One surprise was the “disappointing performance” in ABC’s oncology business, which accounts for about 40% of its Specialty Group business and 7% of overall revenues.
While management pointed to the sequester, such oncology market changes as practice consolidation and white-bagging are bigger long-term negatives for specialty distributors. Below, I highlight some telling comments by CEO Steve Collis regarding the industry’s evolution.
Specialty distributors face significant risks from changes in the community oncology market. Do ABC’s results foreshadow an oncology market turning point, or simply reflect a short-term government reimbursement cut? Will the specialty distribution and full-line wholesale trade classes blur together? Read on and see what you think.
WHAT WAS SAID
My comments below are based on last week’s earnings call. As always, I encourage you to review these materials yourself:
the ABC-Walgreens-Alliance Boots deal, especially regarding the possible pharmacy impact. Very intriguing.
LET'S BLAME THE SEQUESTER!
In his prepared remarks, CEO Steve Collis put the blame squarely on federal government’s sequestration and changes in government reimbursement:
“We had somewhat disappointing results in our Oncology business, as physician practices continue to face economic challenges in the face of declined reimbursement rates. Clearly, there has been pressure on specialty physicians, especially those in smaller practices. In addition, under the sequestration legislation, Medicare physician reimbursement rates for part B drugs were cut on April 1 from a rate of average selling price, or ASP, plus 6% to a rate of ASP plus 4%.”He goes on to discuss how ABC is lobbying to get the sequestration cuts reversed, but also notes that “we cannot be certain if we have seen the full impact of the rate cuts at this time.”
IS ABC RIGHT TO BLAME THE SEQUESTER?
I’m not sure.
The sequester cuts began on April 1—after the first quarter’s close. So, any impact could only have come from expectations of the potential cuts. This is surprising, because many people were expecting a last-minute reprieve. What's more, practices were still receiving Medicare’s usual rate of ASP+6% through March 30, 2013.
For a typical community oncology practice, more than one-third of revenue comes from commercial payers. As I note in The Latest Data on Specialty Pharmacy Reimbursement, commercial health plans reimburse physician practices at rates higher than Medicare. For oncology offices, commercial health plans pay an average of ASP+11.6%, which is about twice the Medicare rate of ASP+6%. Many still pay based on Average Wholesale price (AWP).
As far as I know, commercial health plans did not match the sequester cuts by reducing reimbursement on April 1.
ONCOLOGY MARKET CHANGES
Another explanation relates to the oncology market's long-term structural changes, which may be accelerated by the sequester cuts.
Community oncology practices purchase about $3.4 million of drugs per hematologist/oncologist. The practices earn a 15% gross margin on these purchases. See Benchmarking Pharma Economics in Oncology Practices.
Yet third-party payers are increasingly dissatisfied with the buy-and-bill process for specialty pharmaceuticals covered under a patient’s medical benefit. Drug reimbursement and profit have declined, while oversight has increased via prior authorization, clinical pathways, and other payer tools. Even oral oncology dispensing is under attack from pharmacy benefit managers. What’s more, physicians in community oncology practices increasingly want to get out of the “business of medicine” and back to the practice of medicine. Healthcare reform is accelerating this trend.
In response, health systems are eagerly acquiring oncology practices, in part due to a large system’s ability to extract much more revenue from specialty drugs. See How Hospitals Inflate Specialty Drug Prices.
There are three reasons why this consolidation trend is negative for specialty distributors like ABC’s Oncology Supply business:
1. ABC loses GPO admin fees.
The largest oncology group purchasing organization (GPOs) for physician practices are owned by the largest specialty products distributors. These GPO relationships allow distributors to create preferred supply relationships for product distribution, while simultaneously earning GPO admin fees. For example, ION, the largest community oncology GPO, has a prime vendor distribution arrangement with Oncology Supply. Both organizations are part of AmerisourceBergen’s Specialty Group. However, health systems don’t contract via the community oncology GPOs, so the profits vanish following a practice acquisition.
In response to Citigroup’s George Hill, Collis said:
“I'll just make one clarifying comment. It's important -- when we talk about Oncology, we're talking specifically about Oncology Supply and ION businesses. And that enables us to -- the physician services and contracting we do in ION had been very meaningful. And when we do other sites of care, we don't get those contract benefits. So that's why it's been important. It's been, as you know, a great business for ABC. We've been a great partner to Oncology. So when we talk about Oncology -- here, in this context, we're talking about specifically the Oncology Supply and ION businesses.”2. ABC might lose the customer following consolidation.
Such acute care GPOs as Novation and Premier establish “preferred vendor” arrangement with one or more selected wholesalers. After an oncology practice is acquired, the health system will eventually switch purchasing volume to its own prime vendor wholesaler. More often than not, the wholesaler will be McKesson, Cardinal Health, or a regional wholesaler.
In response to Crédit Suisse’s Glen Santangelo, Collis said:
“But we've also seen -- say, for example, take a town like Louisville, Kentucky. 5 years ago, there were over 20 community practices, there's only a handful now. And what's happened is that the hospitals have acquired them and, many times, those become 340B practices, and about 1/3 of the case about AmerisourceBergen customers. So it's not like we lose the business, but you lose the patients to community setting. We don't have a comparative to ION in the hospital setting.”3. Wholesale margins are lower than specialty distributor margins
Even if ABC retains the volume following a practice acquisition, a health system’s purchases will switch from Oncology Supply (a specialty distributor) to AmerisourceBergen Distribution Corporation (a full-line wholesaler). ABC’s margins from full-line wholesaling to hospitals are generally lower than its specialty distribution margins to a community oncology clinic. It’s analogous to the situation when a small retail pharmacy is acquired by a large drugstore chain.
DON’T FORGET ABOUT WHITE-BAGGING
White bagging is another market change not mentioned on the call, but also nipping at specialty distributors.
In the white bagging process, a specialty drug is dispensed to the patient by a specialty pharmacy but shipped directly to the physician office. The provider holds the patient-specific product until the patient arrives for treatment. The specialty pharmacy adjudicates the claim and collects any copayment from the patient prior to treatment. The provider does not purchase or seek reimbursement for the drug.
For infused oncology drugs administered in physician offices, the latest data clearly show buy-and-bill being displaced by specialty pharmacy providers. See Specialty Pharmacies Keep Gaining on Buy-and-Bill. These data are consistent with the Zitter Group’s data highlighted in The Future of Buy-and-Bill According to Payers and Oncology Practices.
White bagging corresponds to the substitution of the specialty distributor-to-provider distribution channel for a specialty pharmacy-to-provider distribution channel. There is no buy-and-bill and no transaction with a specialty distributor for the product. The largest specialty pharmacies bypass distributors, so product volume would leave the wholesale distribution channel and move to the pharmacy channel.
Suffice to say, this trend is bad news for companies such as AmerisourceBergen and McKesson, both of which want to protect the conventional community oncology distribution channel.
Given the strong pipeline of new oncology treatments, the long-term oncology business outlook is very positive. But specialty distribution and manufacturer channel strategies may look very different in the years ahead. Stay tuned.