Tuesday, August 26, 2014

McKesson, Rite Aid, and the Changing Generic Channel (rerun)

I’m taking a break from blogging this week and rerunning some of 2014's popular posts. Click here to see the original post and comments from February 2014.

As predicted, McKesson and Rite Aid announced a new generic purchasing agreement. Click here to read the press release.

Once they get organized, McKesson-Celesio-Rite Aid will be the largest generics buyer in the world. (See table below.) The new relationship has some common elements with the Walgreens-AmerisourceBergen (ABC) tie-up, although McKesson gains a more valuable sourcing position compared to ABC.

More significantly, the deal continues a revolution in how wholesalers interact with their biggest retail customers. Below, I contrast the various wholesaler-customer deals and highlight implications for wholesalers’ channel role, generic buying, downstream speculative buying, AMP-based FULs, and more. Be prepared for more change.

THE RISE OF GLOBAL GENERIC PURCHASING ORGANIZATIONS

Over the past two years, the following three new combinations have emerged to aggregate global generic purchasing power.
Here’s a look at global oral solid generic purchasing power, courtesy of Tom Gallucci and his team at FBR Capital Markets.

[Click to Enlarge]

THE NEW ERA

Larger pharmacies typically buy brand-name drugs—but not generics—via a drug wholesaler rather than directly from a manufacturer. (To understand why, see Chapter 6 of the 2013–14 Economic Report on Retail, Mail, and Specialty Pharmacies.) The changing relationship between wholesalers and large pharmacies is highlighted by Walgreens’ unprecedented arrangement with AmerisourceBergen.

In September 2013, ABC began a 10-year agreement to be Walgreens’ primary brand-name drug supplier. ABC took over distribution for the 60% of brand-name drugs that had been distributed from Walgreens’ own warehouse network. In 2014, ABC will assume responsibility for generic products that Walgreens has historically self-distributed.

The new McKesson-Rite Aid arrangement shares two common elements with the Walgreens-ABC deal: 1) McKesson will take over distribution of generic pharmaceuticals for Rite Aid, and 2) McKesson will take over direct-store delivery of brand-name and generic drugs.

But unlike the WBAD-ABC arrangement, generics will be sourced under McKesson’s OneStop Generics program. McKesson does not report the total dollar revenues from OneStop generic drug sales but does report growth rates. (See Exhibit 71 of our 2013-14 wholesaler economic report.) McKesson also has the advantage of Northstar Rx, a McKesson subsidiary that sells private-label generic drugs as a manufacturer.

By contrast, the WBAD joint venture is attempting to source generic drugs for Walgreens and ABC. (See Breaking WBAD: An Update on Walgreens-Alliance Boots Synergies.) Under the Generic Pharmaceuticals Purchasing Services Agreement between ABC and WBAD, AmerisourceBergen has the right to source generic drugs and other products through WBAD. This element is so important that AmerisourceBergen can cancel Walgreens’ equity warrants if WBAD terminates the purchasing agreement.

The McKesson-Rite Aid arrangement also differs than the CVS Caremark-Cardinal Health 50/50 generic drug buying joint venture, described in Cardinal and CVS Caremark Form a Generic Power Buyer: Deal Analysis. That deal combines purchasing power, but does not really change each companies' current supply chain and distribution operations.

IMPLICATIONS

Some reflections on the changing channel:
  • The McKesson-Rite Aid and ABC-Walgreens deals increase the wholesale market’s total size, by (1) shifting generic volume to the wholesale channel, and (2) moving self-distributed brand volume to direct-store-distribution. Wholesalers are becoming virtually impossible to displace for primary care products dispensed by retail pharmacies.
  • Generic manufacturers need a survival strategy. For generic drugs, formulary power lies with the distribution channel, not with the payer channel. If we consider Express Scripts and Walmart, then five entities will purchase about 90% of generic drugs for the U.S. market. The brutal math is one inspiration for the just-announced Actavis-Forest Laboratories deal
  • Downstream speculative buying will become much harder for Walgreens and Rite Aid. The chains’ inventories will sit in wholesale warehouses, whose inventory levels are visible to manufacturers with good agreements.
  • As the generic wave ends and as acquisition-cost-based models become more common, pharmacies that combine below-average operating expenses and below-average acquisition costs will be best positioned to succeed.
  • Here’s a deep irony to contemplate. As wholesalers become more successful at generic buying, the Average Manufacturer Price (AMP) for multisource drugs will decline. This will reduce the AMP-based the Federal Upper Limits (FUL) for Medicaid prescriptions, pressuring pharmacy profits from generic prescriptions. (See Obamacare Will Squeeze Pharmacy Profits.) Smaller pharmacies, which are wholesalers’ most profitable customers, will suffer the most from these new limits, especially if private payers adopt the AMP-based FULs.
The coming end of the generic wave (and the corresponding specialty boom) will reshape the drug channel for everyone. Get ready for a new channel lineup.

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