BAB117 Revised February 15, 2005 BABSON Premier, Inc. (A) Rick Norling, CEO of Premier, Inc., a leading hospital purchasing organization, unfolded the March 4, 2002, West Coast edition of The New York Times. The article he had been anxiously anticipating - the first in a series - was prominently featured in the upper left corner of page one, over a photograph of a doctor tending a newborn baby. Under the series title, "Medicine's Middlemen," ran the headline, "Questions Raised of Conflicts at 2 Hospital Buying Groups." Norling quickly scanned the first few paragraphs. Amid a tangle of wires and worried faces, the brief life of Joshua Diaz was slipping away, and Dr. Mitchell R. Goldstein knew he must soon make an agonizing decision. For 30 minutes, Dr. Goldstein's emergency team had medically assaulted the 2- week-old baby with lifesaving measures, none of which appeared to be working. Worse, a device called a pulse oximeter failed to detect a pulse or show how much oxygen Joshua's blood was ferrying to his vital organs. "I had the nurse and respiratory therapists asking me, 'Why are we doing this?"" said Dr. Goldstein, of West Covina, California. Some feared they were just torturing the baby. But the doctor pressed ahead after attaching a second, experimental monitor that showed encouraging signs: Joshua's blood was taking on more oxygen. Today, Joshua Diaz is a healthy 7-year-old living in Ontario, Calif. "We probably would have given up," Dr. Goldstein said, were it not for the second monitor. Norling took a deep breath. "A desperately ill baby, heroic doctors and nurses, and a lifesaving device," he thought. "I'm not sure I like the direction this is headed." Professor Anne T. Lawrence, San Jose State University, prepared this case as the basis for class discussion, rather than to illustrate either effective or ineffective handling of an administrative situation. The author wishes to thank Richard A. Norling and Megan Barry, both of Premier, Inc., and Kirk O. Hanson and the staff of the Markkula Center for Applied Ethics at Santa Clara University for their assistance in the preparation of this case. This case received the Emerson Center Award for the Outstanding Case in Business Ethics for 2004, awarded by the North American Case Research Association and Saint Louis University, and is published in collaboration with Babson College Case Publishing. Copyright O 2005 by Anne T. Lawrence and licensed for publication to Babson College and to Harvard Business School Publishing. To order copies or request permission to reproduce materials, call (800) 545-7685 or write Harvard Business School Publishing, Boston, MA 02163. No part of this publication may be reproduced, stored in any retrieval system, used in a spread sheet, or transmitted in any form or by any means - electronic, mechanical, photocopying, recording, or otherwise - without the permission of copyright holders.Premier, inc. (A) BAB117 The article went on: But seven years later, its inventor, Joe E. Kiani, says he still cannot sell his oximeter, regardless of the price, to many American hospitals, even though medical experts say it helps the most fragile of patients premature infants. The reason, Mr. Kiani says, is that he has effectively been locked out his much larger competitor has secured exclusive contracts to sell its device to thousands of hospitals, in part by paying fees to two national purchasing groups that largely determine which products many hospitals buy. These two private groups act as middlemen for about half the nation's nonprot hospitals, negotiating contracts last year for some $34 billion in supplies, from pharmaceuticals to pacemakers, bandages to beds. Each group has the same basic mission: to use the market power of its more than 1,500 hospitals to nd the best medical products at the lowest prices. But many in the medical world Mr. Kiani among them question whether that mission is being compromised by financial ties that the groups, Premier and Novation, have to medical supply companies, ties that, according to an investigation by The New York Times, are both extensive and highly unusual.l Over the past year, Norling and his colleagues at Premier had cooperated extensively with the reporting team from The Times, sitting for interviews, answering written questions, and providing scores of company documents. Yet, as the dialogue proceeded, Premier executives had become increasingly concerned that The Times might le a story critical of the company. Now, despite their best efforts, the inuential newspaper had published what appeared to be a direct attack on the company's hard-earned reputation for integrity. Although much of the article, on rst reading, appeared to Norling to be unfair and misleading, in the aftermath of public outcry over the Enron collapse no company could afford to be complacent about charges of ethical malfeasance. Norling quickly finished the article, then slipped it into his briefcase. He, his executive team, and the Premier board would need to address this challenge head on. Premier, Inc. In 2002, Premier, Inc. was a voluntary alliance of more than 200 independent notfor profit hospitals and healthcare systems. The company was wholly owned and governed by its member organizations. These included some of the nation's foremost academic, religious, and community medical centers; among them, the Cleveland Clinic, Catholic Healthcare West, Baptist Health Systems of South Florida, Vanderbilt University Medical Center, Montefiore Medical Center, Mount Sinai Hospital, and PeaceHealth. Together, Premier's members made up about a quarter of all notfor-prot hospitals in the United States. in addition, more than one I Walt Bogdanich, Barry Meier, and Mary Williams Walsh, \"Medicine's Middleman: Questions Raised of Conicts at 2 Hospital Buying Groups,\" The New York Times, March 4, 2002, p. A1, A18. Premier, inc. (A) BAB117 thousand other health care institutions also used its group purchasing, insurance, and other programs as non-owner afliates. Headquartered in San Diego, California with other major facilities in Chicago, Charlotte, and Washington DC Premier had 1600 employees and, in 2001, revenues of $515 million. Premier's stated mission was \"to help our notforprot members deliver better healthcare to their patients at lower cost.\" The company's business was comprised of three main segments. Group purchasing. Premier's primary role was to provide group purchasing services and supply chain management for its allied organizations. The company aggregated the buying power of its many members and afliates to select and negotiate the best prices for a wide range of medical products and services. Norling stated the company's value proposition this way: Group purchasing enables our member hospitals to deal effectively with a huge, complex medical product marketplace, characterized by large, global suppliers of pharmaceuticals, clinical equipment and other products needed to provide care. Premier also has the size and scope to identify and evaluate new technologies from manufacturers and suppliers of all sizes a task beyond the capability of any single hospital purchasing department. Premier's group purchasing services were supported by contract administrative fees, or CAFs, paid to Premier by the vendor, based on the dollar amount of goods sold. These typically varied between 2 and 3 percent of the purchase price, with an average CAF of 2.1 percent.2 Health care informatics. The term health care informatics refers to the use of appropriate information to support clinical care, research, teaching and administration in the healthcare industry. Because Premier served hundreds of healthcare organizations, it was able to collect and analyze large amounts of clinical, nancial, and operational data. The company maintained many comparative databases that were made available to its members, who could use them to discover opportunities for improvement and benchmark their performance against others. Informatics data were also sold to hospital vendors and other rms. Other support services. Finally, Premier also operated several subsidiary enterprises designed to support the delivery of healthcare services, which the company grouped under the heading of \"performance solutions.\" These included the following. 0 Healthcare Waste Solutions managed waste, including biomedical waste, for members and affiliates. I Insurance. Several Premier subsidiaries developed group insurance and benet policies and provided risk management and audit services for health care organizations. 2 Contract administrative fees were normally paid in cash. However, in a very few cases involving small startup firms, Premier accepted stock or options in lieu of cash fees from vendors. At the time of The Times article, Premier did not have any contracts in effect in which payment was received in the form of equity. Premier, inc. (A) BAB117 0 Physician Practice Management, another subsidiary, provided practice management services to health care professionals. 0 Provider Select, Inc, provided group purchasing services for physicians. 0 Premier Technology Management managed, maintained, and repaired clinical equipment for members and afliates. The company was also part owner of several other enterprises, including a venture capital fund, a generic drug company, and an online buying service called Medibuy. Premier's organizational structure is shown in Exhibit 1 (page 13). The Hospital Group Purchasing Industry The broader industry of which Premier was a part was a critical, but often little understood, part of the healthcare delivery system. Group purchasing organizations, or GPOs, have been defined as \"organizations whose primary product or service is the development of purchasing contracts with product or non-labor service vendors that its membership can access.\"3 Although group purchasing organizations traced their lineage to the early 20lh century when hospital administrators in New York established a common purchasing agent for laundry services it was not until the 1980s that they emerged as a powerful force in the healthcare industry. At that time, pressure from Medicare and private insurers to constrain runaway healthcare costs forced many hospitals to look for new ways to save money. At the same time, consolidation in the pharmaceutical and medical products industries weakened the bargaining power of individual hospitals. In this setting, GPOs which were able to aggregate hospitals' buying power to seek better prices for products and reduce administrative costs became increasingly attractive. Growth of the GPO industry was also spurred by several regulatory actions by the federal government. In 1985, the Department of Health and Human Services (DHHS) issued an important opinion sanctioning vendorpaid administrative fees as a mechanism for funding GPOs, which in turn were expected to reduce health care costs. The following year, Congress passed an exemption to the Federal Anti-Kickback Law (which prohibited payments for referring buyers of supplies that were reimbursable under Medicare). The exemption explicitly permitted payment of administrative fees to GPOs by vendors, so long as the GPO identified those fees to its members and disclosed actual payments made. In 1987, Congress further mandated that administrative fees over 3 percent warranted oversight by the DHHS for possible Medicare fraud, in effect setting a ceiling of 3 percent for such fees under most conditions.4 Once the legal status of vendor-paid fees was claried, the GPO industry grew rapidly. However, the industry remained highly fragmented, in part because of concern that concentration would violate antitrust law. In 1994, the Department of Justice and the Federal Trade Commission issued regulations clarifying antitrust issues in the GPO industry. The agencies 3 Gene Schellner, The Value of Group Purchasing in the Healthcare Supply Chain (Tempe, Ariz.: School of Health Administration and Policy, Arizona State University, 2000). 4 Lawton R. Burns, The Health Care Value Chain: Producers, Purchasers, Providers (San Francisco: Jossey-Bass, 2002), p. 69. Premier, inc. (A) BAB117 stated that joint purchases could not account for more than 35 percent of the relevant market for a product or service (but, by implication, market shares below this amount were acceptable). The immediate consequence of these safe harbor rules, as they were known, was rapid consolidation in the group purchasing industry approaching the mandated threshold of 35 percent market share. In the notforprofit segment, American Healthcare Systems, SunHealth Alliance, and Premier Healthcare Alliance combined in a series of mergers to form Premier, Inc. in January 1996. At around the same time, a parallel set of mergers of GPOs operated by the University HealthSystem Consortium and the Voluntary Hospitals of America produced Novation. Other mergers occurred in other niches in the healthcare industry. In 2002, between 600 and 700 GPOs operated in the healthcare industry in the United States. In all, about $40 billion was spent by hospitals under GPO contracts annually in the United States.5 The two clear leaders, as shown in Exhibit 2 (page 14), were Novation and Premier. Novation had affiliations with about 39 percent of the nation's 6,000 or so hospitals; Premier, with about 26 percent. Their market shares, as measured by percentage of annual purchasing volume under contract, were 14.6 and 12.5 percent, respectively. The rest of the GPO industry was less concentrated. A report commissioned by a trade association in 2000 found that GPOs saved affiliated hospitals from 10 to 15 percent on their purchases, although other studies disputed this gure.6 Premier's Contracting Relationships In its role as a purchasing agent, Premier was embedded in a complex network of relationships, as diagrarnrned in Exhibit 3 (page 15). On one hand, the company maintained relationships with hundreds of suppliers, ranging from huge multinational corporations to tiny startups. On the other, it interacted with its 200 members and hundreds of other affiliates. These relationships comprised multiple interests, personalities, and histories. In 2002, Premier had contracts with 436 separate vendors. These contracts provided a huge array of products, from such mundane items as bandages, beds, syringes, lights, stretchers, diapers, and thermometers, to cutting edge biomedical equipment and pharmaceutical drugs. Although 190 vendors were considered small businesses by the standards of the Small Business Administration, the supply chain was quite concentrated; 45 percent of supplies came from the largest 20 vendors. The challenging job of selecting products and services for its members required Premier to balance the equally important, but sometimes contradictory, goals of cost-containment and quality. To assist its own extensive purchasing staff, Premier routinely convened committees of clinicians and experts to guide its contracting decisions. Once items were selected, Premier negotiated contracts with suppliers. In some product categories, such as food services, Premier 5 Herbert Hovenkamp, \"Competitive Effects of Group Purchasing Organizations' Purchasing and Product Selection Practices in the Health Care Industry,\" April 2002 (paper prepared for the Health Industry Group Purchasing Association). 6 Muse and Associates, \"The Role of Group Purchasing Organizations in the U.S. Health Care System\" (March 2000). For a contrasting perspective, see U.S. General Accounting Office, \"Group Purchasing Organizations: Pilot Study Suggests Buying Groups Do Not Always Offer Hospitals Lower Prices," April 30, 2002; available online at www.gao.gov. Premier, Inc. (A) BAB117 entered into sole-source contracts (only one vendor was on the formulary list). In the case of pharmaceuticals, Premier entered into multi-source contracts, to give clinicians the widest possible choice of products. For clinical and non-clinical products, from MRI machines to bed linens, Premier entered into a range of sole and multi-source contracts, depending on the particular item. Premier did not itself purchase the products; rather, member hospitals made their own purchasing decisions, buying items from Premier's formulary lists directly from suppliers. Member hospitals were not required to buy all their supplies from Premier's formulary lists of contracted items; they were free to buy whatever they wanted, whenever they wanted. (In the scene that opened The New York Times article, for example, the oximeter used by Dr. Goldstein was an off-contract item purchased by his hospital, which was a member of Premier.) However, it was in the GPO's interest to maintain high rates of contract compliance by member hospitals. Accordingly, Premier provided socalled commitment incentives for hospitals. Members that voluntarily committed to make 90 percent or more of their purchases (by category) under contract received greater discounts. Premier defended these commitment incentives on the grounds that they enabled the company to negotiate lower prices and reduced medical errors by standardizing equipment. At the end of each fiscal year, after retaining sufcient capital to fund its own operations and future strategic needs, Premier returned excess cash to its shareholders in the form of an annual distribution, paid in September. Over the years, hospital administrators had come to rely on these end-ofyear checks as a way to help balance their budgets. In 2001, Premier distributed $115 million to shareholder members, based on each one's level of ownership, relative size, and participation in Premier's programs. Technology Assessment and Innovation Management Programs To help its members obtain the best possible medical technology, the company regularly reviewed new products and services and added them to its formulary lists when appropriate. To cite just one example, in early 2002 Premier signed a contract with an Israeli company that had developed a \"camera pill\" a tiny camera shaped like a vitamin pill that patients could swallow, allowing clinicians to view color photographs of the inside of the intestine for diagnostic analysis. The camera pill was considered a major advance over traditional endoscopy for both the patient and the physician. A problem arose, however, when new products emerged that offered potentially superior characteristics but directly competed with products that Premier already had under contract. To address this situation, in 1997 the company established a technology breakthrough program. Under this initiative, clinician committees organized by Premier reviewed new products that potentially offered significant clinical, safety, or operational advantages relative to products still under contract. A technology breakthrough clause included in its contracts permitted Premier to Sign a breakthrough product, whether or not the company had an existing contract for a product designed to perform the same function. For example, in 1999, the company added three new safety syringes to its product line, even though it already had similar products under contract, because of their superior ability to protect the safety of patients and healthcare providers from blood-home pathogens. Premier, Inc. (A) BAB117 Once a product was certified under the breakthrough technology program, members could purchase it without affecting their compliance with commitment agreements. By early 2002, 15 products had been reviewed under the technology breakthrough program, and nine contracts had been awarded as a result seven of them to small businesses. The oximeter profiled in the New York Times article, which was made by a small company called Masimo, was reviewed by the technology breakthrough program in 2000. Premier concluded that the Masimo oximeter \"was comparable to other technologies currently available\" and declined to add the device to its formulary lists. Masimo was informed of this decision in March 2001. Another activity Premier initiated to support medical innovation was the Premier Innovation Institute. Launched in 1998, the Institute was a joint activity involving Premier and several leading manufacturers of health care products, including Mallinckrodt, Johnson & Johnson, and Roche Diagnostics. Each participant contributed about $1 million to the venture, which was set up as a freestanding mutual benet company under California law. The purpose of the Institute was to nd ways to overcome the time lag between the introduction of superior new products and their use by clinicians. To this end, the group sponsored pilot projects, research, conferences, and other activities. Premier emphasized that the Institute was entirely separate from its group purchasing: In no way was the Institute connected to Premier's group purchasing activities. It was made clear to all companies invited to take part that sponsorship had no inuence on whether group contracts were awarded or maintained.7 In 2000, Premier disbanded the Institute, saying that it had determined that the company itself could provide \"innovation expertise for suppliers' product development in a simpler and more cost-effective way.\" Corporate Governance and Reporting Practices Premier was sometimes referred to as a \"hybrid" organization, because of its dual character as a forprofit entity owned entirely by notforprofit organizations. Its corporate governance and reporting practices reected its mixed heritage. Premier was governed by a board of directors comprised mainly of shareholders. In February 2002, as shown in Exhibit 4 (page 16), the board had 12 members, who were elected by shareholders. By tradition, nine seats were lled by executives from member hospitals and healthcare systems. Two seats were lled by non-shareholders; at this time these were a venture capitalist and an executive of a supplier firm. Premier's CEO, who was also a member, served as chairman. The board was further organized into four major committees: the committee on directors (nominating committee), the compensation committee, the nance committee, and the audit committee. In addition, from time to time the board appointed a number of so-called shareholder committees, composed of executives drawn from the various member organizations, to advise the board in particular areas such as group purchasing and afliate relations. 7 Premier, \"Statement [on the] Premier Innovation Institute," 2001. Premier, Inc. (A) BAB117 Premier reported its financial results at its annual shareholder meeting, and copies of the report were made available to shareholders and to the Department of Health and Human Services, if requested. In addition, the company provided each member with an annual statement that reported the amount of fees eamed as a result of that organization's purchases. Because of its small number of shareholders, Premier was not subject to standard SEC rules for reporting by publicly held rms. The company was not required to report data on executive compensation, and it did not do so. Financial Performance Exhibit 5 (page 17) reports selected financial data for Premier for its first six years of operation, 1996 to 2001, in millions of dollars. As shown, Premier enjoyed sustained upward growth in annual combined net revenue during this period. Of its combined net operating revenue, the lion's share came from group purchasing services. In 2001, for example, 85 percent of revenue came from group purchasing, 6 percent from healthcare informatics, 3 percent from performance solutions, and 6 percent from other sources (including investments). Exhibit 5 also shows the total amount of distributions returned to shareholders each year. At the end of fiscal year 2000, Premier had total assets of $511 million. The finance committee of the board had oversight responsibility for the company's investments. The company's portfolio was invested in money market funds, government and corporate bonds, stocks, independent venture capital funds, and its own internal subsidiaries. In addition, Premier also operated its own venture capital fund, the Premier Medical Partner Fund Limited Partnership (PMPF). The fluid, modeled after a similar one operated by Premier's predecessor American Healthcare Systems, was launched in 1996. The PMPF initially raised about $30 million, with about half coming from Premier itself and its members, and the remainder from outside investors. The outside investors included several suppliers; among them were Becton Dickinson, Mallinckrodt, ServiceMaster, and 3M. The PMPF invested in private entrepreneurial companies developing healthcare products or services. The goal of the fund was to seek \"superior return on capital and appropriate diversification of investments of funds not immediately needed.\" Other objectives were to support healthcare entrepreneurship and to \"provide [Premier] and its hospital and health system members an additional 'window' on new and emerging technologies.\"8 In 2001, the value of the fund comprised seven percent of the company's total investment portfolio. That year, the fund had investments in eight private companies. One of these, American BioScience, Inc., was the parent company of American Pharmaceutical Partners, a maker of generic drugs that had a group purchasing contract with Premier. In defending this particular investment, Norling stated: That investment was made to encourage the success of a new company, providing a new channel of generic drugs, that would be in the interest of our member hospitals and health care systems, as well as the communities they serve... If the equity in that company ever becomes protable (it is a private 8\"Premier, \"Premier Venture Capital Investments Including Premier Medical Partner Fund,\" 2001, p. 2. Premier, Inc. (A) BAB117 company now), Premier's earnings on that equity will be distributed back to its not-for-profit member-owners. The company noted in a policy statement: None of Premier's venture capital activities are connected organizationally or operationally to Premier's group purchasing activities... There is absolutely no assurance that the companies provided venture capital will enter into group purchasing contracts with Premier. Such an award would not be precluded if a company's products or services were chosen competitively through Premier's processes for such contracts." Premier's Ethics Policy At the time that Premier was created in 1996, it inherited various ethics policies from its predecessor organizations. As part of a larger process of harmonization, the company reviewed these documents and finalized its own conflict of interest policy in October 1997. New employees were advised of this policy, which was administered by the Human Resources Department. 10 The purpose of the policy was: To ensure appropriate identification and recording of all instances in which an employee may be presented with an actual or potential conflict of interest [and to] provide guidance concerning the handling of conflicts of interest and compliance with laws and regulations relating to securities and investments. The basic policy was stated this way: Employees shall exercise good faith in carrying out their responsibilities and duties, administering the company's affairs honestly and economically, and exercising best care, skill, and judgment for the benefit of the company. Employees may not use their position or knowledge gained therefrom in such a way as to obtain personal advantage or financial gain, and all their acts as employees shall be for the best interests of Premier. If an employee, or an employee's spouse or immediate family member, was in a situation that could be or lead to a conflict of interest, or be perceived as a conflict of interest, this circumstance should be disclosed in writing, the policy indicated. They should not participate in any decisions in which they had a conflicting interest, or engage in any outside activity that would put them in competition with Premier unless specifically approved by the CEO. No employee was to accept a gift, favor, or hospitality of more than nominal value, and all employees were to comply with all relevant laws on insider trading. 9 Ibid., p. 2. " The quotations in this section are drawn from "Policy No. 2.17, October 1997, Conflict of Interest," Premier company document. COPremier, inc. (A) BAB117 With respect to the company itself, the policy stated that: In principle, Premier and related companies shall not enter into business relationships with firms whose owners, partners, signicant investors (more than 5.0 percent of outstanding equity shares), or executive employees (ofcers) are Premier directors, officers, or employees, unless specific authorization is obtained from the Premier Board of Directors after full disclosure of such interests. This prohibition obviously does not apply to Premier's contracting to provide its services to owners, afliates, and other customers in the ordinary course of business. In early 2002, Premier was in the process of reviewing this policy, with an eye to clarifying and updating it. The New York Times' Allegations11 The Times article that Norling had slipped into his briefcase that morning had raised several serious allegations concerning the group purchasing industry and its ethical practices. Among them were the following. 0 Sellerupaid fees undermined the objectivity of the selection process for products and services. The GPOs favored vendors from whom they received the biggest fees. The article stated: The problem begins with this simple fact: The buying groups are financed not by the hospitals that buy products but by the companies that sell them. In other words, the groups take money from the very companies they are supposed to evaluate objectively. Each year, companies pay Premier and Novation hundreds of millions of dollars in fees that represent a percentage of hospital purchases. The more hospitals spend on medical supplies, the more dollars Premier and Novation get from the suppliers. Critics say such conicts of interest can mean that the buying groups do not always choose the products that are best for patients, hospitals or the taxpayers and insurers that pay their bills. \"It's just like payola,\" said Paul Lombardi, head of contracts for the Swedish Medical Center in Seattle. 0 Investments by GPOs (and their employees) in vendors biased the selection process in favor of companies in which they had an equity stake. The article noted: Premier...has sometimes accepted stock in supplier companies in lieu of or in addition to cash payments. It has also invested in a number of companies in the H All quotations in this section are from "Medicine's Middlemen: Questions Raised of Conicts at 2 Hospital Buying Groups,\" op. Cit. 10 Premier, inc. (A) BAB117 medical supply field. Just three months ago, American Pharmaceutical Partners, based in Los Angeles a company that Premier helped start and steered hospital business to went public. At that time, the buying group's stake was worth $46 million. Premier said it invested in suppliers to encourage competition, to promote new technology and to make money for its hospital shareholders. The Times also reported that several executives, including Norling himself, held stock or options in companies with purchasing contracts with the GPO: Some top buying group executives have found other ways to profit personally. Richard A. Norling, Premier's chairman and chief executive, was allowed to retain and continue collecting a supplier's stock options that he converted into a $4 million profit in 2001. Mr. Norling received those options while serving as a director of one of Premier's predecessor buying groups that gave him the options as one of its directors. Mr. Norling said that he recused himself from any buying group decisions involving the company, Express Scripts that gave him the options as one of its directors. 0 Investments or contributions by vendors in GPO-sponsored private equity funds, research institutes, and conferences biased the selection process in favor of companies that had made such investments. The article specifically mentioned vendor investments in the Premier Medical Partner Fund and the Premier Innovation Institute, as well as a 2000 conference which vendors were invited to attend for a fee. 0 A lack of transparency in reporting fostered collusive relationships and the pursuit of selfinterest. The article stated: Premier and Novation, which say their contracting decisions are untainted by supplier payments, release no public accounting of how much each supplier pays then, or the terms of individual contracts. \"Billions of dollars are being controlled by two companies, and nobody knows who they are," said Larry R. Holden, president of the Medical Device Manufacturers Association, a Washington-based group of mostly small companies. \"Nobody looks at their books. Nobody knows what companies they are invested in." 0 New products, particularly those developed by small companies, were \"locked out\" by the group purchasing industry, suppressing innovation and hurting patient care. In its discussion of why Masimo did not receive a contract from Premier for its pulse oximeter, The Times wrote: For all the benefits of Mr. Kiani's oximeter, many hospitals would not buy it. And some would not even allow his sales staff to demonstrate how it worked. A 11 Premier, Inc. (A) BAB117 reason: Masimo did not have a contract with Premier or Novation. Both had awarded \"sole source\" contracts to Nellcor, which meant that hospitals were given strong financial incentives to buy Nellcor oximeters. Mr. Kiani said he had not known that manufacturers were expected to supply the money that finances the big hospital buying groups. \"I didn't think this kind of system existed,\" he said. .. .Mr. Kiani's company had limited ability to pay fees because, like other small firms, it had a single product line. Nellcor had no such problem, because its corporate parent, Mallinckrodt, sold many other medical products through the buying group. Nor did Mr. Kiani know when Masimo approached Premier in 1998 that Mallinckrodt had paid $1 million to belong to Premier's Innovation Institute. The unit promised to nd ways to get new technology into hospitals. Mallinckrodt was also one of 12 limited partners in Premier's venture capital fund, the Premier Medical Partner Fund. Some of the limited partners had Premier contracts. Premier says suppliers got no special favors by nancing either the Institute or the fund. But, several small manufacturers say, the money solidified an already close relationship that big suppliers had with Premier. Contemplating the Next Steps Reading over the article one more time in his office, Norling pondered what to do next. An executive with deep roots in the healthcare industry, Norling had earlier worked for Fairview Health Services, a chain of hospitals in Minnesota, and before that for a community health system in Burbank, California. These hospitals, like those in the Premier alliance, were not-for-profit organizations whose mission was to promote good health, carry out research, and train medical professionals. He had recently been named president of the Foundation for the Malcolm Baldridge Award, an organization that raised funds and managed the investments of the prestigious quality award program. Asked once in an interview what characteristics he had most admired in his mentors, Norling had cited their \"fortitude and stamina to do the hard work, analysis, and organizational development necessary to make their organizations customer- facing." Now, his gut was telling him that The Times article was an urgent problem that needed immediate management attention. Norling turned to the phone and started making calls to key decisionmakers on his board and executive team. 12 Premier, Inc. (A) BAB117 Exhibit 1: Organizational Structure of Premier, Inc. PREMIER, INC. SHAREHOLDERS PREMIER PURCHASING PARTNERS, L.P. LIMITED PARTNERS PREMIER INSURANCE PARTICIPATING MEMBERS PREMIER, INC. VAR 10ON HEALTHCARE 100%LY WASTE PROVIDER MANAGEMENT SELECT, INC PLANS, LLC AMHS/P CO. PREMIER PREMIER CAPITAL SOLUTIONS, LLC TECHNOLOGY CORPORATION SERVICES (IMS MANAGEMENT, IN GP PREMIER PURCHASING PARTNERS, L.P. DIVISION ONE DIVISION GROUP PURCHASING AND INVESTMENTS OTHER AmHS HERITAGE, LLC MEDIBUY 36% PREMIER PRACTICE MANAGEMENT, INC. PREMIER MEDICAL REMIER HEALTH ALLIANCE PARTNER FUND, LP. OF NEW YORK, INC. BRIDGE MEDICAL 54%. PACIFIC VENTURES FUND 4.7%% PREMIER HOSPITALS MEDIBANK 0.8% ALLIANCE FOUNDATION VISUCUE LEGEND OWNERS/MEMBERS 10096 PARENT COMPANY PREMIER RISK PURCHASING GROUP PREMIER IMS AMERICAN EXCESS SUBSIDIARY (ATTY IN FACT) ASSOCIATION (ATTY IN FACT) MANAGED COMPANY INVESTMENT AMERICAN DIVERSIFIED REINSURANCE, LTD. PREMIER INSURANCE EXCHANGE RRG AMERICAN EXCESS INSURANCE EXCHANGE RRG 13Premier, Inc. (A) BAB117 Exhibit 2: Top Group Purchasing Organizations, By Market Share and Number of Affiliated Hospitals GPO Market Share No. of % of Annual Affiliated Purchasing Hospitals Volume under Contract Novation 14.6 2,333 Premier 12.5 1,566 AmeriNet 4.6 1,543 MedAssets/HSCA 4.5 1,251 MHA (Managed Healthcare Assoc.) 3.3 820 Sources: Market Share: Herbert Hovenkamp, "Competitive Effects of Group Purchasing Organizations' Purchasing and Product Selection Practices in the Health Care Industry, " April 2002 (paper prepared for the Health Industry Group Purchasing Association). Number of Hospitals: SMG Market Letter, "Group Purchasing Organizations: Managing Supply and Demand, " v. 15, no. 4 (2002). Market share data are for 2001; Hospital data for January 2002. 14Premier, Inc. (A) BAB117 Exhibit 3: Premier's Multiple Relationships BASIC ORGANIZATIONAL RELATIONSHIPS VENDORS HOSPITAL OWNERS GPC HOSPITALS Patients Source: Kirk O. Hanson, presentation to Initiative on Social Enterprise, Harvard Business School, January 9, 2003. 15Premier, Inc. (A) BAB117 Exhibit 4: Premier, Inc., Board of Directors, February 2002 Terry Andrus, President, East Alabama Medical Center Richard W. Brown, President and CEO, Health Midwest Lloyd Dean, President and CEO, Catholic Healthcare West Barry R. Freedman, President, Mount Sinai Hospital Kester S. Freeman, Jr., CEO, Palmetto Health Alliance John N. Hatsopoulos, Chairman and CEO, Tecogen, Inc. Douglas D. Hawthorne, President and CEO, Texas Health Resources G. Edwin Howe, President, Aurora Health Care William Mayer, Park Avenue Equity Partners Richard A. Norling, Chairman and CEO, Premier, Inc. Elaine Ullian, President and CEO, Boston Medical Center Richard Umbdenstock, President and CEO, Providence Services Note: All members were representatives of shareholder organizations, except for John N. Hatsopoulos, William Mayer, and Richard A. Norling. Tecogen, based in Waltham, Mass., was a manufacturer of cooling, refrigeration, and cogeneration systems for industrial customers, including hospitals. Park Avenue Equity Partners was a venture capital firm serving corporations and high net worth individuals and families; its investments included medical equipment manufacturers. Source: Premier, Inc. 16Premier, Inc. (A) BAB117 Exhibit 5: Premier Combined Net Revenue from All Sources and Distributions to Members, 1996-2001 (fiscal year), in $ Millions 600 500 400 I Revenue I Distributions 1996 1997 1998 1999 2000 2001 Source: Premier, Inc. Net revenue is reported from all sources, not just group purchasing services. Shareholder distributions for 1999 were unusually high because of a special one-lime payment to return owners' capital accumulated in earlier years. 17