In July, CVS filed suit against Prasco, LLC, a company that had a contract to supply generic Allegra to CVS. I posted the complaint online here since it is a matter of public record.
The contract allegedly specified that CVS had a “Most Favored Nation” clause to guarantee than CVS paid the lowest price of any customer, regardless of class of trade. (See paragraph 11.) But paragraph 21 of the complaint states: “As a result of the merger, CVS learned that, contrary the Agreement, Prasco had not, in fact, charged CVS the lowest price offered to any other customer. Instead, CVS learned that Caremark had been charged a lower price than CVS.”
CVS is following a time-tested post-merger purchasing strategy – compare contracts and ask for the best price. They are taking advantage of the fact that generic companies compete for supply contracts and “shelf space” by lowering prices to the biggest customers. In fact, CVS reported strong Q2 financials because they claim to have already reaped their projected $500 million in purchasing power synergies.
Of course, CVS’ synergies are coming at the expense of generic drug manufacturers such as Teva Pharmaceutical Industries (TEVA), Watson Pharmaceuticals (WPI), and Mylan Laboratories (MYL). Generic drug makers now have nine major U.S. customers:
- The Big 3 wholesalers – AmerisourceBergen (ABC), Cardinal Health (CAH), and McKesson (MCK)
- The Big 6 largest chain and mail-order pharmacies – CVS Corp with CareMark (CVS), Express Scripts (ESRX), Medco (MHS), Rite-Aid (RAD), Walgreens (WAG), and Wal-Mart (WMT).
Exhibit B of the Prasco complaint also demonstrates the power of a big buyer in the generic drug supply chain. “CVS Generic Pharmaceuticals Business Standards” (as of 2004) gives CVS price protection as a generic drug’s price falls. In other words, they can recover any decline in inventory value for products in their distribution centers plus five week’s inventory at store level (apparently without regard for actual store inventories.) This is the opposite of the investment buying by the channel that occurs for branded pharmaceuticals.
All in all, it’s a scary time to be a generic drug manufacturer, but a good time to be a big buyer of generic drugs.