Rite-Aid + Brooks-Eckerd: Will three wrongs make it Rite?

So much for taking the rest of August off!

As you all know by now, Rite-Aid plans to buy Brooks and Eckerd stores. Following this deal, Rite-Aid/Brooks-Eckerd will become the third-largest store-based pharmacy, jumping ahead of Wal-Mart.

My thoughts:

• Good for Rite-Aid
• Better for PBMs and payers
• Bad for wholesalers
• Potentially bad (over the next few years) for the chain pharmacy industry

Impact on Retail Pharmacy

Retail chains need scale so they can control access to patients and gain leverage against the payers, PDPs, and PBMs that want access to this network. As I point out in my June 8 dead canaries post, CVS and Walgreens are both trying to grab market share as quickly as possible. Chains with strong store loyalty and a high share of outlets in a given geographic market can negotiate better reimubrsement rates.

For reference, here is our breakdown of 2005 retail pharmacy sales by channel and company.

RetailPharmacy-2005.pdf

Ironically, this move may turn out to be negative for the chain pharmacy industry. The Rite-Aid/Brooks-Exckerd combination creates a credible third large chain pharmacy that PBMs and payors can play off against CVS and Walgreens. The presence of three big suppliers in a market creates much more competitive pressure, as wholesalers have discovered to their regret.

What about wholesalers?

As far as I know, both Rite-Aid and Brooks-Eckerd are McKesson customers, which means that there will be no meaningful volume movement between wholesalers. The deal will create even more customer concentration for McKesson, whose top two customers are CareMark and Wal-Mart.

Nevertheless, this deal creates risk because wholesalers have become dangerously dependent on these low margin power customers. Retail chains such as CVS, Walgreens, and Wal-mart have developed self-warehousing capabilities for distributing drugs to individual stores from their own warehouses. They act as their own wholesaler for generics and many OTC/CPG products.

In Q2, deliveries to customer’s warehouses were 49% of Cardinal’s Pharma Distribution & Provider Services revenue and 32% of McKesson’s Pharmaceutical Solutions revenue. Wholesalers rationalize these sales by arguing it incremental business that would otherwise go direct (true) and generates a reasonable return of capital (insufficient disclosure to verify this claim). Last year, I argued that changes in the drug channel could shift this business back to direct sales. (See my September 2005 white paper Preparing for the Future Retail Pharmacy Supply Chain.) Still a risk, in my opinion.

The Sink to the Bottom Line?

Let’s face it – Rite-Aid, Brooks, and Eckerd are notorious underperformers in retail pharmacy. Yes, things have improved, but none of the companies are as well run as CVS or Walgreens. As one industry executive quipped to me this morning: “If you tie two rocks together, they still won’t float.” Nonetheless, the deal makes sense given the marketplace dynamics.

That’s all for now. Back to my vacation from blogging!

Why so few posts?

I apologize for the unusually long delay between posts. I’ve found myself unexpectedly busy with client work this month. I am also finishing up the manuscript for the next edition of Facing the Forces of Change, a major supply chain trend report sponsored by the National Association of Wholesaler-Distributors. (Both HDMA and HIDA are part of NAW.) The report covers the entire US economy, not just health care. The last edition came out in 2004, so this will be a major update. I’ll include some links in future posts for readers interested in how other channels operate. Plus, I am trying to squeeze in a little R&R with my (very understanding) family!

That said, things have been pretty quiet on the drug channels front. Topics that I expect to be covering post-Labor Day include:

• CMS’ retail class of trade guidelines
• Competitive effects of the PDMA and pedigree
• The (re)importation debate
• The changing wholesaler profit model
• Coming battles over how to best split up the financing pie among drug channel participants
• The fate of independent pharmacies

As always, I welcome your suggestions and comments on blog topics. In the meantime, have a great August! I'll be back after Labor Day unless some major news breaks.

Read the Health Wonk Review

Legendary producer Bill Graham once promoted the Grateful Dead with a sign that read: “They're not the best at what they do. They're the only ones that do what they do. Cheers!”

I was reminded of this quote as I read the excellent collection of links in the aptly named Health Wonk Review on The Health Care Blog. The Review also includes a nice citation to yours truly.

Check it out and be amazed at the variety of knowledgeable experts out there.

Curious about European Drug Distribution?

A few people have emailed me over the weekend with questions after last Friday's post about counterfeit Lipitor. (Why is everyone too shy to post a comment?) My analysis was also picked up by at least one other blog. (Thanks, OnThePharm!)

Here are two good resources about the European market:

1) The European Pharmaceutical Wholesale Industry (2005) -- Published last November by the European Association of Pharmaceutical Full-line Wholesalers (GIRP). While unsurprisingly self-serving about the role of wholesalers, this is a mostly accurate factual resource about drug distribution in the EU.

2) Coincidence or Crisis? Prescription Medicine Counterfeiting (2006) -- An edited collection of chapters from the always provocative Stockholm Network. Be sure to read Chapter 5, which was written by Graham Satchwell. He also wrote a book called A Sick Business in 2004 about organized crime's role in pharmaceutical counterfeiting.

BTW, secondary wholesalers have their own trade association -- the European Association of Euro-Pharmaceutical Companies (EAEPC) -- dedicated to preserving parallel trade regardless of the consequences.

Please contact me directly if you'd like to talk privately about the US vs. European distribution models, as they are quite different.

London Calling: Fake Drugs Get Real

The British fake Lipitor scandal continues to expand after an additional recall was announced yesterday.

It’s really a shame that the public perception of pharmaceutical manufacturers is so low that no one believes in the dangers of cross-country importation. As I commented on the PharmaMarketing blog’s recent snarky PhRMA Intern post, just because an issue favors pharmaceutical manufacturers doesn't mean that it's wrong. That's not demagoguery, just reality.

This got me thinking: What can we learn from the European situation that can shed light on the misguided attempts to allow importation into the US? (See my cosmic irony post.) Plus, there’s a special bonus for everyone who reads to the end of this post!

Of course, the secondary market here in the ex-colonies pales when compared to parallel trade in the EU. Multi-billion parallel trading runs rampant within the EU as authorized wholesalers in countries such as Spain and Greece sell to importers in higher priced countries such as Germany and the UK. Products are often repackaged by intermediaries along this supply chain. Mention pedigree, as I did to some European executives recently, and you will get either a blank stare or a hearty laugh.

EU competition policy hinders manufacturers’ efforts to monitor the distribution channels of their products. Direct restrictions on parallel trade conflict with the principal of European market integration, which allows a product available in one member country to be legally distributed in any other country. As a result, manufacturers face ongoing legal challenges using supply quotas, allocation of available quantities, or refusals to supply as mechanisms to limit purchases for export.

Here's my take on the winners and losers in the EU system:

• Wholesalers & Parallel Distributors are the big winners. Wholesalers and importers/exporters absorb 80% or more of the price differences between countries.
• Pharmacies also win from parallel trade. UK pharmacies profit from parallel imports because reimbursement is the same regardless of the source of the drug. Thus, a pharmacy can keep the difference between the import price and what they pay to a wholesaler.
• Government payers, such as the British National Health Service, indirectly benefit from parallel importing because pharmacy compensation rates can be reduced as long as pharmacies can be subsidized by parallel import profits. The NHS even goes so far as to assume a certain level of parallel importing and then claw back some of the profits. The average claw back was 10.4% in 2002.
• Manufacturers are the big losers, of course. Cross-country arbitrage costs them billions in lost revenue. Their costs also go up because they can not allocate production or distribution properly because market information is so wacky. IOW, Spaniards probably do not consume all of the products shipped to their country.
• Ironically, consumers receive almost no price benefit from parallel trade, especially in countries with flat rate patient co-payment such as UK and Germany. Yet consumers also bear all the risk when products are counterfeited, mishandled, or inappropriately relabeled.

Bottom line:
Parallel import in Europe is a basically a punitive tax on innovative pharmaceutical manufacturers, with consumers bearing all the risk and getting little of the benefit.

SPECIAL BONUS

Tired of seeing boring old art or pictures of your kids in your office? Then check out this July Pharmaceutical Executive magazine article and the scary mug shots of the bad guys.

Mug Shots of the Bad Guys

What the Bad Guys did
(Hint: If you can't read this page, left-click and then click the box on the bottom right to expand.)

Suitable for framing? Better yet, how about we all send these links to Senator Vitter?