19 July 2013

How should GPO's help small business ?

Services that help small business compete better are very important to the capitalistic ecosystem.  One of the most common is general purchase organizations (GPO's) that essentially pool purchasing power to lower costs for their members.  GPO's are broad across industries, vary in organization, and realized differing levels of success throughout the years.  I've often wondered what the optimal structure of a GPO should be to yield the largest impact for the most number of small businesses they support.

Historically, GPO's took shape in the form of cooperatives.  Each member generally paid a fee to buy an ownership stake and then paid monthly dues to support the co-op's infrastructure.  Local grocers,  distributors and other small businesses now had leverage over manufactures and other suppliers to exert lower prices, better service, and other incentives.  It also helped the small guys compete with larger, more sophisticated corporate competition.  There were limits to their success however.

The problem was that co-ops were no more than a loose associated of individually-owned businesses with no real capital or governance to change business models to adapt to market conditions.  Ace Hardware, one of the largest ever created, is now a fraction of what it once was thanks to the rise of chains like Home Depot.  Associated Press was poised to thrive during the migration to digital news consumption, but could not get their media outlet owners to move quick enough (Innovator's Dilemma at play as well).  For an individual member who might have lost their small ownership stake in a declining cooperative, the real impact was on its underlying business that could not successfully compete.

Not all of them have been failures.  REI, which did close to $2B in revenue in 2012, has thrived as a member-owned coop.  REI is unique in that it operates similar to a public company with a board and governance provisions similar to larger concerns. Other successes can be seen in the meteoric rise of hospital system GPO's that address rising healthcare costs. The top six GPO's alone account for almost $750M in aggregate purchases serving close to 14,000 hospitals.  As the GPO's act as separate entities from their members, they are able to move quicker and focus better on its business objectives. 

There is a continuum of needs being addressed ranging from small discount plans to full service GPOs.  On the one hand, while the historic cooperatives may have be limited in their reach, they provided benefits with little commitment or loss of control from their members.  Large, successful GPOs offer a wider array of services, but take a larger cut of the pie (MedAssets, for example, operate at 30% EBITDA margins).  The risk in a broad shift to for-profit concerns is that the central focus turns away from member needs and towards padding individual bottom lines.

Small businesses have a hard time reacting to macro trends in their industry given their general internal focus and lack of resources required.  GPO's fill some this void but often come at a heavy price tag.  While this is probably no different from MSO or franchise organizations, the notion of a highly effective industry cooperative seems appealing.  Imagine if an entity like Associated Grocers was able to build a world-class distribution system to thwart the massive Walmart market share grab starting in the late 1990s.  It could've provided competitive equalization and perhaps kept more of the value chain with small businesses.  Or perhaps this is just summer nostalgia kicking in longing for childhood walks to Piggly Wiggly.

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