Ten Strategic Questions for 2009

Well, here it is -- my 95^th (and final) post for 2008.

Before I wrap up for the year, I want to give you a brief update on Drug Channels and then highlight key trends (riddles?) for 2009. I hope you find these useful whether you’re a drug channel market player building a strategy, a manufacturer that wants to incorporate trade economics into your channel strategy, or an investor assessing company prospects.

Since this is a longer-than-average posting, you will be rewarded with a bit of multi-denominational holiday humor -- my two favorite holiday songs -- once you get past the yada yada.

AN UPDATE ON DRUG CHANNELS

Since I began tracking site statistics carefully in March 2007, total monthly traffic to Drug Channels has grown by 600% to about 15,000 per month. My readers continue to come from a diverse set of companies throughout the healthcare industry – see question 4 in my blog FAQ for more details. Fortunately, enough people keep hiring me for advice or speaking engagements, so I can pay my mortgage and keep this site free for everyone else.

I’ve also been privileged to hear that many readers have been generous with their time and insights in 2008. For example, the former owner of an independent pharmacy recently chatted with me about his reasons for selling his six-store chain to Walgreens. His feelings on the bittersweet nature of the transaction really help to put the economics of the industry into perspective. (Thanks, BG!)

And in case you haven’t noticed, the number of reader comments has increased dramatically this year. Two recent examples are Counterfeits at Medicine Shoppe Pharmacies?!? (17 comments) and CVS Escalates the Generic Price War (16 comments).

QUESTIONS FOR 2009

Here are some major topics that I expect to be watching in 2009, framed as “strategic questions” with links to my relevant background posts.

1) How deep will the pharmacy shakeout be? The price war started by Wal-Mart is reducing the profitability of generic prescriptions, which are a major source of profits for both retail and mail order pharmacies. At the same time, overall prescription market growth has slowed, which will make the competition for market share even more intense. Look out below!

• CVS Escalates the Generic Price War
• Walgreens’ $4.33 Surrender to Wal-Mart
• Will the economy hurt drug stores?

2) Will CVS Caremark finally prove the strategic value of a PBM-Retail combo? It’s not yet clear how CVS and Caremark will gain a competitive advantage under common corporate ownership. The purchasing gains are well-known, but will initiatives such as Maintenance Choice or Bridge Supply really be enough to sway their PBM market share or boost mail order? If they show traction, then I expect Medco (MHS) and Express Scripts (ESRX) to seek retail partners. If not…

• CVS Escalates the Generic Price War (esp. last section)
• CVS' Channel Power
• The Walgreens-McKesson Specialty Handoff
• What Happened at Walgreens?

3) Will direct-to-payer reimbursement models get more traction? Wal-Mart’s “direct-to-payer” model with Caterpillar introduced a new source of competition into the system. Wal-Mart’s cost-plus reimbursement methodology favors larger, more efficient dispensing operations. Even Walgreens is promising a billion dollars of cost savings and experimenting with more central fill operations.

• New Details on WMT-CAT Pharmacy Deal
• WMT + CAT: Pharmacy's Future?
• Wal-Mart's PBM Game Plan

4) How will the generic price war affect wholesalers? The generic price war is having a secondary effect on wholesalers, which provide generics for about half of the retail market. The largest retail chains and mail order pharmacies bypass wholesalers and buy generics directly from manufacturers. Yet brand manufacturers and customers still prefer to have wholesalers in the supply chain rather than setting up direct relationships, especially given wholesalers’ tendency to perpetually “re-price” (translation: reduce) their margins for the biggest buyers.

• Wholesaler Impact of a Longs Drug Deal
• Rite-Aid: From Worse to Awful

5) What happens when AMP resurfaces? A delay in the implementation of Average Manufacturer Price (AMP) until 10/1/09 was included in the physician payment fix bill over the summer. The pharmacy litigation continues. What will happen when this issue comes up in the FY2010 budget negotiations? Will the AMP hype continue? Does everyone realize that the generic price war is now removing generic margin dollars from drug channels much faster than AMP ever would have?

• AMP Delay Buried in New Medicare Bill
• An AMP Fix for Rural Pharmacies
• 11,105 Pharmacies Gone?!? Just More AMP Hype
• The AMP Saga Goes On and On and On

6) How will Democrats reform Medicare Part D? There is little doubt that the new administration and Congress will focus on changing certain elements of the Part D program – an achievable health care reform compared to some other potential areas. I wonder if branded drug makers are having second thought about the Medicare Part D benefit, especially since the much-maligned “donut hole” also appears to be encouraging greater generic substitution.

• Get Ready for Part D Reform
• Pharmacy Profits & Part D
• Part D and Generics

7) What will wholesalers want from manufacturers? Fee-for-service negotiations between manufacturers and wholesalers are taking place in a very different environment compared to 2004. The financial condition of the big three drug wholesalers has been relatively good, especially as the wholesalers refocus on their core businesses. The remaining regional wholesalers are starting to sell out, further strengthening position of the Big Three. At the same time, the wholesalers' cash flow cycle is reverting back to historical norms, perhaps suggesting lower profitability in 2009. So what’s next?

• Cardinal: The Once and Future Wholesaler
• Big Premium in the McKesson–McQueary McDeal
• McKesson Gets Out of Pharmacy Outsourcing
• WSJ Hypes McKesson Buyout (Again)

8) Will drug importation be resurrected again? HHS Secretary-to-be Daschle has been a long-time fan of drug importation. I believe that importation (a.k.a. legalized diversion) is risky. I doubt that Daschle will be able to certify the safety and effectiveness of imported drugs before they can be imported, but some sort of political compromise is possible.

• Drug Importation: A New Beginning?
• Cardinal Goes to China
• Drug Importation and Global Wholesale

9) Will we ever get national supply chain security standards? I’ve had fun (?) tracking the ups and down of pharmaceutical supply chain regulation this year. The good folks at the California Board of Pharmacy provided me and all Spinal Tap fans great fodder when they debated e-pedigree legislation going to 2011. However, I was disappointed that a more coherent national approach did not get very far. Let's see what the FDA does to meet the March 2010 deadline set by the FDA Act of 2007.

• CA Pedigree: Going to '11?
• Federal Pedigree Sand Trap
• CA E-Pedigree: Going to ... 2015
• CA E-Pedigree: Hasta La Vista, 2011
• The FDA and EC Dive into Supply Chain Security
• My Op-Ed: Securing the Supply Chain

10) Will the future of AWP (and its replacement) be resolved? No.

• The Future of AWP: Ask Again Later
• AWP: Dead Parrot or Just Resting?

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HOLIDAY CHEER

In March, the California Board of Pharmacy went to ’11. In their honor, I present…Christmas with the Devil by Nigel and the gang! (Click for a link to the video -- the song starts at the halfway point after a brief interview with the boys.) There’s someone up the chimney hole, and Satan is his name!

And for those of us celebrating the more minor festival of lights, can I interest you in Hanukkah? (my new favorite holiday song)

Happy New Year!! I’ll be back in 2009!

Big Loophole in New EU Serialization Proposal

The European Commission released its “pharmaceutical package” yesterday. As I mentioned in Monday’s post, a strict ban on repackaging of parallel traded drugs was not included in the final proposal. However, the Third Legislative Proposal, which deals with counterfeit drugs, proposes “security devices” with traceability for pharmaceuticals. Yup, that means serialization (actually, serialisation), but nothing like the Californian vision of serialized e-pedigree that’s due to take effect in only 2,212 days.

The Financial Times emphasized the anti-counterfeit nature of the proposal in European Drugs To Carry Barcodes, but I see some significant concessions to parallel traders in the proposed legislation. The proposal puts some limits on the extent of repackaging but seems to contain a major loophole (described below) that could negate any benefits from serialization.

Three links for your reading pleasure:

• Pharmaceutical Package (main page)
• Press release (with a statement from Vice President Günter Verheugen)
• Text of Third Legislative Proposal

Be forewarned – the proposal is written in the international language of “bureaucratese” and perhaps should be read only by true fans of supply chain security. Here are a few items for your consideration:

A serialized track-and-trace foundation. Product must have “safety features making it possible to ascertain identification, authenticity and traceability of medicinal products.” In other words, the proposal lays the groundwork for a full track-and-trace system, but does not require it.

On-package security will grow. These safety features must allow wholesale distributors and pharmacists to: “(a) verify authenticity by assessing overt, covert, or forensic devices; (b) identify individual packs; (c) verify whether the outer packaging has been tampered with.” Note that point (b) also supports serialization.

Multiple serial numbers? The proposal states that the safety features can not be removed or covered-up. However, there is an exception (loophole?) that allows the repackager to remain compliant even when "replacing the safety feature with a safety feature that is equivalent as regards the possibility to ascertain identification, authenticity and uninterrupted traceability of the medicinal product" Replacing?!?

The last point sure makes it sound like the manufacturer’s original serial number could be covered up by a repackager’s number. Presumably, there would have to be some sort of mapping between the two numbers. In practice, I wonder if replacement could end up negating the benefits of serialization by creating multiple sets of numbers on packages from the same production lot.

Nonetheless, I suspect that most pharmaceutical manufacturers in Europe will take the first step and ramp up serialization efforts in anticipation of this proposal being formally adopted. Keep in mind that all proposals still need to be approved by the member countries.

As always, just my €0.02.

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P.S. Check out the latest Health Wonk Review at the e-CareManagement blog.

Drug Importation: A New Beginning?

Drug importation into the U.S. has been declared dead more times than a narcoleptic Jason Voorhees. As a follow-up to Monday's post about parallel trade in the European Union, I regret to inform you that we may be headed for another sequel.

A couple of months ago, I was relieved to note that both Presidential candidates were backing away from drug importation into the U.S. (See Getting a Clue on Importation.)

Unfortunately, former Senate Majority Leader Tom Daschle, who has been nominated by President-elect Obama to head the Department of Health and Human Services, is a big fan of importation.

Check out Senator Daschle’s 2004 Op-Ed Health-care system picks winners and losers, in which he states:

Second, to lower drug costs, we can pass bipartisan legislation supported by Republicans John McCain and Olympia Snowe and Democrats Byron Dorgan and myself that allows for the safe importation of lower-cost drugs from Canada and other countries.

FYI, he is referring to his co-sponsorship of the 2004 Senate importation bill (S.2328), which didn’t get very far. He was no longer in the Senate by the time the 2007 version (S.242 Pharmaceutical Market Access and Drug Safety Act of 2007) came along, so he could not join then-Senator Obama in supporting this bill.

The conventional wisdom suggests that the contaminated heparin incident, among other things, has pushed drug importation off the radar screen. But I’m not so sure given Sen. Daschle’s many, many public pro-importation comments over the years. And some groups, such as wholesalers, will potentially benefit from legalized importation, as I note in Drug Importation and Global Wholesale.

Stay tuned for Part XIII...

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New Drug Channels readers can read a summary of my views in Importation Illusions (published in Pharmaceutical Manufacturing) or in many previous DC posts.

An Unfortunate Victory for EU Repackagers

Reuters reported on Friday that the EU plans to drop a proposed ban on repackaging of pharmaceuticals. See EU Exec Drops Drug Repackaging Ban Plan for the latest story and EU Drugmakers Demand Repackaging Ban To Stop Fakes for the original June request for a ban by EU drug makers.

In my opinion, dropping the ban is a very bad decision. Repackaging eliminates the benefit of just about every practical anti-counterfeit tracking technology, including the emerging serialization requirements in some EU countries. Apparently, tablets can even be removed from blister packs under EU law. It’s hard to see how this will benefit consumers. “Hey, it’s a bit cheaper, but it might be fake. Good luck!”

The issue relates to our old friend parallel trade. Combining the European Union’s market integration principles with national price controls has created an enormous cross-border gray market, often called parallel trading. Wholesalers in countries such as Spain and Greece sell to importers in higher priced countries such as Germany and the U.K. Drugs may pass through dozens of hands before reaching their destination.

Surprisingly, the average European consumer receives almost no price break from parallel trade, especially in countries with flat-rate patient co-payments such as the U.K. and Germany. Instead, wholesalers, importers and exporters are the big winners from parallel trade because they absorb 80% or more of the price differences between countries. Hence, these are also the groups that oppose the repackaging ban.

Unfortunately, parallel trade also means that products are often repackaged by multiple intermediaries along the supply chain and may pass through dozens of hands before being resold. Legitimate products can easily get mingled with counterfeits, with no feasible way to introduce pedigrees across countries. It’s no surprise that counterfeit cases are growing quickly in Europe. As I pointed out in a June 2008 posting, seizures of counterfeit drugs at the EU border rose 51 percent in 2007 compared with 2006.

Only one thing is certain – litigation over parallel trade will continue. In September, the European Court of Justice gave GlaxoSmithKline a partial victory in its long-running attempt to limit parallel exporting from Greece. See Europe Allows Companies to Limit Drug Sales from the Wall Street Journal.

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FYI, I wrote two background posts on parallel trade in August 2006. Amazingly, all of the links in these posts still work if you are curious:

• London Calling: Fake Drugs Get Real, which provides a high-level overview of the winners and losers from parallel trade
• Curious about European Drug Distribution?, which has background material on the EU market
  

BTW, you'll notice a lack of pictures in my 2006 posts. Hope you'll agree that Drug Channels is much more fun with the accompanying photos. In fact, one client recently confessed that he sometimes reads my blog for the pictures, not the articles. Hmmm, I recall using that excuse in reverse during my youth...

A Quantum of Solace from Cardinal

Now that Cardinal Health (CAH) has finally resolved its long-standing DEA issues, the company has quietly launched a series of intriguing Medication Safety web pages.

I’m impressed by these initial public efforts at education and greater transparency, although it’s obviously a work-in-progress. Cardinal needs to more clearly describe how a more secure supply chain will translate into sales growth among its now highly monitored pharmacy customers. I’d also like to see the initiative evolve into anti-counterfeit education aimed at changing behavior by pharmacy buyers and consumers.

See Cardinal: The Once and Future Wholesaler for my recent update on the company’s pharmaceutical distribution business.

MONITORING SUSPICIOUS ORDERS

Cardinal posted their long-awaited explanation about plans to prevent diversion by its customers at The Cardinal Health Suspicious Order Monitoring Program. According to the site, the system “flags and holds orders that warrant further inspection,” presumably with enough accuracy and effectiveness to avoid catching innocent pharmacies in their net. I hope Cardinal provides details on the system’s effectiveness, especially given the risk of false positives among the customers they are trying to win back.

The new system is reportedly devoted solely to controlled substances and DEA compliance (per Mark Hartman, SVP of supply chain integrity and regulatory operations as cited in Pharmaceutical Commerce). In other words, the company “continues to work” on systems for complying with the December 2006 (!) Assurance of Discontinuance signed with the New York Attorney General. See my post Cardinal's Sins for background on that matter.

BTW, there are links to some good article on diversion prevention under Resources.

FFF GETS AN “A”

Cardinal has also added web pages about counterfeit drugs called What you can do, although I don’t understand the target audience for this material. Are they speaking to consumers, most of whom have never heard of a “drug wholesaler”? Are they communicating to the pharmacies that they will now be monitoring?

IMO, Cardinal should take a look at the approach used by privately-held distributor FFF Enterprises for years.

While I don’t have first-hand knowledge of FFF’s operations (nor do I have a business relationship with FFF), I have been very impressed by their public commitment to educating pharmacy buyers on the benefits of supply chain security. FFF’s website has a set of pages labeled Patient & Product Safety, trumpets a concept called “Guaranteed Channel Integrity,” and recently announced its (trademarked) 8 Critical Steps to Guaranteed Channel Integrity™.

SELL BENEFITS, NOT FEATURES

I have long argued that the risk of counterfeits could be reduced by tackling the demand-side security problem, i.e., making sure that pharmacy buyers and consumers purchase within a secure supply chain. Thus, consumers shouldn’t buy from random online websites, pharmacies should be very cautious about secondary sourcing, there should no be “trading networks” to facilitate transfers between unaffiliated independent pharmacies, etc.

Regulatory and technology solutions are necessary but are not sufficient to close these diversion gateways and stop counterfeits from entering the legitimate pharmacy supply chain. But with regulation on hold and technology in flux, manufacturers and other wholesalers should follow the examples of Cardinal and FFF to emphasize WIIFM (What’s In It For Me) for pharmacy customers and consumers.

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Disclaimer: Any similarities between Daniel Craig and Cardinal Health executives, current or past, is merely coincidental.

Worthwhile Stuff to Read

Hope you all had a nice Thanksgiving holiday. Here are a few interesting articles for your reading pleasure.

As always, I welcome links to interesting stories from Drug Channels readers.

AmerisourceBergen's Scrimp-and-Save Dave (Business Week) – Ever wonder about the glamorous life of a Fortune 28 CEO? Then read this Business Week article about Dave Yost, President and CEO of AmerisourceBergen (ABC). He “answers his own phone, flies economy class, and rarely strays beyond a shortie turkey hoagie with provolone from the local deli near his sterile industrial park headquarters in Valley Forge, PA.” Dave apparently conducted the interview from “a 1970s-era plaid chair … that looks like a yard sale find.” Interesting article, but I wonder if cost-cutting is the same as efficiency.

Pharma Ponders a Track-and-Trace System (RFID Journal) – A review of this year’s NACDS/HDMA RFID Track & Trace Healthcare Summit from an unabashed pro-RFID booster, i.e., the editor of RFID Journal. The following conclusion caught my attention: “At the meeting, I got the feeling many attendees were there to hear the latest regarding which regulation is in the offing, and that they were happy to learn that no regulation is imminent. There was little discussion of the potential business benefits of employing RFID and 2-D bar codes for track and trace.” Yikes!

Knockoff Report – A fascinating blog devoted to collecting stories about counterfeit goods of all types, including: pharmaceuticals, liquor, DVDs, tires, Madonna tickets, condoms (?), and just about anything else you can imagine. Fun but scary reading. Hat tip to Pharmacoma.

The Future of AWP: Ask Again Later

Last week’s legal developments don’t make the future of Average Wholesale Price (AWP) much clearer, despite my use of a magic 8-ball.

McKesson Corp (MCK) settled its pending class action suit for $351 million and set aside a further $143 million reserve for certain future claims. See McKesson Agrees To Settlement In Pricing Suits.

Meanwhile, NACDS and FMI filed another brief in opposition to the controversial proposed First Databank settlement, although they overstate their arguments in a few places. Expect this battle to heat up over the next month as we get closer to the hearing about First Databank’s settlement.

McKesson: Without a Doubt

McKesson’s trial was scheduled to begin in December. You can view a presentation of selected evidence in the Plaintiffs’ Illustrative Exhibits in Support of Motion for Class Certification, which includes apparently damaging emails involving some familiar companies. Just keep in mind that this information was cherry-picked by the plaintiffs, so it is presented out of context and therefore may not be reliable.

Naturally, the settlement terms include “an express denial of liability of any kind.” (Read McKesson’s official statement.) The lead lawyer from the firm that filed the class action actually wrote a blog post about the settlement with his spin.

The settlement gives us some insight into litigation calculus. Conceptually, the settlement amount should be less than the sum of:

• future legal costs, plus
• the expected loss, where the expected loss = Probability of Losing * Total Damages.

If we assume $20 million in future legal costs and take the plaintiff’s original estimated damages of $5 billion, then the $351 million settlement implies a 6% probability of losing the case. Put another way, McKesson settled even though the numbers suggest a more than 90% chance of winning.

First DataBank: Cannot Predict Now

Read AWP: Dead Parrot or Just Resting? for my detailed overview about First Databank’s plans to unilaterally roll back the AWP for all drugs to 1.20 and discontinue publishing the Blue Book AWP data. This post is still valid because the next phase is a fairness hearing scheduled for mid-December.

Pharmacy groups object to the First DataBank settlement because a roll-back would translate into lost dollars for pharmacies that get reimbursed based on AWP. The National Association of Chain Drug Stores and the Food Marketing Institute recently filed a new brief and economic report opposing the amended June settlement.

Dr. Mosteller’s economic report (starting on page 21) highlights many issues that I have covered in my blog over that past few years, such as the reality that reimbursement relationships will be restructured to maintain dollar-based economic arrangements regardless of the benchmark. See PBMs and AMP (November 2007) or my original comments on the AWP settlement (October 2006).

Ask Again Later

The latest legal brief from NACDS and FMI perhaps overstates the Life Without AWP (LWAWP) issue when it says “no one has any idea as to what type of pricing benchmark will succeed it.” What, don’t they read Drug Channels?!? I’ve spent the past three years talking about a few likely candidates, including Wholesale Acquisition Cost (WAC), Average Manufacturer Price (AMP), and cost plus (a la Wal-Mart).

One final thought that has been nagging at me. Pharmacies were apparently not involved in the alleged decision to increase the WAC-to-AWP mark-up from 1.20 to 1.25. But didn’t pharmacies benefit from the allegedly inflated AWPs? I can’t seem to find any motions offering to refund any “overpayments.” I’ll keep looking…

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Thanks to the concerned readers who inquired about the lack of posts last week. Alas, I was swamped with (paid) work, including a day testifying as an expert to a jury. I can’t write more about my expert testimony except to say that I had a lot of fun. You may rely on it.

CVS Escalates the Generic Price War

Did anyone else notice the recent move by CVS Caremark (CVS) to offer a discount generic program?

Walgreens caved into Wal-Mart last June when it reversed course and started promoting the Walgreens Prescription Savings Club. See my post Walgreens’ $4.33 Surrender to Wal-Mart.

Now it’s CVS pharmacy's turn, but with the added confusion that the company also runs one of the largest mail order pharmacies. If we put aside the spin, the new program sounds like a logical pre-emptive strike against anticipated share losses. Translation: an old-fashioned, race-to-the-bottom price war!

A barrier has been breached with CVS’ entry into the discount retail generics game. Sorry to be the bearer of bad news, but it’s inevitable that this war will suck a lot of margin from the pharmacy and PBM industry over the next few years.

WHAT CVS SAYS

On Monday, CVS launched its new Health Savings Pass, which allows customers to buy 90 day supplies of over 400 generics for $9.99 (after paying an enrollment fee of $10). Tom Ryan said the following on CVS’ October 30 earnings conference call: “Let me be clear, I told you that we haven’t seen a material share loss due to our competitor’s $4 generic program and that’s still the case today.”

OK, let’s assume that he includes all types of retail pharmacy within the definition of “competitor.” So we can conclude that the generic programs of Wal-Mart (WMT), Walgreens (WAG), Kroger (KR), et al are apparently not having a material effect on CVS’ retail sales.

Why give up the generic margin? Mr. Ryan offered the following explanation, which I have parsed into two separate components:

• “We’re in the middle of an understated [sic] difficult economic crisis to say the least. People are struggling with healthcare costs more than ever before especially the under and un-insured. We felt it was the right time to offer a differentiated affordable option.”
• “Given the enrollment fee and the fact that we expect some share gain and increased foot traffic we think the RX Health Savings Pass shouldn’t cost us more than $0.01 or so per share on an annual basis.”

Sorry, but I don’t follow the logic about market share gains with the uninsured and under-insured in the first statement. Third-party payers represented 95.3% of CVS Caremark's retail revenue in 2007 (per their 10-K). The retail chain has never historically competed on price.

The second statement is more telling. Sure, the enrollment fee will help maintain loyalty as consumers try to amortize the fixed annual cost over their scripts. The $10 per customer will also provide some (non-reimbursement related) cash flow to cushion their loss of generic margin.

CVS VS. CVS

Frankly, I’m puzzled by the fit between the new generic program and the legacy Caremark mail order business. Mail order becomes less attractive if a 90-day mail script is the same (or more than!) three 30-day retail scripts. Perhaps CVS Caremark is counting on additional front-end sales to balance out lost mail margin, but I have trouble making the math work. Maintenance Choice, which is apparently gaining some marketplace traction, relies on a similar internal retail-versus-mail profit tradeoff.

I’m curious to hear from Drug Channels readers. What’s happens next in the retail pharmacy industry?

New Details on WMT-CAT Pharmacy Deal

A just-published article in Drug Benefit News provides new details about the Wal-Mart’s (WMT) $0 generic co-pay program with Caterpillar (CAT). Neal Learner, managing editor of DBN, did a superb job of reporting details on the program that I have not seen in any other publication. Here’s the link: Caterpillar/Wal-Mart Rx Drug Pilot Scraps Use of Average Wholesale Price, Uses Drug Cost-Plus Pricing

Anyone involved in the pharmacy channel – pharmacies, pharmacy benefit managers (PBMs), insurers, payers, drug wholesalers – should be paying attention to the Wal-Mart/Caterpillar arrangement. Pharmacy channel margins on generic drugs will be increasingly seen as a mechanism to control total drug spending. As a result, I expect even more adoption of cost-plus reimbursement models as Wal-Mart continues to challenge the pharmacy industry's traditional economic model.

KEY POINTS

This arrangement can best be described as a “preferred network” versus an explicitly “restricted network.” Members have a zero-dollar co-pay at Wal-Mart, but can choose to fill their prescriptions at other retail pharmacies for the normal $5 generic copay. See my original analysis of the deal (WMT + CAT: Pharmacy's Future?) for a summary of implications for the pharmacies and PBMs.

AWP is an endangered benchmark. Todd Bisping, pharmacy benefit manager at Caterpillar, describes AWP as a “flawed methodology.” I agree. See my June overview AWP: Dead Parrot or Just Resting? for more.

Wal-Mart’s reimbursement is explicitly cost-plus versus the more traditional list price-minus. The new pricing methodology is “based on Wal-Mart’s actual invoice prices on drugs.” Note that Wal-Mart’s invoice price for generics should generally be below a generic manufacturer’s Average Manufacturer Price (AMP) because of Wal-Mart’s buying power.

Payers recognize that retail pharmacies need to make a profit. Mr. Bisping notes Wal-Mart’s reimbursement includes “some money for their overhead and any margin they have to make.” It’s not clear from the article whether the margin is expressed as a percentage (basis point) mark-up, a fixed dispensing fee per script, or some combination. We also don’t know the magnitude of these profits, although Wal-Mart has been willing to accept lower margins on generic drugs than traditional chain and independent pharmacies. See Wal-Mart Redux.

This program incorporates a new benefit design strategy. Mr. Bisping states: “We felt that by negotiating directly with the pharmacy, that we could make price matter as well as choosing the pharmacy that we think will provide the best service for our employees.” This deal turns traditional benefit design on its head. Normally, those of us with third-party coverage generally pay an identical co-payment regardless of our pharmacy’s efficiency or cost structure. In contrast, the members share in the cost-savings associated with using a lower-cost channel. I explained these economics in January’s post Wal-Mart's PBM Game Plan.

PBMs get disintermediated from an important financial flow. Wal-Mart’s strategy explicitly cuts outs the PBM rather than making Wal-Mart into a PBM. Caterpillar’s PBM (RESTAT) apparently has a fairly transparent pricing model, so there were fewer business issues compared to a traditional PBM.

GET READY FOR THE COST-PLUS REVOLUTION

When generic dispensing rates (GDR) were 20%, payers did not pay much attention to the costs or margins associated with generic drugs. But GDRs are now 70% and rising, which means that pharmacy channel costs and margins will be increasingly seen as a mechanism to control drug spending. The coming wave of generics will focus even more attention on hidden economics of the channel (retail pharmacy, drug wholesalers, and PBM mail order).

Nonetheless, there are some tricky policy and benefit design issues associated with tightening generic margins. You may want to re-read Generic Drug Profits: Too High or Appropriate Incentive?, in which I highlight the powerful economic incentives for rapid generic substitution that are created when the pharmacy channel earns higher profits.

My really tough question remains unanswered: At what level of drug channel profits could payors still encourage rapid generic substitution while not “overpaying” for generics? Wal-Mart seems intent on challenging the pharmacy industry to answer this question in a new way.

My 2009 Economic Forecast

Congratulations to President-elect Obama on his impressive and historic victory! Whether you are happy or sad about the outcome, I’m sure you share my relief that the longest presidential election campaign in history is finally over. Only 1,460 shopping days until election day 2012.

As we turn our attention to the year ahead, I want to let you know about my 2009 Economic Forecast for Wholesale Distribution webcast next week on Thursday, November 13, at 2:00 PM EST. Some Drug Channels readers may want to sign up even though the event is not specifically about the pharmaceutical industry.

On this webcast, I will give you a working familiarity with just about every major macroeconomic issue that’s currently in the news. You will also get a 30+ page report with detailed, written commentary on every slide. The event is being supported in part by IBM Corporation.

Some of the topics that I’ll cover include:

• U.S. Macro Economic Outlook, including GDP and Employment
• The credit crunch and the bailout
• Exports, Commodity Prices, and the Dollar
• B2B Industry Outlook for Manufacturing, Construction, and Retail industries
• 2009 Forecasts for 19 Wholesale Distribution Sectors (drug wholesalers are one of these 19 sectors)

And now for something completely different

Why am I doing this webcast?

Well, only 75-80% of my time is spent on pharmaceutical supply chain and pharmacy economics issues – consulting, research projects, speaking engagements, litigation expert work, etc. I spend the balance of my time as a business economist/consultant focusing on general supply chain economics for a wide range of business-to-business markets. You can read a sample of my macroeconomics writing on my other (non-pharma) blog:

• Mostly Bad News in Q3 Snapshot of U.S. Economy
• Commodity Deflation is Closing the Growth Gap
• How Economists See 2009

Of course, you Drug Channels readers are my favorites. Just don’t tell the readers of Distribution Trends!

I’ll return to my regularly scheduled programming in the next post. In the meantime, enjoy the hypnotic ad below and feel free to email me any economic questions that you’d like me to address on next Thursday’s webcast.

Get Ready for Part D Reform

The USA Today published an apparently exclusive analysis last Thursday showing that Medicare drug plan spending drops $6B in 2008, driven by ever-increasing generic dispensing rates. No matter how tomorrow's election turns out, there will be serious reform efforts aimed at the Part D prescription benefit in the coming year despite this good news on costs.

So, how will Part D reform happen? On the eve of the Presidential election, here are some initial thoughts on three likely options for reducing Part D. The impact on manufacturers, insurers, pharmacies, and wholesalers will range from trivial to world-changing, depending on how Part D reform happens.

As a bonus, I’m including a special Presidential election photo of my wife's great Halloween costume at the bottom.

PART D BASICS

Here are three useful background resources:

• MedPAC’s very helpful little primer on Medicare payment basics: Part D payment system
  
• The Kaiser Family Foundation publishes regularly updated fact sheets about the Medicare prescription drug benefit
  
• Pharmacy Profits & Part D, my post on pharmacy economics

It’s especially important to understand that CMS does not pay directly for any drugs nor does it reimburse pharmacies for filling Part D scripts. Instead, CMS pays a monthly per-enrollee prospective payment to plan administrators – stand-alone prescription drug plans (PDPs) or Medicare Advantage Prescription Drug plans (MA–PDs). These plans perform functions similar to, but not precisely the same as, a pharmacy benefit manager (PBM).

One benefit of today’s structure is the choice created with a competitive system with over 1,800 plans. There is substantial variation in deductibles, cost sharing, and coverage in the gap. The biggest perceived downside is the fragmentation of buying power among the many plans.

Senator Obama wants to “Allow Medicare to negotiate for cheaper drug prices” (Source). “Direct negotiations” has a simple, populist appeal that is hard to ignore. But this approach faces an extraordinarily large hurdle because the entire Part D program would have to be reconstructed to make it work. I think the program is too popular and entrenched at this point. Nonetheless, a majority of pharmacists support direct negotiations according to a recent Drug Topics poll.

Keep in mind that Senator McCain is no fan of Part D either, saying recently: “The prescription drug benefit was the wrong solution to the wrong problem.” (Source) He voted against the bill that created the Medicare Part D benefit and is a long-time critic of the pharmaceutical industry. Senator McCain claims not to favor direct negotiations because it would give the government a bigger role in setting prices.

THREE PART D REFORM OPTIONS

Given the predilections of both candidates and the fiscal realities of Medicare, I believe that Part D will be reformed over the next few years regardless of who wins tomorrow. Here are my pre-election picks for realistic ways that the system will change, from smallest to greatest impact on the drug channels system:

1) Set up a Medicare Part D Rebate Program. The Medicaid Drug Rebate Program requires a drug manufacturer to have a national rebate agreement with the government for outpatient drugs dispensed to Medicaid patients. States can negotiate additional rebate agreements, too. So when “dual eligibles” – beneficiaries eligible for both Medicaid and Medicare Part D – were moved into Part D, manufacturer rebates declined. House Oversight and Government Reform Committee Chairman Henry Waxman (D-CA) highlighted this issue in a July 2008 report called Medicare Part D: Drug Pricing and Manufacturer Windfalls, which claims that the discrepancy in pricing between Medicaid and Part D “produced a windfall worth over $3.7 billion for drug manufacturers in the first two years of the Medicare Part D program.” A Part D rebate program would be much simpler to administer than “direct negotiations” and would be most politically viable by starting with dual eligibles.

2) Create a Government-run PDP. Another option would be to create a Government-run prescription drug program, an idea that I wrote about in November 2006. (See CMS as a PDP: A Part D compromise?) Medicare beneficiaries could have the option, but not the obligation, to enroll in a national plan based on directly negotiated prices. The current system of private PDPs could remain, in effect putting the government into competition with private plans. Two weeks ago, Avalere Health published a framework for thinking through this possibility called Mapping the Route: Approaches to Scoring a Government-Run Part D Plan. It’s a nice piece of work and worth reading for a high-level overview of the benefits and pitfalls of this approach.

3) Use Average Manufacturer Price (AMP) to Control Spending. CMS is currently collecting AMP data from manufacturers for use in the Medicaid rebate program. What if CMS requires Part D PDPs to adopt AMP-based methodologies for pharmacy reimbursement? Or mandates the use of AMP-based Federal Upper Limits (FUL) for both brands and generics in Part D? Long time readers may recall my post Part D + AMP = Trouble from last year. True, there are some AMP hurdles to overcome and the pharmacy industry will fight hard, but AMP would provide private insurers with a logical methodology to limit prescription spending.

DRUG CHANNELS IMPACT

I focus on the business impact of public policy in Drug Channels, so I’ll be keeping an eye on these options as they develop. As a brief summary, the first option above would be least disruptive to the pharmacy and drug wholesale industry because it would mirror the Medicaid program. Any additional savings would be paid as rebates and bypass the retail pharmacy supply chain.

The other two options would have much more significant effects. For example, the use of AMP within the Part D program would benefit pharmacies with the lowest cost of operations and a willingness to operate on a cost-plus basis. This is an important part of Wal-Mart's pharmacy strategy and has prompted new announcements by both CVS and Walgreens. More to come later this week.

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A PRE-ELECTION, POST-HALLOWEEN BONUS PIC

I’m sure all Americans will appreciate my wife’s excellent Halloween costume, regardless of your political leanings. As you can see, she dressed up as … Tina Fey?

Phillies win!! Economy doomed?

Woo-hoooo!!!

The Philadelphia Phillies, the hometown team of your friendly neighborhood blogger, are World Series champions for the first time since 1980! There were loud celebrations in the streets of Philadelphia last night, but few overturned cars and no mass arrests.

Gosh, Adam, what could this mean for the U.S. economic outlook? Funny you should ask!

Two smart-aleck economists at Economy.com put together a sobering analysis called A World Series of Irrational Exuberance, concluding: “The data strongly suggest that a Philadelphia Phillies victory in the current World Series spells bad news for the economic cycle.” Check out this chart from their article:

Oh well. The parade is tomorrow afternoon right outside my office. Stop by if you are in the neighborhood.

Prescriptions and the Economy: A Contrarian View

Last week, the New York Times ran a story on the impact of the economy on prescriptions. (See In Sour Economy, Some Scale Back on Medications.) The article provided many compelling personal stories to illustrate the following macro data trend:

“Through August of this year, the number of all prescriptions dispensed in the United States was lower than in the first eight months of last year, according to a recent analysis of data from IMS Health, a research firm that tracks prescriptions.”

But what if the data are wrong?

I’m not suggesting that the prescription market is booming. However, I have some concerns about the ability of IMS Health to measure a changing retail marketplace with incomplete data, so perhaps the news is not quite as bad as reported.

Here's why. The top six dispensing pharmacies – CVS Caremark (CVS), Walgreens (WAG), Medco Health Solutions (MHS), Rite-Aid (RAD), Wal-Mart (WMT), and Express Scripts (ESRX) – now account for more than half of all retail prescriptions. Yet two of these six do not report sales data to IMS Health.

• As far as I know, Wal-Mart does not sell its prescription records to any third-party data provider.
• At least one of the major mail order pharmacies apparently stopped selling its data to IMS Health in January 2008.

These gaps would not bother me if market share was stable at the top six players because estimation would be a straightforward “fill in the missing number” exercise. But we know that’s not the case, especially when it comes to Wal-Mart.

Wal-Mart does not release any specific data on its pharmacy department, but anecdotal evidence suggests that the company has picked up share in selected regional markets. What do you think is going to happen to Walgreens market share in Peoria, IL, as the Wal-Mart/Caterpillar partnership gets going? Look at a map of Walgreens stores in the Peoria, IL area. Ouch.

The Times gave some lip-service to other explanations for the drop in scripts when briefly noting “…safety concerns over some previously popular drugs and the transition of some prescription medications to over-the-counter sales…” But the main point of the article was to link the economy to the slowdown in script growth.

I suppose it would be unfriendly to mention that most consumer-related metrics of the economy – retail sales, new unemployment claims, etc. – did not start to show signs of recession until this year. Look at the chart in the NYT article again, which shows the monthly year-over-year decline starting in early 2007. Well, this won't be the first time that I've highlighted partisan reporting about the industry by the New York Times. (See Sloppy reporting about Wal-Mart from way back in 2006.)

I’m sure the folks at IMS Health try hard to fill in the gaps, but there’s simply no way for them to do anything but guesstimate when they lack actual data for a significant and fast-changing part of the pharmacy market.

The Walgreens-McKesson Specialty Handoff

Walgreens (WAG) announced the acquisition of McKesson’s (MCK) specialty pharmacy business yesterday in a win-win transaction for two major Drug Channels participants. See Walgreen Co. to Acquire Specialty Pharmacy Business from McKesson Corporation.

The deal makes sense for both parties as long you understand that specialty distributors sell products to physicians, providers and pharmacies, while specialty pharmacies dispense products to individual patients. It also makes a lot more sense for Walgreens than buying Longs Drug Stores (LDG).

GOOD FOR WALGREENS

Walgreens made a good strategic move when it acquired Option Care in July 2007. At the time, I wrote: “Specialty pharmaceuticals are the biggest driver of drug spending right now. There is a lot of money to be made managing the benefits for payers, but that’s only possible by also dispensing these drugs. Thus, Walgreens can continue to grow their small in-house PBM, which is not even ranked in the top 25 based on lives covered. I also think that today's acquisition reduces the likelihood that Walgreens will emulate CVS and acquire a PBM.” (See Walgreens Expands In Specialty from July 2007.)

My conclusion is still valid. Further investment in rolling-up specialty pharmacy fits better with Walgreens than merging with an independent PBM or buying a regional chain with overlapping geography.

The biggest specialty pharmacies are now owned by the big 3 PBMs – CVS Caremark (CVS), Express Scripts (ESRX), and Medco Health Solutions (MHS). Yet the overall specialty pharmacy market is still relatively fragmented, so there is plenty of room for further consolidation. Plus, Walgreens gains further opportunities for disruptive competition with PBMs – a strategic posture that seems to be paying off for Wal-Mart (WMT). (See WMT + CAT: Pharmacy's Future?)

Specialty drugs are also shielded from generics (for now). I expect a pathway for biogenerics to emerge within the next few years, although the strategic logic of the WAG-MCK deal is not affected by this future potential downside.

GOOD FOR MCKESSON

The deal is also a good move for McKesson. Specialty pharmacy is a very small part of the company’s overall specialty business, lacks scale, and is a fundamentally different business than McKesson’s core wholesale distribution operations. The company has wisely jettisoned other non-core businesses, such as the sale of its acute-care med-surg business to Owens and Minor (OMI) in 2006.

McKesson dramatically expanded its specialty distribution business when it acquired OTN/Onmark and combined the businesses under McKesson Specialty. (See my Oct. 2007 post Fresh Consolidation in the Oncology Channel for more on that deal.) McKesson is better off building scale against AmerisourceBergen's Specialty Group (ABC), the current market leader in specialty distribution.

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Hmmm, I sound really upbeat in this post. Hope I’m not getting soft in my old age!