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What Is a Group Purchasing Organization and How Does One Work?

Posted by Ara Arslanian on November 19, 2018


Purchasing Team Gains Leverage Because of GPOGroup purchasing organizations (GPOs) primarily exist for one simple, yet compelling reason: to help businesses interested in buying similar products gain leverage through combined purchasing power.

A study by The Hackett Group defines a GPO as “an entity that is created to leverage the purchasing power of a group of businesses in order to obtain discounts from suppliers based on the collective buying power of its members.”

For companies that use GPO agreements (i.e., GPO members), that leverage ultimately generates preferable prices and contract terms, saves time and frees up internal procurement resources.

But GPOs also exist to benefit suppliers, or the network of companies that offer goods and services to member companies. For suppliers, GPO advantages come from having an expanded market share, increased access to industry insights and data and better buyer relationships.

Group Purchasing Organizations Are Mainly Found Within These Industries

GPOs are found within multiple industries, including healthcare, hospitality, foodservice, electrical, plumbing, nonprofit and industrial manufacturing.

This is because of the sheer number of small- and mid-market companies that occupy these sectors. GPOs allow the spend of all of these companies to combine, which increases their buying power. At the same time, the market percentage of the suppliers in these industries becomes greater. However, if an industry is consolidated and has only a few market leaders, a GPO may not be as effective.

The Main Types of Group Purchasing Organizations

There are three main types of group purchasing organizations:

  • Vertical market: A vertical market GPO is focused on one industry or vertical. For example, in the healthcare market, there are small- and mid-sized medical centers or hospitals that join forces to reduce their costs.
  • Horizontal market: Horizontal market GPO members exist in many different industries, but they purchase a lot of the same goods and services to build their products and run their companies. OMNIA Partners is an example of a horizontal market GPO.
  • Master buyer: This is when one chief buying organization has substantial contracts in place with vendors and allows additional companies to buy off those contracts. The automotive industry is a perfect real-world example of the master buyer model because Tier 1 and Tier 2 suppliers can access the pricing contracts large automotive manufacturers have negotiated with vendors.

Related: What Kind of GPO is Right for Me?

How a Group Purchasing Organization Works

GPOs create and manage contracts for indirect services or commodities – and they also create and manage relationships between three parties: the GPO itself, its members and its suppliers.

To show exactly what this looks like, we'll examine the basic details of how GPOs that focus on indirect spend in the enterprise space work. Indirect spend describes any company expenditures that are required for running a business – such as office supplies, temporary labor and industrial supplies – but aren't directly related to a company's products or services.

How these GPOs work can be outlined in three ordinal steps.


Step 1: Membership, Leverage and Savings Grow


What is a GPO?These GPOs create a membership base comprised of companies seeking to channel spend using the GPO's agreements. The combined spend of these companies – and the acquisition of multiple customers at once – creates leverage. That leverage is what motivates suppliers to offer their best pricing and service levels to the GPO.

Companies have historically used GPOs to gain quick access to cost savings. Although still true, this traditional view of GPOs doesn't fully recognize the sustainable value that a modern GPO provides. Savings diminish over time, so a modern GPO constantly looks for ways to bring more value by enhancing their agreements and supplier performance.


Step 2: Better Pricing and Contract Terms Are Produced


How a GPO WorksWith a steady stream of spend in place, these GPOs are now able to source agreements with the right suppliers – or those that can provide better pricing and contract terms than GPO members can achieve on their own. Suppliers typically forgo margin opportunities because GPO membership reduces the costs associated with acquiring new business.

The leverage of combined spend most obviously impacts the purchase of office products, safety supplies and other commodities. However, sophisticated GPOs can also increase procurement’s spend influence in areas like HR services and IT.


Step 3: Continuous Improvement Further Mitigates Risk


As members continue to use GPO agreements, contracts are constantly managed by the GPO. As more members join and more spend flows through the agreements, these GPOs can negotiate even deeper discounts and/or improved terms and conditions with suppliers. By this point, the GPO can further mitigate risk and create a path toward continuous improvement by engaging with multiple people at multiple levels throughout supplier organizations.

Related: GPO FAQs

How Is a Group Purchasing Organization Funded?

Typically, a GPO is funded via membership fees, administrative fees or some combination of the two. A membership fee can be a one-time payment that's paid upon joining the GPO. Alternately, the membership fee can be structured as an annual dues-based payment. In some cases, GPOs waive membership feeds if a member participates in a certain number of agreements or surpasses a spend threshold.

Suppliers always pay GPOs administrative fees. Regardless of whether the fee is a flat rate or based on the amount of spend passing through the agreement, a GPO's funding structure is always transparent to its members.

How Do You Know if a GPO Is the Right Option for Your Company?

The only way to really know for sure is to continue to educate yourself. For starters, read our primer, “Is a GPO Right for Me?” and also learn more GPO basics. If you're still left asking "How does a GPO work?", or remain unsure of whether one is right for your company, please contact us to learn more.

Topics: Group Purchasing Organization, Procurement

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