Thursday, November 03, 2011

What’s Behind the Drug Shortage Epidemic

On Monday, President Obama “took action” and issued an Executive Order called Reducing Prescription Drug Shortages. Whew! Glad he fixed that problem!

OK, not really. I'm glad the President is focusing attention on this public health catastrophe. Alas, this PR-friendly move will have only a limited direct effect on shortages. The President basically told the FDA to work harder, but didn’t provide any new enforcement tools or authority.

On the bright side, Monday’s flurry of activity did provide two useful background reports on the supply chain dynamics behind shortages. Together, these reports provide a compelling, but in my opinion incomplete, explanation for why the supply chain for generic injectable drugs is so fragile. Most notably, the Obama administration's prescription ignores the fact that the reduced return on investment from generic injectable manufacturing has quite predictably reduced the level of investment.

Read on and see if you agree.

HOW SHORTAGES HAPPEN

Two worthwhile background reports were issued at the same time as the Executive Order. These are must-read documents if you want to truly understand the generic injectable supply chain and distribution system.
If you're too busy to wade through the 60+ pages, here’s the story they tell in a nutshell.
  • There are very few manufacturers for any individual injectable drug, demand is growing rapidly, and highly-specialized manufacturing capacity can’t be quickly increased in the short-run.
  • Any supply shock to the system, such as a manufacturing problem, can rapidly create a shortage because alternative capacity can’t ramp up to meet demand.
Here’s how the FDA report illustrates this dynamic:

The FDA is taking positive action to prevent shortages or lessen their impact. The FDA’s Drug Shortage Program (DSP) helped to prevent 38 drug shortages in 2010 and 99 to date in 2011. Here’s how they did it:

Each report highlights the market concentration in the generic injectable market. In 2010, the top five generic injectable manufacturers accounted for 80% of the packages/bottles/vials sold in the U.S. market by volume and 73% of the dollars in sales. Contrary to popular belief, concentration has decreased slightly over time. (See pages 30-32 of the FDA report for more.)

WHAT’S MISSING

As I see it, both reports fall short by ignoring the economic market factors that create such a narrow supply base. Investment incentives matter because the FDA cannot compel a company to manufacturer a generic injectable drug. Here are three major culprits:
  • Large GPOs and wholesalers “pick the winners” when awarding sole- or dual-source contracts, driving prices down and encouraging concentration. While this is logical and sensible cost-saving behavior, these power buyers inadvertently make the generic injectable market financially unattractive for manufacturers. Put another way, short-run gains for buyers has created a long-term problem for the health-care system.
  • Lightly-regulated gray market wholesalers speculate on products in limited supply, driving up prices to healthcare providers (a la Drug Shortages and Gray Market Profiteering). The manufacturers don't receive these higher prices, so there is no clear profit signal to encourage potential manufacturing entrants. I speculate that this problem persists because budget-strapped states lack the resources to routinely vet all of the entities with a wholesale license.
So, any other ideas?

15 comments:

  1. Plus there is an aggressive push for litigation against pharmaceutical manufacturers for anything remotely resembling artificially inflated prices.  It is an easier decision for a manufacturer to exit a market or not enter rather than to consider a price increase to meet demand for a drug that is decades old and has few remaining competitors. 

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  2. Mike WinkelmanNovember 03, 2011

    Adam:  I agree with your analysis.  Pretty shallow thinking in Washington.  There is an easy fix.  I believe that there is no shortage of these drugs in other developed countries such as the UK, Canada, etc., where quality standards are as good as ours.  If bureaucrats really want to fix the problem, they need simply allow these drugs in short supply to be imported.

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  3. Well Adam, what the heck. Might as well tie this to the AMP discussion. Maybe we can beat the 68 post record by addressing this topic!

    Clearly with AMP there will decreased generic pricing through "power purchasers" and GPO's. As pricing continues to fall to the floor, one can expect less mfgrs having the desire to have that product in their line....driving generic prices through the roof. 

    Some potential results over time: 

    1. High generic COGS with the low AMP that is currently in place. Think of it this way.... "Low reimbursement for mature generic injectable drugs reduces the incentive for a manufacturer to enter the market. One likely cause is 2005's introduction of the Average Sales Price (ASP) methodology, as illustrated by the profit timeline shown in Profits from Generic Injectables: Too High or Just Right? Yesterday'sWall Street Journal editorial The Bush-Obama Rx Shortages pins the blame unambiguously on ASP.".....and yes, this would lead to some additional margin erosion on the retail side til things balance out.

    2. Shortages of mainstay "old-time" generic drugs. Ultimately forcing the consumer to purchase newer generic products which are available (at a higher price).

    Strikingly similar!

    Chairs up.

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  4. Hi Adam,
    Thanks for posting this. You do not need to speculate that budget strapped states lack the resources to keep gray market drug wholesalers in check. Local police, state bureaus of insurance, state Drug Enforcement Agencies (DEA) and state Medicaid program integrity and fraud prevention also all lack resources and all remain uneducated about the nature and scope of this problem.
     I worry that we have not seen the worst of it with oral drugs. New FUL pricing and the wave of oral drugs going off patent, consolidation in the PBM/pharmacy sector, and new and reemerging drug shortages of oral antimicrobials all indicate that these problems are going to get much worse before they get ANY better.
    Amplifying the problem is the fact that certain shortages that could be eased a little if certain compounding pharmacies could justifiably participate in tax payer funded programs. Instead, these pharmacists hands are tied by red tape and reimbursement issues. Patients, doctors and pharmacists are left to go without, use drugs that might not be reliable, and in certain cases, patients who can afford to will pay higher our of pocket costs, and/or wrongfully held financially liable for increased costs. Other patients will turn to unregulated Internet pharmacies, unscrupulous providers offering improper (and often cash based) treatments, and oh yes, let's not forget the patients who resort to veterinary medicine when and it is available. 

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  5. Time to think outside the box......

    Creating rational distribution of drugs affecting the lives (and mortality) of the American public is certainly a federal responsibility. So the federal govt needs to step up with an action plan. The trapped miners (Los 33) stretched 2 days of food into 14 by agreeing the situation was dire. They convened and decided a rational rationing of the supply was the only way that in their own minds, if a fellow miner died, it wasn't because of the social breakdown within their group. 

    There isn't a lot of discussion that I have found in this area. During the emergency planning in the US in preparation for a potential overload of the system due to swine/avian flu, governments drew up detailed pathways for the rationing of ventilators for critically ill patients. So what I propose isn't that far off the radar, and I think certainly within the feds authority during times of crisis.

    Because we certainly have plenty of case studies in the current crisis of what happens when a drug becomes short, the govt should purchase/federalize all available supply through normal distribution channels as if it were a recall, at the first indication from manufacturers of the situation, or through other trip wires within the distribution system. Then, a distribution system (let's say using some of the current large box wholesalers) would redistribute through some priority ranking. Maybe in the case of oncology drugs, first priority goes to those completing cycles already in progress. Those details can easily be brain stormed. Once the crisis is over, if there is remaining drug in the federalized supply, it simply flows back into the distribution channels.

    This laissez faire attitude that I now read about meets the commonly accepted definition of insanity. 

    Bill Parker, RPh
    Endgame Solutions

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  6. Regarding the three culprits:

    ASP – agreed, but could this slow down ASP adoption…stay tuned for the NADAC survey results…?

    GPOs – if the “Safe Harbor” provision goes away so do the GPOs.
    “Gray Market” distributors – they exist because of the inefficiencies of the big Three distributors but everyone follows the same state regs.Excellent and insightful Blog today… good reading between the lines…Thanks!

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  7. Adam: Great topic. I agree with your comments, also the shortages will, pardon the pun, "AMP-up"  the anti-AMP forces. Grey market wholesalers are a HUGE issue.  Where's  60 Minutes!

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  8. Mary GoroundNovember 03, 2011

    The industry is headed for a cluster disaster of its own making.  

    Regulators, legislators, and industry do not cooperate, communicate, nor are they honest with each other resulting in blinded, imbalanced regulation, legislative non sequitors (ASP, AMP), and unprincipled trade practices.  

    In their financial reports many generic manufacturers cite the high number of ANDA's pending at FDA without having made any accommodation for those approvals in their capacity plans or capital expenditures. 
    FDA reviews and approves ANDAs without regard to the ability of any applicant to actually satisfy market demand.  User fees may somewhat gate the number of filings, but not enough to infuse rationality into the ganeric markets.  One approved ANDA representing a manufacturing capcity to support 5% market share can crash the price for the remaining 95% of the market.  Once the price is down, it is nearly impossible to bring it back to a responsible level that allows for both value contribution and profitablity.

    Nor has there ever been any serious discussion to the value of FDA reviewing more than 5 (or whatever number) filings for the same molecule...more than ~5 competitors and the value, regardless of profitability, is fractured.  The math to this issue is simple (with no reference to validation batches)...if each applicant assumes a 25% market share target, then with 5 approvals, the market will be at 125% supply with generic price above or about 10% brand published pricing.  With 10 approvals, the market goes to over 200% supply and the price goes at or below 1% of brand published pricing.  Of course, some competitors will assume less than 25% market share, some will assume more than 25%, some pricing will hold higher, some will go lower.  The point is that once the supply is greater than 125%, why bother reviewing applications or giving approvals, the leftovers can be held in case someone drops out (first in first out).  Stabilizing the market is one means of securig supply when it means that the products bring value to the portfolio and the balance sheet.  And that the pricing becomes predicable enough to allow for investment in capital expenditures without it being viewed as wildly specuative.

    With low value to finished goods, the cost of safety stock inventory to secure the supply chain is not palatable to management who must report to share holders or private owners.  Failure to supply payments are more palatable than inventory holding costs.  "Just in time" inventory in a complex supply chain within a highly regulated manufacturing environment is a recipe for shortages.  Inventory turns and run rates have meaning that may bring value.  Safety stock is a drag on profits (until there's a few out of spec results that delay quality releases or result in failed batches).

    One of the above reports mentions that in many instances of current short-supply products there are less than 3 competitors.  In some cases, FDA shows additonal approvals and the absence of more competitors is likely due to low commercial values, low profitablity, and the bench strength of the 3 major injectable manufacturers in leveraging value with GPOs and wholesalers.  

    The payors need inexpensive prescription drugs, however, they need to define inexpensive and the trade-offs allowable for access to the low pricing within the context of publicly traded manufacturers who are expected to show both growth and profits.  And remember, the current shortages are primarily specific to domesticaly manufactured injectables (with some exceptions)...just imagine what oral solids will look like with AMP determining FUL and impacting financial decisions.  Remind me, what % of oral solid generics are imported?  A shift to the slow boats from India could be interesting.

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  9. Why is no one talking about the economics of the generic manufacturers?  This is a volume play.  In a commodity business, one gains volume through price cuts.  These get built into the ASP as the generic dominates the code, and the 2-quarter lag makes it harder to take price increases after a manufacturer has nose-dived the price (below COGS) to get the volume.  But there's a big incentive in switching to the generic in the first place because of that 2 quarter lag.  I'm not sure why ASP, in and of itself, is to blame in this instance?  Generics manufacturers make all of their investment back in the first 6 months after launch; sales after that point are just a marginal buck.  It then becomes seemingly rational to continue manufacturing the marginal unit, even below COGS, because the investment in the manufacturing line has already been made.  (This is the fallacy of including sunk costs though.)  If there were profit at that ASP level, any manufacturer with excess manufacturing capacity would have jumped into the product line.  I think the generics bring this on themselves -- at least from the economic side. (yes, there are manufacturing and regulatory issues at play here as well).

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  10.   You are correct to put the emphasis on a company's incentive to invest in new production capacity.  Two additional factors also contribute to the disincentive to invest in new capacity thereby exacerbating the shortage problem.  First, the mandated rebates imposed on manufacturers for all sales to state Medicaid programs acts as a tax on manufacturers.  The congress is currently considering extending these mandatory rebates to the Medicare/Medicaid dual eligibles, and act that would substantially increase the tax on manufacturers.  Second, both branded and generic manufactures are currently being sued by the US government and numerous state governments in a series of cases involving pricing and promotion activities.  Some firms are contesting these suits in court but others are settling them out of court.  It is difficult to know the totality of the awards, settlements, and legal costs imposed on individual firms, but given the record so far, it has to be substantial in both financial impact and adding uncertainty about the effectiveness of future investments.  A Bloomberg article [http://www.bloomberg.com/news/2011-09-14/watson-pharmaceuticals-will-pay-79-million-to-settle-lawsuit.html] yesterday indicated that one plaintiff had settled 18 lawsuits since 2000 that cost the industry $2.2 billion.  The plaintiff collected $380 of this amount, the balance going to various states.
      Any wildcat driller for petroleum or venture capitalist will tell you that their decisions to invest in new enterprises is very much affected by their expectations of future returns.  When you add the expectation of future price controls, increased taxes, and legal costs to the existing market uncertainties created by FDA regulatory delays and the highly competitive nature of the generic market, is it any wonder why we have a shortage?

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  11. Yes, there are some rough parallels to the retail generics but there are a few significant differences for generic oral solids:

    1. Manufacturing is much simpler for oral solids, so barriers to entry are lower if a serious shortage developed. Also, short-run capacity constraints are not as severe so production can be increased more quickly.
    2. Most generic oral solids have multiple suppliers (10+), so the loss of a single manufacturer does not disrupt the whole market.
    3. Many generic oral solids are maintenance medications, which have much more predictable demand.

    But your general point is accurate, which is why some older generics increase in price and wholesaler margins increase.

    Adam

    P.S. I'll have to more to say on AMP next week.

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  12. Well said, Bob. Hound manufacturers out of a business and they will not come back easily!

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  13. Mike, 

    The security risks from importation by individuals or wholesalers are just too great. But, yes, the FDA can ease the rules to avoid a shortage, which they have done. Note the category "Regulatory discretion regarding importation" in the pie chart above.

    Adam

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  14. Mary GoroundNovember 03, 2011

    I'm not deep enough into the federal rebate program legislation to reply other than to say that these rebates (& legislative risks) are usually part of the profitability modelling done prior to launch decisions.  They may certainly squeeze the profitability decison window to almost closed.

    However, on the federal prosecution side of things, generics do not, generally, promote their products due to the DDMAC constraints...all generics may say per code is "hey, i'm approved and i'm bioequivalent to xx RLD"...the rule of thumb is never make a claim, never cite brand other than therapeutic equivalence, and never say you're any better than any other generic...'cause as a commodity, well. salt is salt and sugar is sugar, and while there may be grades of salt or sugar, there's no grading of generics - you're either approved therapeutically equivalent or not.  
    Pricing is another issue and unless the generic company is a total legal/compliance dolt, there's not much there either.  Generics do not detail to physicians and do not reference indications in promotion so there is no threat of "off label" use since "use" is not a promotional topic...availability is the only claim a generic may make.  Generics are sold to about 20 major customers nationwide and it is done based on price, financial and supply services, regulatory compliance history, supply history, and value of the total portfolio including future launches with possible exclusivity...ie, Teva is biggest because they have the biggest exclusivity stick and the highest total business rebate structure.  Brand companies are much more vulnerable to federal prosecution than generic companies on promotion and on pricing...again, assuming the generic company has half a brain and, obviously, some do not.  Federal reporting is monthly, is certified by the CFO or delegate, and is subject to personal criminal prosecution...you'd be an idiot to fake it or you really like orange jumpsuits and plastic handcuffs.  Federal prosecution of generic companies is most likely to involve compliance issues or, as the Ranbaxy case demonstrated, data integrity issues.  And you really have to be an idiot to put yourself in that position...or really like orange jumpsuits and plastic handcuffs.  No accounting for taste or the degree to which any individual is willing to subject their company to treble damages.As an aside...Observer referenced the investment costs for launch...well, the facilities were likely built long before the filings were submitted or approvals came through, in most cases.  An individual drug's approval does not necessarily represent a large investment for a generic company - oral solid or injectable - ...they're always looking at the total portfolio mix unless one, like a lovenox, requires unusual capital investment & litigation risk.  When or if the approval comes is the point in time at which many generic manufacturers say "oh hooey" we need to make the stuff...a whole bunch of this stuff.  Back to my point...each application needs to have a statement of capacity to supply.  If the total generic applications equal less than say 60% of the total usage, the application should be sidelined.  Price will not decreae enough to make it worth the FDA's resources.  Maybe...open to debate... and the origin of many "pay to delay" negotiations...a formulation for patent challenge is one thing, commercial manufacture of said formulation is another.

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  15. There is no such thing as a "lightly regulated" or "gray market". SECONDARY WHOLESALERS are licensed and regulated by the same state and federal regulations that govern Primary Distributors such as Cardinal, MKesson and ABC. Many are also accredited and all provide a valuable service to the health-care community with specialty niche distribution such as vaccines, plasma derivatives and in many cases shortage medications and servicing small accounts under $20k month not big enough for the big three. Premier has gone out of their way to give the only small business segment of the pharmaceutical distribution industry a bad name using flawed one sided data. Their goal as a GPO is to get rid of vendors who do not pay them 3% of sales and other fees and to get rid of Failure to supply clauses that are costing them money. Usually if you follow the money you find the motives.

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