Walgreen’s PBM Bypass Strategy

On Tuesday, Veronica Dagher at Dow Jones broke the story that Delta Air Lines Inc. (DAL) is talking with Walgreen Co. (NYSE:WAG) about a new direct-to-payer arrangement. See Walgreen, Delta In Talks Over Prescription Drug Plan. Such a deal would provide more momentum for cost-plus arrangements a la Caterpillar (NYSE:CAT)/Walmart (NYSE:WMT)/Walgreen.

A WAG-DAL arrangement signals a possible longer-term disintermediation threat to the Pharmacy Benefit Manager (PBM) business model in the large employer market. Walgreens has built the deepest, broadest multi-channel platform for pharmaceutical distribution and has an especially strong position for specialty drugs. An employer doesn’t need an intermediary (PBM) to assemble and manage a network that only has a single pharmacy provider. Notably, Walgreen recently restructured “to offer integrated ‘Pharmacy, Health and Wellness Solutions’ to employers, managed care organizations, pharmacy benefit managers and government clients.” (source)

A couple of years ago, Walmart was the first-mover bogeyman who was going to blow up the PBM industry. But Walmart is playing a much narrower game and may find itself poorly matched against Walgreens broader set of channel assets. The lack of new deals from Walmart makes me wonder they are having trouble closing deals for Employer Solutions, their name for direct-to-payer contracts.

Expect more disruptive moves as the drug channel ecosystem rearranges itself.

GEOGRAPHY IS NOT ENOUGH

Conventional wisdom suggests that a large retail network can provide countervailing negotiating power against a PBM. Translation: It’s impossible to assemble a network without a major chain.

Like CVS, Walgreens accelerated its growth by acquiring regional pharmacy chains. Duane Reade is only the latest in a long list that includes Happy Harry’s, Drug Fair, Snyder’s, and others. Walgreens has visibly used this leverage against state Medicaid programs, e.g., Walgreens to Washington: Make my day. However, any disputes with private payers rarely spill into public view.

CHANNEL DIVERSITY

Rather than making an ego-driven acquisition of a PBM, Walgreens has instead assembled an impressive roster of non-retail dispensing and provider channels. I’ve been tracking this evolution in Drug Channels posts (click links below):

• Specialty Pharmacy (McKesson’s (NYSE:MCK) specialty pharmacy business, Cardinal Health’s (NYSE:CAH) SpecialtyScripts subsidiary, Medmark, Schraft’s)
  
  
• Home Health Care/Infusion (Option Care, CuraScript Infusion from Express Scripts, IVPCARE, Home Pharmacy of California)
  
  
• Work Site pharmacies (I-trax, Whole Health Management)
  
  
• Long Term Care (SeniorMed)
  
  
• Retail Clinics (Take Care)

Look at Walgreens drug distribution and dispensing footprint today compared with 10 years ago:
Compare Walgreens to the other big players in specialty pharmacy—CVS Caremark (CVS), Express Scripts (ESRX), and Medco Health Solutions (MHS). These companies primarily dispense self-injectable specialty drugs via a single channel (central-fill mail order), although CVS Caremark has retail capabilities. But none can offer the seamless trade-off between medical versus pharmacy benefit—a point of differentiation Walgreens touts in its marketing materials.

FULFILLING THE PROMISE

Walgreens can now credibly bring together benefit management with a broad diversity of dispensing formats and locations. In some sense, Walgreens is fulfilling the promise of the CVS Caremark combination. But unlike CVS Caremark, Walgreens is willing to disrupt the traditional PBM business model.

Another channel truism: You can remove an intermediary but not the services provided by that intermediary. Walgreens owns a smallish PBM (Walgreen Health Initiatives), so it can arguably offer a completely integrated, end-to-end solution. Recall that RESTAT, Caterpillar’s PBM, continues to perform claims adjudication, rebate negotiation, pharmacy network management, and other PBM services. RESTAT does not earn a spread on prescriptions filled within the retail network and passes all rebates back to Caterpillar. See CAT Rolls Out Preferred WAG-WMT Pharmacy Network.

As in the Caterpillar deal, Delta will presumably contract for pricing directly with Walgreens, eliminating opportunities for a third-party to earn spreads on prescriptions filled within the Walgreens network. The intrepid Ms. Dagher reports: “Caterpillar expects to see double-digit savings in its pharmacy costs this year, thanks in part to the direct prescription drug purchasing plan it inked with Walgreen Co. (WAG) last August.” (Caterpillar Sees 'Substantial' Pharmacy Cost Savings In 2010).

If the savings number are real (no proof yet), then Walgreens-Delta will add further momentum to more innovative contracting and network models.