Drug Wholesalers and Brand-Name Drug Prices: Understanding CVS Health/McKesson and Why Pharmacies Lose Money on GLP-1s

Consider two apparently unrelated drug channel anomalies:

• In McKesson’s 2023 fiscal year, CVS bought $75 billion in pharmaceuticals from McKesson’s wholesale business—a jump of more than 35% compared with the previous year.

• Despite skyrocketing sales for anti-obesity GLP-1 drugs, many retail pharmacies are losing money on every prescription.

The common factor behind these two disparate situations: Pharmaceutical wholesalers’ unusual pricing for brand-name drugs sold to pharmacies, hospitals, and other buyers. Below, I walk through the economic fundamentals to help you understand another obscure aspect of our opaque drug pricing system.

This morning’s announcement of CVS Health’s CostVantage pharmacy reimbursement model reflects the latest attempt to fix the system’s wacky economics. Tomorrow on Drug Channels, I’ll delve into the pros and cons of this new approach.

For more on the economic forces behind healthcare industry changes, join me for my upcoming live video webinar, Drug Channels Outlook 2024, on December 15, 2023, from 12:00 p.m. to 1:30 p.m. ET. Click here to learn more and sign up.

UPSIDE DOWN ECONOMICS

Many people have predicted the demise of pharmaceutical distributors. But having studied the industry for longer than I care to admit, these businesses remain among the most resilient in the U.S. healthcare system. For example, DCI projects that for calendar year 2023, U.S. revenues from the drug distribution divisions of the Big Three wholesalers—AmerisourceBergen (Cencora), Cardinal Health, and McKesson—will reach $700 billion, a 13% increase from the 2022 figure.

Chapter 4 of Drug Channel Institute’s (DCI) 2023-24 Economic Report on Pharmaceutical Wholesalers and Specialty Distributors dives deeply into the underlying factors behind drug wholesalers’ profitability.

Briefly, a drug wholesaler’s gross profit from distributing drugs can come from manufacturers (buy-side) and from customers (sell-side). We use the buy-side and sell-side terminology because a wholesaler buys products from a manufacturer and then sells products to such external customers as pharmacies, hospitals, physician offices, and other buyers.

But when compared with other non-pharmaceutical distribution systems, the U.S. drug channel contains economic arrangements that can appear highly illogical.

For example, “cutting out the middleman” (middleperson?) often makes little sense for brand-name drugs. That’s because large-volume buyers negotiate with drug wholesalers to capture buy-side discounts and fees that brand manufacturers offer only to the wholesale class of trade. Even the largest mail pharmacies and self-warehousing retail chains buy brand-name drugs from a wholesaler instead of directly from the manufacturer.

For smaller pharmacies, wholesalers’ sell-side discounts for brand-name drugs are typically linked to generic purchases. Consequently, smaller pharmacies have historically purchased brand-name drugs at costs that are only slightly higher than those of the largest pharmacies. In exchange for these favorable discounts, a pharmacy must agree to a minimum purchase volume of generic drugs. As we discuss below, wholesalers are challenging these historical pricing approaches.

THE $75 BILLION CHANNEL

Consider the longstanding relationship between McKesson and the mail and specialty pharmacies of CVS Health’s Caremark pharmacy benefit manager (PBM) business. DCI estimates that these businesses are among the largest U.S. pharmacies. See The Top 15 U.S. Pharmacies of 2022: Market Shares and Revenues at the Biggest Companies.

The Caremark-McKesson relationship began in 2001. Last year, CVS and McKesson announced the most recent extension to their agreement, through June 2027.

The chart below, which appears as exhibit 159 in of our wholesale industry economic report, shows the long-term evolution of McKesson’s sales to CVS. As you can see, we estimate that in McKesson’s 2023 fiscal year, its sales to CVS Health were nearly $75 billion—up by $19.3 billion (+35%) compared with the previous year.

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Observations:

• DCI’s research suggests that last year’s contract renewal significantly expanded the companies’ relationship. For years, CVS had maintained direct sourcing for some specialty products, particularly those from smaller manufacturers. As part of the contract renewal with McKesson, CVS appears to have shifted a substantial volume of specialty drug purchasing from in-house sourcing to sourcing via McKesson.

• McKesson’s sales to CVS benefited from general growth in CVS Specialty’s business and higher revenues from GLP-1 products.

• For 2023, purchases by CVS Health accounted for about 31% of McKesson’s U.S. drug distribution business. For the preceding seven years, CVS had been only about one-quarter of McKesson’s business.

Note that CVS Health primarily sources generic drugs via Red Oak Sourcing, its joint venture with Cardinal Health. 

While CVS Health and its peers continue to shift more business to the large wholesalers, smaller players have faced a profit squeeze. That’s why smaller manufacturers of so-called specialty lite brand-name drugs are experimenting with direct distribution approaches that bypass wholesalers. Despite this micro-trend, direct arrangements remain a small part of the overall market.

THE GLP-1 SQUEEZE

Anti-obesity GLP-1 drugs highlight another twist on the convoluted economics of U.S. drug distribution.

Over the past two years, anti-obesity GLP-1 agonist drugs have become a significant factor behind wholesalers’ double-digit revenue growth. However, GLP-1 products contribute little to wholesalers’ operating profitability from pharmaceutical distribution. (By contrast, wholesalers’ patient reimbursement hub businesses have been profiting from providing services that help patients overcome insurance coverage barriers from these products.)

Wholesalers’ limited profits from anti-obesity drugs are due partly to the fact that these drugs are primarily being dispensed by wholesalers’ largest customers, which receive the deepest sell-side discounts. What’s more, wholesalers receive the lowest buy-side distribution fees (as a share of cost) for brand-name products sold by the largest manufacturers.

Consequently, wholesalers have reduced sell-side discounts for GLP-1 products—but mainly to their smaller customers with the weakest negotiating leverage. For instance, a wholesaler’s selling price for a typical brand-name drug might be the wholesale acquisition cost (WAC) list price minus six percentage points, i.e., 94% of WAC. However, wholesalers may use different pricing models for GLP-1 products.

Thus, pharmacies may only be able to acquire these products are smaller discounts, such as WAC-2% (98% of WAC). Section 4.4.2. of DCI’s wholesale industry economic report contains our estimates of the underlying buy-side and sell-side gross margins for core drug distribution at the Big Three wholesalers.

Here’s the problem: PBMs' reimbursements to pharmacies typically average 96% of WAC or lower. This means that many pharmacies are receiving prescription reimbursements that are below their cost of goods for a GLP-1 product purchased through a wholesaler. PBMs do not generally increase reimbursement to account for a pharmacy’s purchasing prowess (or lack thereof). Hence, retail pharmacies find themselves with rapidly growing revenues from an unprofitable product.

COST-PLUS TO THE RESCUE?

I’m intrigued by CVS Health’s announcement of its CostVantage program for retail pharmacy reimbursement. Like Mark Cuban Cost Plus Drug Company (MCCPDC), this model will reportedly use a measure of pharmacy acquisition cost plus an undisclosed percentage margin and a flat fee for pharmacy services. If this model is accepted by payers and PBMs, then retail pharmacy margins will be higher and more stable than they otherwise would have been.

For a deeper dive into CVS Health's new model, tune into Drug Channels tomorrow.