jewelry store discount.” Since nobody is really sure what the price should be, double the price you want to sell the item and advertise that as list then tell someone they are getting a 50% discount and everyone goes away feeling like a winner.
The only way to know when this is going on is to routinely check prices across multiple distributors. Once you’ve signed the agreement, are you really going to do this? We do every day at LPS.
Distributors have been writing agreements for a very long time. They are experts. They have paid high powered consulting firms to come up with ways to get your business then make as much profit as possible. If you are like most customers, you trust your GPO has done their due diligence when negotiating the agreement.
If properly utilized, these agreements can be of great benefit. But without knowing the pitfalls, you can pay far more than you should.
If you would like a (free!) high powered consultant working for you, we are here to help.