JNJ: We Want Federal E-Pedigree Standards

Mike Rose, VP of Supply Chain Technology at Johnson and Johnson (JNJ), testified at Tuesday’s Senate Hearing called Protecting Consumers by Protecting Intellectual Property. He was refreshingly unambiguous on JNJ’s position regarding e-pedigree, saying:

“Within the US, a federal standard is required for electronic pedigree.”

and

“The federal government can and should take the lead in establishing a single federal standard for electronic pedigree.”

(You can read his full statement here.)

He’s absolutely correct. Complying with a grab bag of state laws does little more than add unnecessary costs without an equivalent increase in safety. Inconsistent state laws ignore the fact that today’s pharmaceutical supply chain is a national business for drug makers, large wholesalers, and multi-state pharmacy chains. Read my op-ed Securing the Supply Chain for more.

At the same time, pharmacists are mounting an effort to slow down or stop the movement to a national e-pedigree standard due in part to the implementation costs associated with track-and-trace. (See Pharmacists Haggle over Pedigree Costs.)

On Monday, I’ll look at the new NACDS/NCPA study that estimates first year track-and-trace costs to be $110,000 per pharmacy. Get ready for an industry-wide debate over a timely and heretofore unanswered question: How much supply chain security are we willing to pay for?

Big Premium in the McKesson–McQueary McDeal

Apologies for yet another McKesson (MCK) post, but I certainly can’t ignore this week’s news given that I wrote on Tuesday about the company’s active efforts to alter its business mix.

McKesson (MCK) is acquiring McQueary Brothers Drug Company, one the few remaining regional drug wholesalers in the U.S. (See the official announcement.) McKesson is paying a substantial premium for the McQueary’s business, although the deal could be justified given today’s pharmacy industry dynamics. Will the higher price lure the remaining regional wholesalers to sell out, further concentrating the channel for manufacturers and independent pharmacies?

PAYING A PREMIUM

Here’s my math.

McQueary Brothers is one of the few wholesalers that does not report its sales in HDMA’s Factbook. However, the press release states that McQueary serves “more than 400 independents.” Assuming typical purchase levels by an independent pharmacy ($1.5-2M per year), McQueary’s revenues are probably in the range of $600-$800 million. Let’s say $700 million as a round number.

The purchase price was $190 million, implying a price/revenue ratio of about 0.27X. For those of you keeping score at home, this ratio is more than twice the comparable figures of other recent acquisitions, such as D&K by McKesson or Bellco by AmerisourceBergen (ABC). I presume an EBITDA multiple would reflect a similar 2X+ premium.

At first blush, this premium may seem surprising given the limited number of possible buyers (um, 3?) and the potential risk of a distress sale if independents come under further pressure. As I wrote back in March 2007: “Industries do not consolidate forever (even drug wholesaling). I expect that the remaining regional wholesalers will be looking for a reasonable exit strategy, too.”

BUT STILL A GOOD DEAL

However, McKesson’s desire to win this deal at a higher purchase price makes sense once we consider today’s pharmacy realities:

1) Smaller retail pharmacy customers rely on a wholesaler for many more supply chain services than a self-distributing chain. Thus, the threat of disintermediation is low and the gross margins are generally higher for the wholesaler. (More details: Trouble Ahead for Independent Pharmacies.)

2) Smaller buyers – regional chains, independents, supermarkets, etc. – buy their generic drugs via wholesalers, which also boosts a wholesaler’s gross margins. (More details: CVS' Channel Power.)

3) McKesson has been actively trying to deepen its relationships with customers, either through ownership (such as the OTN acquisition) or through a franchise relationship such as the nearly-2,000 pharmacies participating in HealthMart.

As a bonus, McKesson gets a small top-line boost from an (improbably) growing segment and can easily fund the deal given its extremely low levels of debt.

So what’s next? Will the McQueary buyout premium trigger a final feeding frenzy for the remaining regionals? Will manufacturers take action to address the unsettling levels of concentration in wholesale and pharmacy channels?

Any brave souls care to venture a guess?

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And before you ask, no, that’s not a picture of younger me above. Everyone knows that I don’t wear yellow.

Behind the Scenes of Pfizer UK

I’m blogging to you from the 2007 PharmaLink conference in Las Vegas. I’ll be speaking on Tuesday about the future of manufacturer-wholesaler relationships.

Today, I heard a fascinating presentation from Steve Poulton, Director of Commercial Operations for Pfizer UK. He explained how Pfizer shifted from selling through wholesalers to selling directly to dispensers using a single wholesaler as a logistics partner (Alliance Unichem).

I’ve been covering Pfizer’s strategy in previous posts (See Pfizer's UK Deal: Change is Here! and Pfizer wins again). Briefly, Pfizer now pays a per-package logistics fee to one wholesaler to distribute its products to pharmacies, hospitals, and dispensing physicians in the UK. Customers are purchasing from Pfizer, even though Alliance Unichem handles ordering and fulfillment.

Steve provided a lot more detail on the mechanics and costs behind Pfizer's strategy shift. A few interesting things that I learned:

• Pfizer spent a lot of time and money setting up this program. There were many (10?) internal teams plus a steering committee. Total time from conception to "go live" was more than 3 years.
• Over 22 million packs have been delivered since the program began.
• Service levels to customers—defined as “on time, in full” deliveries—are now running at 99.4%, which is higher than when Pfizer used to sell through wholesalers. Hence, there have been very few actual customer complaints.
• Pfizer did not intend to use only one wholesaler. However, AAH was told by its parent company (Celesio) to withdraw from contract negotiations. Phoenix, the third large UK wholesaler, apparently did not submit a proper response to the original RFP. Ironically, both AAH and Phoenix are now working with other manufacturers on logistics deals.

Clearly, the title of my most recent post on the UK situation was not accurate in stating Pfizer's UK Plan in Trouble. In particular, Steve claims that the use of a single wholesaler is not a problem because the government is only concerned that (a) costs to the National Health Service don’t go up, and (b) patients can still access Pfizer drugs.

Despite these positives, I’m still skeptical that Pfizer’s plan will stop counterfeits. UK pharmacies can still choose to be naughty and purchase parallel import or gray market products. Pfizer can guarantee the security of its own supply chain but can not force pharmacies to buy through the legitimate channel. Once again, pharmacies are the weak link in guarding the supply chain against counterfeits—a demand-side security problem that just won’t go away. (Sorry, pedigree fans.)

I also want to add that a Pfizer-type arrangement would be much, much more difficult here. There are only 15,000 points of dispensing over there compared to 150,000+ in the US. I saw a few US executives stop taking notes once Steve talked about the organizational and financial realities of direct distribution.

All in all, this was a great behind-the-scenes peek at an apparently successful channel redesign. Wish you were here!

Demystifying 867 Data

I want to let you know about a webinar this Wednesday called Demystifying 867 Analytics, which looks at the use of point-of-sale data from retailers and wholesalers. You should sign up and listen.

Yes, I know, webinars are usually boring, but this one will benefit from the presence of Josh Halpern and Jeff Sager from Integrichain. In my opinion, Integrichain is quickly becoming the leader in providing demand visibility at the outlet/point-of-care level to pharmaceutical manufacturers.

I’ve been particularly impressed with the company’s ability to connect multiple data streams from the pharmaceutical supply chain -- ex-factory sales data, wholesaler data (EDI 867 and 852 transaction sets), and third party data. Integrichain’s outlet-focused, bottoms-up (my words) methodology should also allow new data sources, such as ePedigree information, to be easily incorporated. In other words, they are not beholden to a single data stream or data provider.

Integrichain is benefiting from the IMS Health data mess. Novartis actually asked their sales reps to return bonus money because of faulty IMS market share data. Merck, Wyeth, and Lilly are reportedly also having problems with the accuracy of IMS’ mix of projected and survey data.

In the sprit of full disclosure, I should mention that I like Integrichain and its approach so much that I agreed to serve on the company's Advisory Board.

Since the webinar is on Halloween, I presume that you’ll be listening in costume. I’ll be dressed as an RFID tag from the Springfield Nuclear Power Plant.

An RFID tag is especially appropriate because this blog is sometimes hard to read ...

Pfizer's UK Plan in Trouble

Pfizer may have to end or amend its exclusive distribution deal with UniChem, the wholesale arm of Alliance Boots (AB), under proposals being considered by the Office of Fair Trading (OFT). See Pfizer May Have To Unpick Exclusive Distribution from the Times (London).

Pfizer’s new plan (first discussed here last September) has at least two primary objectives: (1) Lower the risk of counterfeit products entering the supply chain, and (2) Recapture lost revenue from parallel importing.

My prediction: The OFT will require Pfizer to expand its network to at least one other wholesaler, but not require them to sell to all wholesalers.

In March, the UK wholesalers failed to get a legal injunction to stop Pfizer from implementing its new distribution plans.

Yet wholesalers have been much quieter about the announcements from other manufacturers like Sanofi-Aventis or Novartis, especially since these manufacturers plan to include other wholesalers (AAH or Phoenix). From what I hear, most major drug makers will announce more selective UK distribution plans by the end of 2007.

Frankly, the whole issue really comes down to basic business economics. Manufacturers in many industries can and do legitimately limit the number of wholesalers who are authorized to sell its products. Channel mavens like me refer to the degree of distribution selectivity – from one wholesaler (exclusive distribution) to an unrestricted number of wholesalers within a given market (intensive distribution).

I believe that any excluded UK wholesalers will continue their attempts to stop Pfizer (or others) from implementing strictly exclusive distribution, but will not be able to stop selective distribution.

It’s interesting to note the contrast with the U.S. Here, U.S. wholesalers successfully stopped the FDA from implementing the pedigree requirements in the Prescription Drug Marketing Act. Robert Drucker is probably a hero to any non-selected UK wholesalers given his company’s legal battle against the big three wholesalers and 16 major drug manufacturers. (See RxUSA’s July 2006 complaint for the alleged details.)

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P.S. Readership at Drug Channels is waaaay up since last year. In case you weren’t reading back in August ‘06, here is a background post on European drug channels: Curious about European Drug Distribution?

I discuss the US angle on distribution deals in light of U.S. importation bills (such as S.242) in Will US logistics deals be illegal?.

Diversion from Canada via China

Bloomberg has a great story today in which Johnson & Johnson talks publicly about how they disrupted a counterfeit diabetes test supplier. See China Counterfeit Diabetes Tests Tracked by J&J. Unfortunately, the story once again shows the dangerous connection between diversion and counterfeiting.

The article makes for a gripping read. Following customer complaints, detectives followed the bogus products to 700 pharmacies where the products were sold, then to eight U.S. wholesalers, and then to two importers, one in the U.S. and another in Canada.

Here’s the rub: the defendant wholesalers apparently believed the counterfeit strips were lower-priced gray market products diverted from normal distribution channels.

So, we (re)learn the lesson that diversion is the primary way for counterfeit products to enter legitimate channels. That’s why allowing importation will open up new gateways for counterfeits. I just wish that Senator’s Dorgan and Snowe would try to understand the dangers!

Unfortunately, there’s still a fatal flaw in J&J’s distribution channel. One LifeScan executive is quoted as saying: “We recommend customers obtain their diabetes testing supplies from reputable sources to reduce their risk of receiving counterfeit product in the future.”

Sounds sensible, but a “recommendation” is much too weak. Why doesn’t LifeScan require all pharmacy customers to purchase only from authorized distributors and then require authorized distributors to only buy directly from the manufacturer? That's the situation for prescription drugs, where Inventory Management Agreements (IMAs) and Fee-for-Service agreements have limited product leakage into the grey market and closed a significant entry point for counterfeiters.

And I pointed out yesterday, there is still no way for the ultimate consumer/patient of these diabetic tests to know whether their pharmacy or its wholesaler got the product from a legitimate source. Very few people are willing to discuss this truly scary part of product security.

Hat tip to Pharmalot for highlighting this story.

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P.S. Given the quality problems of Chinese goods, many people seem eager to throw out overseas sourcing for political reasons. Not me. I am simply arguing against diversion, not against Chinese sourcing. See The Risks of Chinese Sourcing on my Distribution Trends blog for more details.

Investment Buying: Not Dead Yet

Many inventory management agreements and fee-for-service agreements between manufacturers and wholesalers will be renegotiated over the next 24 months. So it’s interesting to note that investment buying remains an important source of drug wholesaler profits. (Click here for a little musical accompaniment to today's post.)

Peter Loftus from Dow Jones wrote a must-read article Wholesalers' Speculative Buying Still Unsettles Drug Sales to follow-up on the Pfizer (PFE) and Wyeth (WYE) inventory issues described in Harry Potter and the Wholesaler Inventory.

Here’s a key quote from the article:

Cardinal Health still practices what it calls "investment buying" with certain manufacturers, said spokeswoman Tara Schumacher. The company doesn't comment on specific customers or products. Also, it has "hybrid" relationships with some drug makers, engaging in speculative buying for some products and fee-for-service on others. "From the beginning, we knew we wouldn't have a 100% shift," Schumacher said. "That was never the intent. We wanted to ensure we were negotiating fair prices for each customer. We're comfortable with the economics of some of the contracts not being fee-based."

Translation: Investment buying is still around, just less prevalent and less visible. In some cases, investment buying appears to have shifted away from wholesalers to other points in the pharmacy supply chain.

I must give credit to Cardinal Health (CAH) for discussing this “open secret.” The adoption of inventory management and fee-for-service agreements has dramatically reduced (but not eliminated) drug wholesalers’ dependence on investment buying and price inflation. I estimate that inventory profits (investment buying + passive gains) are now less than one-third of wholesaler gross margins from large branded manufacturers.

If you don’t believe Cardinal, check out AmerisourceBergen’s (ABC) July 26 earnings announcement, in which they noted that “…operating income benefited from an above market sales increase in our proprietary generic drug program which offset in part the impact of fewer drug price increases in the June quarter.” (emphasis added)

The Wall Street Journal's Health Blog is more pejorative about these activities, writing Drug Wholesalers Back at Betting Window. That’s not really fair. Investment buying is nothing more than a means by which manufacturers can compensate wholesalers for the legitimate costs of distributing drugs. Unfortunately, there can be excesses in this system (summarized in the third paragraph of my 2005 article).

At least two senior wholesaler executives hate when I write about this topic. But facts don't cease to exist because they are ignored.

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P.S. Check out the new Health Wonk Review, edited by Julie Ferguson at Workers' Comp Insider.

Harry Potter and the Wholesaler Inventory

Both Pfizer and Wyeth are in the news because of unusual wholesaler buying patterns.

The WSJ Health Blog has a good summary (Inventory Bugaboos Dog and Aid Drug Makers). Relevant excerpts:

• “On Tuesday, Pfizer blamed wholesalers’ inventory reductions for part of the 25% decline in U.S. sales of cholesterol-fighter Lipitor to $1.38 billion in the quarter…Ian Read, president of world-wide pharma operations at Pfizer, said Lipitor inventories fell to 1.8 weeks on hand at the end of the first quarter compared with almost a month, or 3.8 weeks on hand, at the end of the second quarter.”

• “But for Wyeth’s heartburn medicine Protonix, the wholesalers appeared be stocking up rather than winding down their supplies in the second quarter. Sales of Protonix, which competes with AstraZeneca’s Nexium, jumped 25% to $550 million in the quarter compared with the year-earlier period, the company said today.”

As you all know -- or should know -- the drug wholesale industry changed over the past few years with the widespread adoption of inventory management and fee-for-service agreements. (Here is my brief summary of this transition.)

These new agreements require wholesalers to provide inventory and shipment data to manufacturers. Most manufacturers use software from either Edge Dynamics or Valuecentric to analyze these incoming wholesaler data.

But according to my sources, neither Wyeth nor Pfizer are customers of either software company.

Perhaps they have been relying on Professor Trelawney for channel data, instead?

P.S. Hope you enjoy an unspoiled Book 7 at 12:01 AM!