McKesson’s CEO Cashes In

They say you get what you negotiate, not what you deserve.

Well, here’s the proof from the cover story in last Thursday’s Wall Street Journal: How Some Firms Boost the Boss's Pension.

In case you missed it, this story focuses on an obscure formula that some companies use to jack up lump sum pension payouts for the top brass. The story prominently features John Hammergren, CEO of drug wholesaler McKesson.

If Mr. Hammergren had quit or retired last March, he would have been entitled to a lump-sum pension of $84.6 million, which the article claims is “among the highest for any U.S. executive.” And because McKesson used its own discount rate rather than the IRS-set rate, his pension would have included an extra $18.2 million.

Mr. Hammergren has reportedly also negotiated a few unusual pension boosters: “McKesson credits him with years he didn't serve, and also counts 150% of his annual bonus in the final pay calculation, instead of just the bonus he was actually paid.” See for yourself (on page 2).

Whatever. It’s a free market. Thanks to some sort of change in Federal disclosure rules, shareholders are now fully informed about the plan and can make their own judgments. Nonetheless, I’m still surprised that McKesson’s Board would go along with such “enhancements” to an already generous plan.

Good Stuff to Read

Here are a few interesting articles that I come across but don’t have the time or inclination to blog about. Enjoy!

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

Better Scripts for Drug-Retailing Story – According to this article in Barron’s, the folks at Credit Suisse see early signs of improving fundamentals in the drugstore industry and view both CVS Caremark (CVS) and Walgreen (WAG) as “attractive value opportunities.” Before you invest, just remember the following confession from Barron’s: “The shares of 108 companies that were the focus of bullish articles in Barron's last year showed an average decline of 29.4%, versus a drop of 25.9% in the relevant benchmark indexes.” (source) Caveat investor!

NHS bridges gap in medicines tracking – The European pharma industry continues to move forward with serialization and track-and-trace initiatives. This article describes the Pharma Traceability Pilot, which reportedly tracked 15 different drugs from their manufacturing origin in Ireland and the Netherlands to a British pharmacy. Apparently, UK pharmacists are not yet opposed to serialization like their counterparts in the ex-colonies.

How Do Hospitals Get Paid? A Primer – This New York Times story, written by famed healthcare economist Uwe Reinhardt, provides a brief and understandable summary of the bizarre economics behind hospital reimbursement and pricing. After reading it, you may even come to believe that the pharmaceutical supply chain seems simple. True wonks, such as your faithful blogger, will surely enjoy the full Health Affairs article subtitled "Chaos Behind A Veil of Secrecy." Awesome!

Parallel Trade and UK Drug Shortages

As a follow-up to yesterday's Pfizer Tries to Choke Demand for Parallel Imports, check out NHS Drug Shortage Looms as Pound Falls from the UK's Health Service Journal.

According to the article, "drug manufacturers and wholesalers have begun rationing the amount of certain drugs each UK pharmacist, GP and hospital dispensary can buy."

The article describes a dramatic slowdown in parallel drug imports into the UK. The British pound has plunged due to the financial crisis, while the U.S. dollar has been somewhat spared because we remain the primary international reserve currency. See U.K. Pound Serves as Omen for Dollar from The Wall Street Journal.

Ironically, the weak pound is now encouraging speculators to export UK drugs to more lucrative markets. The executive director of the British Association of Pharmaceutical Wholesalers warned that the UK could become “the new Greece or the new Spain,” i.e., a primary source of drugs for the EU.

According to the article: “Manufacturers and wholesalers have responded by imposing quotas on the volume of drugs UK pharmacies can buy in an attempt to cut off supply to parallel exporters. Individual pharmacies are being monitored for unusually large orders, which might suggest they were selling drugs on into Europe.”

Unexpected shortages in parallel exporting countries such as Greece or Spain are typical, but have been rare in the richer countries of Northern Europe. Nonetheless, I don't see how patients benefit from this type of unpredictable, currency-driven supply chain volatility.

Hopefully, any remaining fans of U.S. drug importation will take note of these unsettling developments.

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Also related to yesterday's post, here are three rat-free sites that educate U.S. consumers about counterfeit drugs:

• BuySafeDrugs.info
  
  
• DangerousPill.com
  
  
• SafeMedicines.org

Pfizer Tries to Choke Demand for Parallel Imports

Mmmmm, rats. They’re not just for breakfast anymore!

Pfizer has started a new advertising campaign in the UK that’s designed to educate consumers about the dangers of counterfeit drugs. Watch the video for yourself at realdanger.co.uk or by clicking the picture below.

Warning: Don't watch it on an empty stomach.

Although the ad is stomach churning, it’s not really controversial. Is there anyone out there touting the benefits of counterfeit drugs?

To me, Pfizer’s ad campaign only makes sense if you also understand its UK distribution channel strategy. Otherwise, you will miss the as-yet-unstated goal of this campaign – eliminating the demand for parallel import product.

BAITING THE TRAP

Pfizer uses a "direct-to-pharmacy" distribution model in the UK. A single wholesaler -- Unichem -- operates as a fee-for-service logistics provider. Pharmacies are direct customers of Pfizer, not a wholesaler. I described Pfizer’s implementation plans in Behind the Scenes of Pfizer UK. You can also read the official FAQ from Unichem.

In my opinion, Pfizer has two different objectives for its direct-to-pharmacy model:

1. Lower the risk of counterfeit products entering the supply chain
2. Recapture lost revenue from parallel importing (since the UK is one the primary destinations for parallel trade product)

Unfortunately, a British pharmacy could still choose to purchase parallel import and gray market products, while a consumer could choose to bypass a pharmacy and buy from an online seller. So while Pfizer can guarantee the security of its own direct supply chain, the company can not force pharmacies (or consumers) to buy through the legitimate channel.

CLOSING THE RAT HOLE

Note that Pfizer’s channel strategy has created two side-by-side systems for drug dispensing:

• A consumer can purchase through a Pfizer-supplied pharmacy for a guaranteed legitimate product.
• Alternatively, a consumer can buy from an online website or from a pharmacy that lacks secure sourcing practices. The risk is that the pharmacy might be selling a parallel import (or outright fake) Pfizer product.

The rat ads imply (correctly, IMO) that diverted drugs -- such as parallel imports -- are suspect. Thus, Pfizer’s ad campaign lays the foundation for dealing with demand-side counterfeiting problems while also reducing any remaining parallel import demand.

For example, Pfizer could set up an “authorized pharmacy program” in the UK to help consumers identify pharmacies that buy exclusively from Pfizer. As the Pfizer's Real Danger web site states: "One in 10 UK men interviewed recently admitted to purchasing prescription-only medicines from unregulated sources, without a prescription." Your local British pharmacy could turn out to be one of those nefarious sources.

FOILED AGAIN

Did you know that Pfizer already used this strategy in counterfeit-laden Nigeria? As I wrote in 2007's Lessons from Nigeria, Nigerian pharmacies could earn a designation that signaled the availability of “genuine” Pfizer products. At the time, Pfizer’s Marketing Director said:

“We want to have strong allies who will say no to clones, no to parallel imports, no to fakes or counterfeits.”

So keep an eye on this campaign, which combines an innovative channel strategy with creative consumer marketing.

Plus, the next round of ads promise to be equally revolting given other ingredients often found in counterfeit drugs – paint, cement, anti-freeze, etc. BARF!

Why the UPS-Merck Deal Won’t Hurt Wholesalers

Merck recently announced a new outsourcing deal in which UPS will be taking over Merck’s U.S. distribution operations. See UPS to Manage Most of Merck's United States Distribution.

Will this disrupt the U.S. distribution channel and impact drug wholesalers?

Nope.

As I see it, Merck has made a pretty a straightforward outsourcing deal. Merck will use UPS’ supply chain solutions group to run its pick/pack/ship warehouse operations and outbound distribution. UPS will eventually convert the two Merck facilities in Reno and Atlanta to multi-client operations.

In the Wall Street Journal article about the deal (UPS Gets Merck Contract), I said: “Wholesalers will remain the preferred channel because of the pricing dynamics in the pharmaceutical industry.”

Why? As many of you may know, large pharmacy buyers purchase through drug wholesalers as a way to get additional discounts on brand drugs. Since UPS does not take title (ownership) to Merck products under this outsourcing arrangement, product flow in the supply chain won’t change.

Drug wholesalers have many things to worry about – but logistical outsourcing deals are not even on my top 10 list for them.

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President Obama's inauguration is historic and moving, regardless of your political leanings. I'm also grateful to live in a country with 220 years of peaceful and orderly transitions in executive leadership.

Pharmacy Profits and Wal-Mart

Fair warning: This post will make some people quite uncomfortable.

In Who Pays for Prescription Drugs?, I showed you how the payer for prescription drugs has changed over the past 40 years. The next logical questions: How much money do pharmacies make from different payers? How will a dominant government payer influence pharmacy profits? And what happens as competitive pressures increase?

I only have data about independent pharmacies in 2007, but the answers may surprise you. Here’s what I found:

• Medicaid remains the most profitable third-party payer for independent pharmacies.
• Despite what you may have heard, gross margins on third-party insurance business are growing at independent pharmacies.
• The generic price war that was triggered by Wal-Mart is squeezing pharmacy margins on cash-pay consumers. While $4 generics may be good news for uninsured/underinsured patients, they are bad news for pharmacy owners.

THE FACTS

The data in the table below come from the NCPA 2008 Digest, which summarizes self-reported survey data from a sample of independent pharmacy owners.

A few observations:

• Margins for all three categories of third-party-paid prescriptions increased in 2007 versus 2006.
  
• Medicaid prescriptions remain more profitable than either Medicare Part D (+160 basis points) or private third-party payers (+120 basis points). This is something to keep in mind the next time you hear that half of all independent pharmacies will close if Medicaid reimbursements drop by 2 percent.
• Gross margins on Part D business jumped by 270 basis points in the second year of the program. The self-reported gross margins of 18.7% in the NCPA Digest correspond almost exactly with the 18.5% reported by the OIG last year. See Pharmacy Profits & Part D for details.

THE WAL-MART EFFECT

Look at the category labeled “Non Third Party” in the table above. This category includes primarily cash-pay consumers, i.e., people who pay the full cost of their prescriptions out of their own pocket.

In 2007, average pharmacy margins from these uninsured/underinsured people were 42.4%, a decline of over 1400 basis points compared to 2006.

I’ll give you one guess why this is happening.

Wait for it.

Yes, you got it – it’s the generic price war!

These data confirm my supposition that the price war started by Wal-Mart in September 2006 will reduce pharmacy profits from uninsured/underinsured customers. And from the department of tooting-one’s-own-horn (ahem), this margin drop is consistent with the predictions that I made at the time that Wal-Mart announced its $4 generics program in Wal-Mart's Generic Pricing Will Trigger Big Changes and Reconsidering Wal-Mart (but just a little).

In September 2006, I wrote:

“Wal-Mart clearly struck a powerful chord with people. They are signaling their intent to remove profits from the retail pharmacy industry, to the ultimate detriment of pharmacy chains and independents. I believe that we’ll look back and acknowledge September 21, 2006, as a turning point in retail pharmacy's evolution.”

CONSUMERS WIN

Today, many independents will match prices to avoid losing a customer (and to avoid changing their U&C rates). Although they may deny the existence of price competition, Walgreens (WAG) and CVS Caremark (CVS) are also feeling the pressure on pharmacy profits.

Cash-pay customers love the generic price wars, which offer the most value for uninsured and under-insured patients. Price shoppers are fans, too, given the wide and apparently persistent variations in pharmacy prices for many common, high volume generics. (See The Price Might Be Right.)

Keep in mind that despite the drop in cash-pay margins, independent pharmacies also earned 2X margins from non-third-party scripts compared to third-party scripts. This differential reflects our health care system’s “soak the poor” approach, whereby cash-pay customer pay list price while those of us with insurance benefit from our pooled negotiating power.

Will this pattern continue in 2008 and beyond? Will PBM margins on third-party business trend downward as payers get more information about true profitability? Will direct-to-payer, cost-plus deals trigger another margin takedown?

Stay tuned, dear reader.

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Many readers have written to me asking about recent news stories – especially the UPS/Merck deal and CVS Caremark’s 2009 outlook. I’ll try to catch up on these stories in Drug Channels next week.

Who Pays for Prescription Drugs?

If you’re like me, you spent Sunday afternoon drinking beer, watching the Eagles trounce the Giants (whoo-hooo!), and poring over the latest U.S. National Health Expenditure data from CMS. (For the record, scrutinizing health expenditure data is a lot more fun when done in combination with football and beer, but that’s a subject for another post.)

Anyway, as widely reported last week, U.S. spending on outpatient prescription drugs grew by only 4.9 percent in 2007, which was below overall health care spending growth of 6.1 percent.

Here are three links for your reading pleasure, listed in increasing order of policy wonkiness:

• Rookie Wonk: Health-Care Outlays Climb at Slowest Rate in Years (Wall Street Journal)
• Big League Wonk: National Health Spending In 2007 (Health Affairs article)
• Pro Bowl Wonk: National Health Expenditure data (raw data from the CMS site. Yeah, baby!!)

CMS economists attribute the 2007 slowdown to three major factors:

1. A generic dispensing rate of 67 percent in 2007, up from 63 percent in 2006 and 60 percent in 2005.
2. Safety issues – The FDA issued 68 “black box” warnings in 2007 compared to 58 in 2006 and 21 in 2003.
3. Part D spending, which declined following the one-time growth effect of adding the benefit in 2006

I was especially interested to see that public funds paid for 36 percent of total retail drug spending in 2007. The majority of public funds were associated with major CMS programs: Medicare, Medicaid, and State Children’s Health Insurance Program (SCHIP).

During halftime (with Eagles 10, Giants 8), I created the following chart to show how payments for prescription drugs (share of dollars) has changed during my lifetime.

Pretty amazing, isn’t it? Payment for drugs by private health insurance peaked in 2001 at 50 percent. Since then, public funds have been crowding out both public and out-of-pocket payments. CMS has not updated their forecasts yet, but public funds will probably pay more for prescriptions than private insurance within ten years.

So, how much money do pharmacies make from each of these payers?

Stay tuned later this week – the answer will surprise you!

Drug Wholesalers and the Credit Crunch

In December, dearly-departed Pharmalot reported on an intriguing new Moody’s report about how credit market conditions could affect drug wholesalers. See Pharma Wholesalers Feel The Credit Crunch. Unfortunately, I can’t share the complete report with you, but you can order it by calling Moody’s.

The Moody’s report notes: “If external liquidity sources – particularly AR facilities and CP borrowings – become more costly, or distributors prove unable to access enough short-term debt to finance inventory when needed, the effects may show up in lower profit margins.”

True enough. But here are the more intriguing strategic questions for drug channel market participants: How will this shift affect (a) wholesalers’ fee-for-service negotiations with manufacturers? or (b) wholesalers’ selling terms with pharmacy customers?

BACKGROUND

Regular readers know that the drug wholesale industry changed dramatically with the widespread adoption of inventory management and fee-for-service agreements. Read Drive the Right Supply Chain Behaviors for my brief summary of this transition.

Thanks to inventory management agreements (IMAs) and fee-for-service, wholesalers have avoided adding billions of dollars of inventory to their balance sheets even as their sales grew. As a result, wholesalers’ operating cash flows soared as they reduced inventory investments.

Wholesalers used the extra cash to buyback about $15 billion of shares during the bull market, repay debt, and fund acquisitions. Return on Assets has grown in part because the ROA denominator (inventory assets) has dropped sharply. See Drug Channel Profits in the Fortune 500 for more.

But the transition is effectively over. Investment buying is still around, but much less prevalent or visible. (See Investment Buying: Not Dead Yet.) Wholesaler cash flows are now coming back in line with operating earnings. Here's some evidence from a talk that I gave in December called “Incorporating Wholesaler Economics into Trade Strategy.”

CONTEXT

In response to the report, Dave Yost, CEO of AmerisourceBergen (ABC), stated: “We have more than adequate liquidity and any access that we would need. We’re very comfortable with where we are and we're very comfortable with our prospects going forward.” (Source: AmerisourceBergen CEO: Comfortable With Liquidity, Outlook)

Mr. Yost may be correct, but the economic transition for wholesalers is occurring along with some very challenging trends:

• The generic price war among retail pharmacies (and perhaps government actions such as AMP) will flow up the supply chain and reduce the profitability of generics for wholesalers.
• Wholesalers must still “re-price” (translation: reduce) their margins for the biggest buyers.
• Overall prescription growth will remain low.
• CMS’ role as the dominant payer portends much slower drug inflation for branded drugs.

So, think of this issue as a crunchberry of uncertainty to mix into your morning bowl of strategic planning. Crunch-a-tize me, Cap’n!

Walgreens vs. Reality

Happy New Year!

I hope you all were able to enjoy some nice downtime with your families. I was once again fortunate enough to be on a beach that lacked wi-fi access. You can see my massive disappointment in the photo.

Let’s kick off 2009 with a good pre-holiday Wall Street Journal article that you may have missed: Pharmacies Fight Tough Battle on Generic Prices.

The article discusses “what some consider a generic-drug price war.” Yep, I am one of those “some” and am quoted in the article. No surprise to you, dear reader, if you saw CVS Escalates the Generic Price War in November.

But spare a thought for the poor chain executives who must convince shareholders that there is no price war. Walgreen's (WAG) senior vice president of pharmacy pooh-poohed the price war idea and then said: “I think that the pricing is competitive within certain therapeutic categories, and I think what you see is all of the retailers promoting their competitive price.”

Really? Then why did pharmacies have *no* promotion of prices until Wal-Mart (WMT) made its move? Why did Walgreens initially state that it would not match Wal-Mart’s “promotional drug pricing” but then switch course? (See “Walgreens Reacts” in Walgreens’ $4.33 Surrender to Wal-Mart.) Why is Giant Supermarkets now giving away generic antibiotics? Why is Walgreens now emphasizing cost-efficiency instead of growth?

On a related note, I think that I am not going bald. I think what you see is that I am follicly challenged.

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FYI, there is some sad news in the blogosphere. Peerless pharma news junkie Ed Silverman is hanging up his T-1 over at the Newark Star-Ledger’s Pharmalot. Check out his eloquent goodbye and leave him a note. Ed will be moving to Elsevier Business Intelligence, which publishes The Pink Sheet and other pharma titles. Best wishes, Ed!