< Return To Hearing
Dr. Prakash Sethi
March 15, 2006
March 15, 2006
Good afternoon. I wish to thank you for giving me the opportunity to appear as a witness today in my capacity as University Distinguished Professor of Management and President of the International Center for Corporate Accountability, Inc. (ICCA) at Baruch College of the City University of New York. I would also like to congratulate you on your thorough work on this complex and critical healthcare issue over the last several years and on your obvious determination to ensure free competition in the medical supply marketplace.
As I understand it, my assignment today is to examine the Healthcare Group Purchasing Industry Initiative ("GPO Initiative") and to offer my views on whether it will be sufficient to ensure competition in the healthcare supply industry. This topic has tremendous implications for the delivery of healthcare services in the United States, and I am pleased to be able to share my insights on this matter.
Let me begin by saying that I have spent a large part of my academic career of more than 30 years studying, analyzing, writing and implementing corporate and industry codes of conduct. I have published numerous articles and several books on this topic, most recently Setting Global Standards: Guidelines for Creating Codes of Conduct in Multinational Corporations, which was published in 2003.
Industry-Based Codes of Conduct or Principles
Voluntary industry codes of conduct or principles can potentially play a critical role in engendering public trust in the conduct of an industry. A code of conduct is in the nature of a "private law" or a "promise voluntarily made" whereby an institution makes a public commitment to adhere to certain standards of conduct. The "private law" character of voluntary codes gives the sponsoring organizations a large measure of discretionary action. At the same time, it imposes on them the burden of ensuring that their critics and the public-at-large believe in the institutions' performance claims. In turn, if they are to accomplish that they almost invariably have to create independent systems of performance evaluation, monitoring and verification, and public disclosure.
Extensive studies by ICCA of a large number of industry-wide codes suggest that most of these codes have failed because of the unwillingness or inability of their sponsors to create and implement meaningful codes and standards. This is not surprising, since most industry-based initiatives are created in the aftermath of unethical and illegal activities on the part of the member companies Industry members generally do not go beyond superficial statements of broad principles and a promise to make a good faith effort to improve their performance. Only a handful of industry codes, including those developed by the Forestry Council, electronics industry, and the toy industry, have had any impact at all on the conduct of their member companies. Conversely, oil and gas, mining and defense industries seem to have spent the most money to devise elaborate management and governance systems, but their codes have produced little improvement in the member companies' conduct. In my view, the GPO Initiative falls in the second category.
Based on our research and field work in monitoring code compliance, we have identified eight conditions that must be met for an industry-based code to demonstrate measurable and credible compliance with the industry's voluntary initiative.
1. The code must be substantive in addressing broad areas of public concern pertaining to industry's conduct.
2. Code principles or standards must be specific in addressing issues embodied in those principles.
3. Code performance standards must be realistic in the context of industry's financial strength and competitive environment. The industry should not make exaggerated promises or claim implausible achievements.
4. Member companies must create an effective internal implementation system to ensure effective code compliance.
5. Code compliance must be an integral part of a management performance evaluation and reward system.
6. The industry must create an independent governance structure that is not controlled by the executives of the member companies.
7. There must be an independent external monitoring and compliance verification system to engender public trust and credibility in the industry's claims of performance.
8. There should be maximum transparency and verifiable disclosure of industry performance to the public. Standards of performance disclosure should be the sole province of the code's governing board.
The GPO Initiative
This analysis strongly suggests that the current modus operandi of GPOs, doing business under the protection of the Medicare anti-kickback safe harbor, has contributed to a misallocation of a very large portion of the revenue received from vendors in the form of fees and other considerations. Like a spider's web, GPOs engulf both the buyers and suppliers in contractual arrangements that are questionable at best. This control allows them to engage in conduct that illegally and unethically enriches the GPOs at the expense of healthcare providers, new entrants, and the public-at-large. Regrettably, the failure of the industry members to address these issues in the nearly four years -- since this panel first urged them to institute a code to police themselves -- continues the pattern of resistance to change that we have seen time and again with industry codes.
In my professional opinion, the current GPO business model and legal framework has built-in structural flaws, and its financial incentives are so perverse that the GPO Initiative cannot possibly remedy this situation. Anti-competitive contractual arrangements, industry concentration, and especially the vendor-financed fee structure--- all of which arise from the Medicare anti-kickback safe harbor -- have created strong incentives for the GPOs to maximize their income, and equally strong disincentives to distribute this income to their beneficial owners, i.e. hospitals and nursing homes. Indeed, the structure of the new GPO Initiative seems to indicate that its entire purpose is to protect the industry's anti-competitive exclusionary system in which the GPOs' self-interest takes precedence over the welfare of the industry's clients, including healthcare providers, taxpayers, and potential new entrants in the industry.
I do not believe that we can even begin to talk seriously about a GPO Initiative until we have realigned these financial incentives so that the hospitals, and not the vendors, are once again the GPOs' only clients. As long as vendors continue to pay fees to the GPOs, any attempt to create, implement and enforce a code of conduct is doomed to failure.
I respectfully submit that an objective and thoughtful assessment would conclude that these principles fail to measure up, even at the very minimal level, against any of the eight criteria that I have just described. Among the most serious shortcomings of this Initiative are:
1. There is a total lack of independence in the Initiative's governance structure, which is entirely controlled by the top executives of the member companies. Although the Initiative includes a "coordinator," the coordinator has no real authority.
2. Principles are essentially a statement of intent. Any description of what these principles might contain by way of substance is left entirely to the member companies.
3. Member companies also set their own criteria with regard to standards of compliance, performance evaluation, implementation assurance, and public disclosure. Reduced to its bare essentials, the final product of this process becomes nothing more than a compilation of the reports provided by the member companies based on their own self-evaluation.
4. The governance structure of the GPO Initiative does not provide any mechanism for independent external monitoring and verification of member companies' self-reported performance. Instead, it expects the public to accept this self-reported performance at face value. Such an assertion would be a dubious proposition under the best of circumstances. It would be untenable given the industry's current record.
In summary, the new GPO Initiative is encumbered with a lack of specificity, non- existent performance standards, an internally controlled and self-serving governance structure, and an absence of independent external monitoring system. It is unlikely to yield any meaningful reform. Instead it would exacerbate the problem through absence of meaningful change and would further erode the credibility of its sponsors.
It is unrealistic to expect an industry to create a viable code or initiative that has been operating with a business model based on perverse financial incentives, a questionable legal structure, and federal statutes that undermine the imperatives of competitive markets. Therefore, the repeal of the safe harbor must precede any discussion of a GPO industry code of conduct or initiative.
Restoration of market-based competition would be the first step to create a healthy business model for the entire healthcare industry. While market competition can go a long way in minimizing illegal and unethical practices, it cannot completely eliminate them. This is where industry-wide codes of conduct can potentially play an important role in narrowing the gap between societal expectations and industry performance.
Thank you for your attention. I would be pleased to try to answer any questions.