Thursday, January 08, 2009

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?


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.”


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!

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