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.
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.