Are You Saving from Wholesaler Efficiencies?

The Center for Healthcare Supply Chain Research, the research arm of the Healthcare Distribution Management Association (HDMA), recently released its 2010-2011 HDMA Factbook.

IMHO, the Factbook is an invaluable guide to the economics of the pharmaceutical wholesale industry. The report will be particularly useful if you sell to or buy from pharmaceutical wholesalers because it reveals a lot about wholesaler economics—perhaps more than the participating wholesalers may realize.

As I highlight below, you could credibly use the data in the new Factbook as a rebuttal whenever a wholesaler complains that “their costs have gone up.” You may also question the basis-point economics of your fee-for-service agreement.

The report’s price is lower this year, but I can only give it a qualified recommendation because HDMA stubbornly refuses to make the report available in a convenient downloadable format. More on this subject below, too.

THE DATA

The new HDMA’s Factbook is based on data from 25 reporting companies (70% of HDMA distributor members). The respondents include the big three public wholesalers—AmerisourceBergen (NYSE:ABC), Cardinal Health (NYSE:CAH), and McKesson Corp (NYSE:MCK)—along with the regional companies. The big three represent 96.3% of HDMA member total sales, although not every company joins (or reports data to) HDMA. Kinray, which was recently bought by Cardinal Health, was not a member and did not provide sales data. You can presumably deduce the corporate membership from the HDMA Board of Directors.

As always, the Factbook presents a confusing array of figures—weighted averages, averages, medians, and middle ranges. IMHO, the weighted average summarizes the overall industry’s economics most accurately by reflecting the influence of the big 3 wholesalers. A methodological change to the data eliminated historical comparisons, so you’ll only get 2008 and 2009 data.

The statistics use either a company or a distribution center (DC) as the unit of analysis. The DC-level data strip out the effect of ancillary businesses such as packaging or automation. The data exclude pure specialty facilities as well as the large DCs that supply other, smaller DCs within a wholesaler’s network.

A PENNY SAVED

Productivity is crucial to the profitability of pharmaceutical wholesaling because employee compensation costs—salaries, commissions, and benefits—represent 47% of a drug wholesaler’s corporate operating expenses.¹

The amazing gains in efficiency represent one of the more remarkable aspects of the drug wholesaling industry. Here’s some evidence of wholesalers’ growing efficiencies that I gleaned from the 2010-11 Factbook:

• Average Handling Cost per Invoice Line (= Total operating expenses / Invoice lines issued on sales) dropped from $3.13 in 2008 to $2.54 in 2009—a 19% decline. See Table 71.
  
  
• Average Total Distribution Center Operating Expenses as a Percentage of Net Sales dropped from 1.34% in 2008 to 1.17% in 2009—a 13% decline. See Table 21.

A PENNY UNEARNED

As I discuss in the 2010-11 Economic Report on Pharmaceutical Wholesalers, many fee-for-service agreements between brand-name pharmaceutical manufacturers and wholesalers are still computed as a percentage of the total value of product sold through the wholesaler. Therefore, the dollar value of a wholesaler’s quarterly fee payment from the manufacturer goes up whenever a manufacturer increases a drug’s list price, a.k.a., Wholesale Acquisition Cost (WAC).

But a “percentage of price” compensation model is tricky because a wholesaler’s operating costs do not differ for individual drugs that have comparable physical characteristics but different prices. In other words, a wholesaler’s distribution costs do not vary based on whether a drug is $8.00 per pill or $0.08 per pill.

Why does this matter? Consider a manufacturer that increases the WAC list price by 8.8% per year. As the example below illustrates, the wholesaler’s total compensation per unit handled grows by 26% after four years even though the wholesaler is doing the same work throughout this period.

As Mr. Spock would say: Fascinating.

I LOVE THE ‘80s!

While I view the HDMA Factbook as an invaluable resource, I must once again criticize the HDMA’s decision to make the report available as a hard-copy spiral-bound book but not as an electronic PDF file. I find it much more difficult and less convenient to locate material in a hard-copy book versus searching an electronic file. PDF is the universal format of reports such as the NACDS Chain Pharmacy Industry Profile or (ahem) my own industry reports.

Karen Ribler, who heads the research center, tells me that next year’s edition may move into the 21st century. So, stay tuned, I guess.

The Factbook is available for sale from the Center for Healthcare Supply Chain Research’s Online Store. The non-member price is $95.00 (book only) or $170.00 (book plus data CD). HDMA graciously provided me with a complimentary copy of the report (book only). I did not evaluate the more expensive version with the data CD.

¹ Total Company Payroll/Benefits averaged 0.82% of net sales in 2009 (Table 26), while Total Company Operating Expenses average 1.73% of sales (Table 20). Thus, payroll/benefits as percentage of operating expenses equal 47% (= 0.82% / 1.73%).