Contributing to Your Success
Buying groups, purchasing cooperatives, and group purchasing organizations (“GPOs) [1] give independent businesses a way to level the playing field against larger competitors.
Through cooperation with others in the same industry, businesses leverage their collective buying power to purchase the products they need at better prices. As a result, they can come much closer to achieving price parity on their good and services with their larger competitors.
At Ray Law Firm, PLLC, our focus is on helping businesses navigate the legal pitfalls that are encountered in the journey toward forming and operating buying groups and GPOs. Whether a business is looking to start, operate, or join a buying group or GPO, we are here to help every step of the way.
Forming a Buying Group
Before starting the process of forming a buying group or GPO, the organizers need to have a game plan for structuring the buying group or GPO and its ownership, engaging professional advisors, having the legal documents needed for the group prepared, lining up vendors, recruiting members, establishing initial capital and ongoing operational funding, hiring the needed personnel to staff the buying group or GPO. While the order in which these objectives are undertaken and achieved can vary, they all must be accomplished for the buying group or GPO to be successful.
Structure and Ownership
Several questions need to be thought through before the structure of the buying group or GPO can be determined. For example, will it be operated on essentially a break-even basis or is it expected to be a profit center? Will every member have an ownership interest or will it be owned by one entity or just a select few? Will there be a Board of Directors? Is it best to set it up as an LLC, C corp., S corp., T corp., or some other type of entity? In what state should it be formed? The type of entity and state of formation questions are complex. Legal and accounting professionals should be consulted before a final decision is made. The decisions will be tailored to what the goals and objectives of the buying group or GPO are.
While each buying group or GPO will have its own unique characteristics, they do tend to fall into some general categories. If every member will be an owner, the group will often be operated on a break-even basis so that all of the revenues it generates that are not needed for cost of operation are passed along directly to the members. For instance, if a buying group or GPO has sufficient revenues coming in through dues or other sources to meet its operating expenses, then all vendor sales volume rebates can be passed along to the members. GPOs tend to be owned by the participating members, although their ownership schemes can vary, just like buying groups do. On the other hand, if a buying group or GPO is only going to be owned by one person, who may or may not be a member, then the group is almost certainly being set up as a profit center. In that case, it is likely that a portion of the volume rebates will be retained as part of the operating profit of the group. Another model is a hybrid of both. The group might have started off as every member having an equal share of ownership, but then it reaches a certain level of maturity. The existing members at that point might decide to turn the buying group or GPO into a profit center and not permit future owners to become owners. Under that arrangement, the buying group or GPO would likely retain a portion of revenues, to be distributed to the owners separately.
A buying group or GPO with numerous owners will likely have a Board of Directors (if a corporation) or a Board of Managers (if an LLC) to govern it. Even in the case where there is only one owner, having a board of advisors consisting of a group representative of the membership can be beneficial to the success of the buying group or GPO.
Selection of Professional Team
The selection of the legal, accounting, and information technology professionals to assist in the organization and operation of the buying group or GPO is a critical decision. While there are hundreds and even thousands of highly qualified business lawyers available in most states, very few of them have experience in this area of the law. Ray Law Firm has been serving buying groups and GPOs in various locations throughout the country since 1985 and is well equipped to guide the founders in making the right choices in setting up their group. The selection of the accounting firm and information technology consultant will also be important choices that will need to be done correctly. Establishing systems for handling dues, and the receipt, allocation, and payment of rebates, not to mention navigating state and federal tax laws applicable to the group and its members are complicated tasks. Professionals with experience in the areas are in a position to make this work flow more smoothly.
Just Sign on the Dotted Line…
Every Buying Group and GPO has its own unique sets of needs for legal protection, but they also have many things in common. Here is a checklist of documents to consider:
- Formation documents, such as the charter, bylaws, and organization by written consent for a corporation, or articles of organization, operating agreement, and organization by written consent for a limited liability company
- Membership Criteria Policy/Membership Application form
- Investment letters for those purchasing equity in the buying group or GPO
- Shareholders Agreement (if a corporation; otherwise for an LLC, ownership restrictions would normally be found in the operating agreement)
- Membership Agreement
- Trademark License and Marketing Agreement (used in lieu of the Membership Agreement if the buying group has a marketing program involving trademarks)
- Vendor Agreement form
- Antitrust Guide
Approach the Right Vendors
Whether the buying group or GPO will ever become operational depends upon whether a group of vendors can be assembled that will offer programs to the group that will produce much greater savings than the cost of operating the group. If there are one or two buying groups or GPOs already in the industry, the process of convincing the vendors of the benefits that the buying group or GPO can bring to them will be much simpler. They already know. If the group is plowing new ground in the industry, the vendor education process will be doable, but may take greater effort.
In striving to build up a corral of vendors, some have found it useful to start with the less important vendors, to work out the kinks in the negotiation process, so that they are at the top of the game when they take on the most important vendors. We recommend that the group’s negotiator have a checklist in hand as to each of the possible group benefits are covered with the vendor. The Vendor Agreement form provided by our firm contains such a list. For a discussion of some of the benefits provided by vendors, see “Capitalization and Funding” and “Analyzing the Financial Benefits” inforamtion.
Reach Out to Potential Members
The first step in finding members is to develop a list of criteria for what is expected of each member. While certainly their purchasing volume will be near the top of the list, other important criteria would include the vendors with whom they are currently doing business, credit worthiness, the manner in which they go to market (for instance percentage of brick-and-mortar sales vs. online sales might make a difference to the group), reputation in the industry, and general compatibility.
The more dispersed the members are geographically, the better for several reasons. The group will be more cohesive if its members are not competing with each other. In addition, they will be less likely that antitrust violations will occur within the group. The greater the geographical coverage of the buying group, the greater its ability to have a national account program through which the individual members can make sales to a large customer with nationwide coverage.
For the buying group or GPO to succeed, the members must be willing to undergo a certain amount of disruption for the good of the group and ultimately to enhance their own purchasing power. They must be flexible and nimble enough to change product vendors and align themselves with the approved vendors of the buying group or GPO. National trade association meetings are an excellent venue to meet and recruit membership prospects.
Capitalization and Funding
There are two primary sources of funding for a buying group or GPO—(1) the owners and/or members; and (2) the vendors. The initial capitalization for the group occurs when the owners purchase their interest in the buying group or GPO. Thereafter, the owners or members can be required to pay dues to the group on an ongoing basis. The amount of the dues will vary, depending in part upon how successful the buying group or GPO is in negotiating funding from the vendors.
Vendors often provide one or more of the following cash incentives to the buying group or GPO for the privilege of being on their list of preferred vendors:
- Volume rebates
- Growth rebates
- Loyalty rebates
- Headquarters allowance rebates
- Co-operative advertising allowance
- Marketing Support Fund
- Meeting fund contribution
- Information technology support fund
- Central billing rebate
See Analyzing Financial Benefits and Going Beyond the Money, below for additional benefits that vendors may provide to the buying group or GPO.
Staffing the Group
In most cases, a budding buying group or GPO does not have the funds or desire to be fully staffed until its owners see how things go. In the case of a buying group or GPO that is owned by its members, it is common for one or more of the members to shoulder the administrative burden of running the group out of their own offices. They might divide up responsibilities. For example, one member could handle the administration of the group, one could be in charge of member recruitment and another could be the liaison with vendors. If the buying group will have only a single owner, he or she will either need to be an expert in the industry or hire someone who is.
As the group matures and becomes better funded, it will be able to be in the position to take on the personnel it needs to administer its programs. The most important hire, of course, would be the executive director or president of the group, however the office of the top staff person may be titled. He or she should be well versed in the industry and their having prior relationships with several of the members and the vendors of the group would be important. As is the case with any business organization, he or she would need to be able to run the organization within its budget and operate the office efficiently. Other important positions would include overseeing one or more programs of the group, such as purchasing, marketing, or information technology and membership recruitment. Clerical and bookkeeping functions would also need to be staffed. The success of the group will depend upon hiring the best personnel available, so these decisions must be carefully made.
Building the Brand
Buying groups will often be more interested in brand development than GPOs, but even the larger GPOs will want to protect their name, where they have a large number of members and high-volume dollars flowing through their organization.
Buying groups that offer marketing programs or private label goods to their members will have a keen interest in registering and protecting their trademarks. A marketing program typically offers the members a license to use a common trademark to associate with their businesses, so that they can be seen as belonging to a national organization. A private label program involves having a manufacturer use the group’s trademark on the goods instead of that of the manufacturer. A common example of that arrangement can be seen each time one goes to a grocery store and sees the house brand of the store on the shelves, alongside the well-known brands of food. Typically, the manufacturer charges less for private label goods than it does its own branded goods, which goes to show how valuable a brand can be.
The first step in developing a brand is to have a thorough search made to determine its availability for use and registration. After the search has cleared the way, one or more trademark applications should be filed with the US Patent and Trademark Office to register the trademark. The entire process typically takes at least a year to 15 months and can go on much longer. The good news is that the buying group can begin using the mark before it is registered.
Once a brand is established, it is equally important to remain vigilant against attempts by others to use the brand without authorization, whether done knowingly or unknowingly. This task can be done by having trademark watch services provide alerts whenever an application for a similar brand for similar goods or services is filed with the US Patent and Trademark Office, by having Internet searches done, and by having full commercial searches performed on a periodic basis. Any conflicting uses need to be addressed promptly in order to maintain the exclusiveness of the trademark.
Ray Law Firm, PLLC through its buying group work over the years has gained deep experience in handling trademark work for its clients.
Analyzing the Financial Benefits
The number one reason anyone forms or joins a buying group or GPO is to improve their financial situation. Consider the following advantages offered by buying groups and GPOs:
- By harnessing the purchasing power of a buying group or GPO, members can buy products and services at lower prices. Often group members receive rebates which are an important part of achieving the lowest net pricing available. Rebates can be tiered, based upon volume achieved by the entire membership, individual growth and/or upon a loyalty purchasing program
- As a higher-level purchaser, each group member can also achieve better payment terms with most vendors. Such benefits can include extended invoice payment terms and longer periods of time to earn early payment discounts.
- Buying group or GPO members can also enjoy access to unique items that would not otherwise be available. Sometimes a vendor might create an exclusive product, product grouping, or product packaging to which only group members would have access.
- The buying group or GPO might also have a centralized billing arrangement which could generate an additional source of vendor rebates and simplify payments. A member might only have to make only a single monthly payment to the buying group or GPO for products and services purchased through the group, thereby conserving manpower for more productive endeavors. (NOTE: Buying groups or GPOs that have such centralized billing systems should take measures to protect themselves against default in payment by a member, such as cash reserves, letters of credit, collateralization, etc.)
- Buying Groups frequently feature co-op advertising programs. The collective buying power of the group enables its members to save money on regular business services such as marketing and advertising.
- It is not unusual for a buying group or GPO to negotiate headquarters allowances from suppliers approved by the group, each of which might be a percentage based upon the volume of the group with such supplier. Such allowances take pressure off of the amount of dues that a buying group or GPS must charge its members.
Going Beyond Money
In addition to the monetary ones, buying groups and GPOs offer many other benefits.
- If the individual members succeed, the group succeeds. This means each member supports the others, creating a network of peers that can help the member through tough decisions by lending their expertise and opinions.
- In case a member’s exit strategy is to sell its business, it will find a waiting pool of potential purchasers in their fellow members who already know how the business operates.
- The buying group’s or GPO’s increased status with suppliers generates greater access to senior executives of its preferred suppliers. They would not normally take the time to meet with one member as a small business, but they will take the time to attend an event with the buying group or GPO.
- Negotiating with vendors happens at the group level, freeing individual members from having to handle some of those responsibilities and allowing more time to focus on selling the goods.
- Creating access to otherwise unreachable customers with multiple locations via a national or regional account program.
Some Membership Considerations to Keep in Mind
Adding a new member to a buying group or GPO is an important decision that could impact the group and the prospective member significantly in both positive and negative ways. The decision needs to be thought through carefully by all concerned. Some of the things to consider include:
- Are there any unresolved disputes or hard feelings between the prospect and any other members?
Does the prospect make a meaningful contribution to the geographical footprint of the buying group or GPO? - Is the prospect compatible with the buying group or GPO in terms of its purchasing volume, vendors, reputation, and the manner in which it goes to market?
- From the prospective member’s standpoint, although the buying group or GPO may bring significant economic and other benefits to the table, is the prospect willing to sacrifice some of its independence in order to support purchasing, marketing, and other programs of the buying group or GPO?
- The ability of the membership to maintain confidentiality is vital to the success of a buying group or a GPO. Are there any concerns about the prospect’s ability to maintain confidence?
Membership is the lifeblood of the group. As important as quantity of members (and their volume) is, quality of membership is equally important. Both the prospective member and the buying group or GPO should choose wisely.
Operating a Buying Group
Having a viable purchasing program requires skillful efforts on two fronts, almost simultaneously. The first front is with the members of the buying group or GPO. Simply put, the group will need to get them rowing in the same direction to effectively negotiate with the second front, the vendors. For a purchasing program to be effective as to any given product line, several key elements must be present.
These include the following:
- For each product line offered by the buying group or GPO, there should be at least two or three strong competing vendors offering a comparable product.
- The product line offered by each of these competitors must be of high quality and be reasonably interchangeable with those offered by the other competing suppliers.
- The vendor must be able to service the entire buying group or GPO with a high rate of shipping performance.
- The vendor must be willing to sell to all of the members of the buying group or GPO upon the same terms and conditions.
- The members must have the ability and willingness to drop one vendor’s line and go with the line of another vendor in order to support the program of the buying group or GPO.
If a buying group or GPO cannot put most, if not all, of these elements together as to any given product line, the program will have a difficult time succeeding.
Advantages of Buying Groups
Forming or being a part of a buying group or GPO provides the primary benefit of increasing purchasing power which enables its members to enjoy a lower net cost per item. In some industries the purchasing focus is upon products acquired for resale. In others, the focus is upon equipment, supplies or services used by the members in the operation of their business. Group hospital purchases are an example of the latter. It is not uncommon for groups to have purchasing programs in each of those focus areas. Moreover, many buying alliances provide several important additional benefits to their members. They could include:
- Marketing aids
- National account programs
- Information technology programs
- Shared industry information
- Private label programs
- National warehouses to obtain deeper discounts on select items
- Shared insights among the membership; best practices discussions
The number one reason anyone forms or joins a buying group or GPO is to improve their financial situation. Consider the following advantages offered by buying groups and GPOs:
- By harnessing the purchasing power of a buying group or GPO, members can buy products and services at lower prices. Often group members receive rebates which are an important part of achieving the lowest net pricing available. Rebates can be tiered, based upon volume achieved by the entire membership, individual growth and/or upon a loyalty purchasing program
- As a higher-level purchaser, each group member can also achieve better payment terms with most vendors. Such benefits can include extended invoice payment terms and longer periods of time to earn early payment discounts.
- Buying group or GPO members can also enjoy access to unique items that would not otherwise be available. Sometimes a vendor might create an exclusive product, product grouping, or product packaging to which only group members would have access.
- The buying group or GPO might also have a centralized billing arrangement which could generate an additional source of vendor rebates and simplify payments. A member might only have to make only a single monthly payment to the buying group or GPO for products and services purchased through the group, thereby conserving manpower for more productive endeavors. (NOTE: Buying groups or GPOs that have such centralized billing systems should take measures to protect themselves against default in payment by a member, such as cash reserves, letters of credit, collateralization, etc.)
- Buying Groups frequently feature co-op advertising programs. The collective buying power of the group enables its members to save money on regular business services such as marketing and advertising.
- It is not unusual for a buying group or GPO to negotiate headquarters allowances from suppliers approved by the group, each of which might be a percentage based upon the volume of the group with such supplier. Such allowances take pressure off of the amount of dues that a buying group or GPS must charge its members.
In addition to the monetary ones, buying groups and GPOs offer many other benefits.
- If the individual members succeed, the group succeeds. This means each member supports the others, creating a network of peers that can help the member through tough decisions by lending their expertise and opinions.
- In case a member’s exit strategy is to sell its business, it will find a waiting pool of potential purchasers in their fellow members who already know how the business operates.
- The buying group’s or GPO’s increased status with suppliers generates greater access to senior executives of its preferred suppliers. They would not normally take the time to meet with one member as a small business, but they will take the time to attend an event with the buying group or GPO.
- Negotiating with vendors happens at the group level, freeing individual members from having to handle some of those responsibilities and allowing more time to focus on selling the goods.
- Creating access to otherwise unreachable customers with multiple locations via a national or regional account program.
Adding a new member to a buying group or GPO is an important decision that could impact the group and the prospective member significantly in both positive and negative ways. The decision needs to be thought through carefully by all concerned. Some of the things to consider include:
- Are there any unresolved disputes or hard feelings between the prospect and any other members?
Does the prospect make a meaningful contribution to the geographical footprint of the buying group or GPO? - Is the prospect compatible with the buying group or GPO in terms of its purchasing volume, vendors, reputation, and the manner in which it goes to market?
- From the prospective member’s standpoint, although the buying group or GPO may bring significant economic and other benefits to the table, is the prospect willing to sacrifice some of its independence in order to support purchasing, marketing, and other programs of the buying group or GPO?
- The ability of the membership to maintain confidentiality is vital to the success of a buying group or a GPO. Are there any concerns about the prospect’s ability to maintain confidence?
Membership is the lifeblood of the group. As important as quantity of members (and their volume) is, quality of membership is equally important. Both the prospective member and the buying group or GPO should choose wisely.
Legal Pitfalls to Avoid
Adam Smith wrote in Wealth of Nations:
People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.
Without proper legal guidance, buying groups, GPOs or their members can unintentionally cross forbidden lines and violate civil and even criminal laws through activities associated with the group. Criminal sanctions can include fines of up to $100,000,000 and imprisonment of up to ten years. Some of the most problematic activities among members include
- Agreeing upon the prices members should charge their customers (price-fixing).
- Dividing markets according to customers, territory or products (market allocation).
- Agreeing not to purchase products from a vendor (boycott).
- Agreeing to make all purchases from a vendor (implied boycott against that vendor’s competitors).
- Vendor agrees to sell members goods at prices lower than what it sells them to members in other similarly situated groups. (possible price discrimination under Robinson-Patman Act).
These pitfalls are best avoided by having a solid antitrust compliance program in place, a key component of which is having competent legal counsel to advise the buying group or GPO.
