A Pharmacist’s View of $4 Prescriptions

Yesterday’s post on Walgreens (WAG) and Wal-Mart (WMT) (Walgreens’ $4.33 Surrender to Wal-Mart) set a new web traffic record for Drug Channels. Guess I struck a nerve!

Today’s post is a guest editorial from Jeff Ellis, R.Ph., about $4 prescriptions. Jeff is the editor of the E-Info Exchange, the e-newsletter of the Illinois Pharmacists Association. He has kindly given me permission to reprint his June 13, 2008, editorial from the IPhA newsletter. Enjoy!

Adam

P.S. See How Pharmacists View Wal-Mart's Pricing Strategy for my historical (circa October 2006) perspective on the issue.

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In My Opinion

By Jeff Ellis, Editor, E-Info Exchange, IPhA

This week I have focused on the $4 prescription. I honestly thought it would go away as it seemed such an incredibly bad idea, particularly if one expected to at least break even when dispensing a prescription. I did not foresee the tenacity of a certain chain who shall remain nameless and who very possibly owns the world; or the accolades from society that followed. I assume the publicity from the stunt is “priceless”, so it continues. This morning NBC5 in Chicago (I live on the fringes of Chicagoland) announced Dominick’s is getting in line. So that only leaves Walgreens, CVS and Osco holding the line unless I missed the announcement (a very reasonable assumption).

How do you answer this? I have come up with some conclusions.

1. Close.
2. Meet the price (which may lead to #1).
3. Beat the price (which also may lead to #1).
4. React to it using halfway measures and hope it goes away (which also may lead to #1)
5. Offer more value for the higher price. Decide what that value is, publish it to our patients, sell all the employees on the idea and adhere to it slavishly.

There are no doubt many other ways to respond and we all would certainly like to hear what they are. The platitudes and clichés I see in articles seem unimpressive. I hear constant talk about $4 a gallon gasoline and how it is affecting patients. One response is to reduce the amount of money they pay for prescriptions, no matter how annoying, how little service or how long the wait is. (Aside: A gallon of gas is more than a prescription at Wal-Mart.)

We are attempting to sell PBMs, as well as the state and federal governments on the idea that to break even on a prescription we must get about $9 over cost. All studies say so. The $4 prescription is not helping our cause. It is also disheartening to me that such large employers of pharmacists seem to think so little of pharmacy.

If pharmacists decide (individually) they do not want to work for an employer that thinks nothing of their profession, I foresee these employer(s) crying to regulators about how the shortage of pharmacists is affecting their ability to deliver $4 prescriptions to their customers (they are, of course, customers-not patients) and how the only solution is to train technicians to staff their pharmacies and we need a change in regulation to allow this.

Consider the ramifications of that. I am not convinced that some of the leaders and educators of this profession do not see this as the future and are training our young pharmacists for this eventuality. But how many consultant pharmacist positions are out there?

Walgreens’ $4.33 Surrender to Wal-Mart

Walgreens (WAG) has begun touting its Walgreens Prescription Savings Club, which offers a 3-month supply of over 400 generics for $12.99 (plus an annual membership fee). “That’s just over $4 a month” screams the promotional literature. (It’s $4.33 per month for math geeks.)

Walgreens latest move suggests that the low-priced generic wave is having a bigger effect that many people (including me) expected. It also means that competition in the private sector is now removing generic margin from the channel much faster than an Average Manufacturer Price (AMP)-based FUL ever could have.

WAL-MART SETS THE RULES

When Wal-Mart (WMT) launched its $4 generic drug program in September 2006, I wrote the following in Wal-Mart's Generic Pricing Will Trigger Big Changes: “Folks, we are witnessing a triggering event in real-time. I think Wal-Mart’s move will create massive change in the U.S. pharmaceutical distribution system because it threatens our current system of cross-subsidization.”

Non-pharmacy chains followed Wal-Mart’s move – Target, Kroger, Safeway, Giant Food, et al. These retailers have been able to absorb lower generic margins because pharmacy represents a minority of their sales and gross profits.

Non-pharmacy chains are taking advantage of the high generic margins embedded within in the traditional pharmacy business model, especially for cash-pay customers. If you don’t know what I mean by “cross-subsidization,” click here to read my post from May 2006 in which I predicted this outcome.

Here are my three most recent analyses of Wal-Mart’s generic drug strategy:

• Wal-Mart Redux (May 2008)
• Wal-Mart's PBM Game Plan (January 2008)
• Wal-Mart's Gain is not Walgreen's Pain (November 2007)

WALGREENS REACTS

Like many people, I’ve believed for some time that chains such as CVS Corp (CVS) or Walgreens (WAG) were not especially vulnerable to Wal-Mart’s (WMT) $4 generic program because customers with third-party insurance do not save much versus standard co-pays. Walgreens was so confident in its own business model that it issued this Statement On Wal-Mart’s Promotional Drug Pricing in October 2006:

“Walgreens will not match Wal-Mart’s promotion. Once consumers learn the fine print of Wal-Mart's program, they'll realize Walgreens offers the best value for pharmacy patients with its convenient locations, close-in parking and unique pharmacy services.”

But on Monday’s earnings call, Walgreen President Gregory Wasson recanted, stating: “Discount retailers and grocery chains are picking up their pace of promotional pricing, especially in the pharmacy, which they’re using to build traffic.” Hence the emphasis on the new savings card, albeit with the requisite positive spin about convenience, service, brand, yada yada yada.

Overall, Walgreens still looks like a very strong company. The convenience factor is surely higher than Wal-Mart for most consumers. But I wonder whether Walgreens is throwing in the towel too soon simply because we are in a generic drug lull. I also note that Walgreens is aggressively (and sensibly) diversifying away from its core retail pharmacy roots.

Unfortunately, it’s very difficult to assess the true impact of $4 generics because Walgreens provides almost no public disclosure about its generic volume and margins. (Pet peeve: Despite representing 70%+ of pharmacy revenues, pharmacy chains mysteriously still consider financial data about the retail prescription business to be “not material.” Yeah, right.)

COMPETITION IS EVEN WORSE THAN AMP

Most pharmacists have been fretting about reduced generic margins for Medicaid scripts if the Average Manufacturer Price (AMP) rule ever gets implemented (and cheering every legislative victory.) But Walgreens' move signals that competition among pharmacies is now removing generic margin dollars from drug channels much faster than AMP. I suspect that Pharmacy Benefit Managers (PBMs) will be worried by Walgreens decision, too.

I have been trying to warn pharmacists for the past year that AMP is NOT the single biggest threat to the survival of independent pharmacies or to generic script margins. The pharmacy shakeout is coming, but don’t put all the blame on CMS.

11,105 Pharmacies Gone?!? Just More AMP Hype

A new report prepared by PriceWaterhouseCoopers (PWC) claims that 11,105 pharmacies will close due to the Average Manufacturer Price (AMP) provisions in the Deficit Reduction Act of 2005 (DRA).

• Press release from the National Association of Chain Drug Stores (NACDS) and the Food Marketing Institute (FMI)
• Impact of the Deficit Reduction Act of 2005 on Pharmacies by State (Full Report)

However, as I explain below, this report is fundamentally flawed in a way that will be immediately apparent to anyone familiar with pharmacy economics. In my opinion, the “findings” are not a reliable or accurate prediction of the actual outcome of AMP on the pharmacy industry. No one in the channel – manufacturers, PBMs, wholesalers, pharmacies, and payors – should use this report to plan business strategy.

QUICK OVERVIEW

The centerpiece of the report is a state-by-state estimate of the number of pharmacies that will close if AMP is used to compute the FUL. (See The AMP Saga Goes On and On and On for background.) There are many questionable methodological aspects behind these estimates, but the most significant assumption in PWC’s model derives from the variation in the 2001 average pharmacy net profit.

The average Net Profit reported in 2001 was 3.5% (as reported in the 2002 NCPA-Pharmacia Digest.) However, according to the self-reported data from the report: 13% of independent pharmacies had a net loss in 2001; 28% had a net profit of less than 2% in 2001; 33% had a net profit between 2% and 5% in 2002; and 26% had a net profit of 5% or more.

PWC’s model assumes that AMP would cause all pharmacies with negative net profits, i.e., a net loss, to close and also cause some percentage of pharmacies with “low” net profits to close.

BTW, Dr. Schondelmeyer’s November 2007 report from the AMP lawsuit used a similar approach to come up with the “loss of 10,000-12,000 pharmacies” guesstimate that has been cited up until now.

PHARMACY ECONOMICS 101

Understanding the flaw in the report’s method requires a quick review of a retail pharmacy’s income statement:

• Gross Profit = Revenues minus Cost of Goods Sold (COGS)
• Net Profit = Gross Profit minus Operating Expenses
• Operating Expenses = Owner compensation + Payroll Expenses (excluding owner’s comp) + Other Expenses (rent, utilities, etc.)
• Owner's Discretionary Profit Before Tax = Net Profit + Owner Compensation
  

Key insight: A reduction in reimbursement has no direct effect on a pharmacy’s Net Profit.

A reduction in reimbursement, such as the use of AMP for FUL computations, lowers Gross Profit by reducing Revenues (assuming no change in COGS, among other things). However, the impact on net profit depends on whether a pharmacy can alter its operating expenses in response to a decline in Gross Profit.

If a pharmacy’s costs are entirely fixed regardless of changes in reimbursement, then a reduction in reimbursement translates directly into a loss of net profit. However, the impact on net profit would be less significant if a pharmacy can adjust its expenses in response to a change in reimbursement levels.

OPERATING LOSS OR TAX STRATEGY?

A private business may report an “net loss” for many reasons that do not relate to the true financial health of the business. For example, there could be tax minimization benefits for a business owner from reporting a low or negative net profit while generating high personal income for the owner.

Thus, the “average” pharmacy could have reported an “net loss” if the average pharmacy owner had chosen to pay himself or herself a larger bonus of instead reporting a positive net profit on the NCPA survey. In other words, a decline in Gross Profit could be offset by a reduction in profits to the owner without causing the business to shut down.

I’m no accountant, but a “global market leader for tax services” such as PWC should have considered these financial issues in their computations. If you understand these matters, then you too will question the core assumption that 13% of pharmacies with a “negative net profit” will automatically close.

So here’s another way to think through the math.

• PWC estimates that average pharmacy net profits drop by $23,300 due to DRA.
• The most recent data reported (2003) put Owner's Discretionary Profit Before Tax at 8.1% of revenues.
• Using the most recent average revenue data of $3.6 million per independent pharmacy implies that Owner's Discretionary Profits were about $293,000.

Unfortunately for owners of independent pharmacies, the most obvious way to stay in business would be to reduce average pharmacy owner compensation by $23,300 to about $270,000 per year.

Personally painful? Yes. So the real (and still unanswered) question becomes: At what point will an independent pharmacy owner decide that the Owner's Discretionary Profit is too low and shut down or sell the business?

BOTTOM LINE

Look, I understand what’s going on. Pharmacists want to be compensated appropriately for the value that they contribute to U.S. health care. I fully support pharmacists’ First Amendment rights to advocate on behalf of their own interests. See In Defense of Lobbyists from Friday’s Wall Street Journal for a spirited POV on this subject.

I’m just bothered that pharmacists are making the case using misleading analyses rather than explaining their true value to the health care system or confronting the cross-subsidies of the pharmacy economic model. I’m disturbed to think that this report might be used by outside parties to predict the actual impact of DRA. I also suspect that many independent pharmacists may begin to believe (falsely) that AMP is the single biggest threat to their collective survival.

Just to be clear, I have no stake in the outcome of the AMP battle. I’m not being paid to write this blog nor do I get paid for advocating any particular position regarding AMP. I don't have a grudge against retail pharmacists - honest!

But I do believe strongly in the value of independent expert analyses. Unfortunately, the latest AMP report appears to be political theater designed to influence policy makers rather than a genuine attempt to quantify the impact of AMP. Too bad.

Wal-Mart Redux

Wal-Mart Stores (WMT) latest expansion of its generic drug program represents more of the same despite the company's promise on Friday to make a “major health care announcement.” Nonetheless, the company’s latest comments shed additional light on the true economics of the program.

Click here to see the complete list of eligible drugs.

Here are some high level points about Wal-Mart’s generic program.

More Volume = Lower Cost of Dispensing. Way back in my still-valid December 2006 analysis, I predicted that Wal-Mart would benefit from the program by generating incremental prescription volume for its relatively underutilized pharmacies. Wal-Mart senior vice president John Agwunobi confirmed my view yesterday in this Associated Press story, saying: “It also offers us the ability to add capacity to our pharmacies without adding people."

Wal-Mart’s generics are not loss leaders. Last October, I compared Wal-Mart’s retail generic prices to average acquisition costs and found average gross margins of 24%. These calculations dramatically underestimate Wal-Mart’s actual gross margin because Wal-Mart's product acquisition costs are much lower than the independents, supermarkets, and small chains that buy through wholesalers.

State governors love this program. Medicaid does not pay more than a cash customer at a given pharmacy because a pharmacy can not be reimbursed by Medicaid for more than its Usual & Customary charge. Thus, states pay less whenever Wal-Mart fills a Medicaid generic script for which Wal-Mart’s retail price is below the Medicaid reimbursement rate. State revenues are declining due to the economic slowdown, making Wal-Mart look good.

Cash-pay customers also love the program. Wal-Mart is offering a great value for uninsured and under-insured patients, a point that I made in the Financial Times on Monday. In contrast, consumers with third-party insurance do not save much versus standard co-pays, which is why chains such as CVS Caremark (CVS) or Walgreens (WAG) are not very vulnerable to Wal-Mart’s program.

Price shoppers are fans, too. There are wide and apparently persistent variations in pharmacy prices for many common, high volume generics. (See The Price Might Be Right.) Wal-Mart’s program simplifies the search process, especially for elderly Part D participants trying to stay below the donut hole. (See Part D and Generics.)

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Curiously, NCPA declined to issue its usual denunciation about how Wal-Mart’s program is a “classic bait-and-switch” (9/28/06) or “devaluing and destroying the practice of pharmacy” (9/27/07). Perhaps the surviving independents have figured out how to coexist with Wal-Mart, as implied by 2007’s unexpected growth at independent pharmacies?

The AMP Saga Goes On and On and On

There are some new developments for Average Manufacturer Price (AMP), although the situation has now devolved into a somewhat arcane legal battle. Unless there is a legislative fix (unlikely), then I expect that CMS will punt this issue to the next administration in 2009.

OUR STORY SO FAR

As a reminder, the Deficit Reduction Act of 2005 required the Center for Medicaid and Medicare Services (CMS) to set the Federal Upper Limit (FUL) on payment for generic drugs at AMP plus 250 percent. The FUL is currently computed using the Average Wholesale Price (AWP) list prices, although some states opt to establish reimbursement limits below FUL at maximum allowable cost (MAC).

The change to AMP was advocated in September 2005 by the Bipartisan Commission on Medicaid Reform and the National Governor’s Association. This change was made in part because pharmacies were earning extraordinary profits from dispensing generic drugs in the Medicaid program.

In 2002, filling a script for a generic less than 5 years old gave a pharmacy $32 in “spread” – the difference between Medicaid reimbursement and acquisition cost. Filling a branded script yielded a comparatively skimpy $14 spread. (Source: Medicaid’s Reimbursements to Pharmacies for Prescription Drugs, a December 2004 CBO report that always generates hate mail from my pharmacist readers.) Private insurers, in the form of Medicare Part D plans, have done a better job at equalizing the dollar margins for brands and generics. (See Pharmacy Profits & Part D.)

CMS issued its Final Rule for implementing the AMP provisions of the DRA in July 2007. NACDS and NCPA, the two leading pharmacy trade associations, filed suit against CMS. To my surprise, they got an injunction that prevented CMS from adopting the AMP-based pharmacy reimbursement formula and publishing AMP data on the Internet. If you believe the over-heated rhetoric, then this legal delay saved up to 12,000 pharmacies from financial ruin.

COMING NOT-SO-SOON

More recently, NACDS and NCPA have opposed CMS’ subsequent clarification of “multiple source drugs” (a.k.a. generics) based on two technical legal objections. Yesterday, the two organizations were granted permission to file an amended complaint that challenges this new multiple source drug rule. The wheels of justice can grind slowly, so I don’t expect a resolution anytime soon.

Legislative action continues via pleas to pass The Fair Medicaid Drug Payment Act of 2007 (S.1951 and H.R. 3700). Neither bill has progressed very far. Senator Baucus, who sponsored S.1951, seems preoccupied with delaying the Medicare physician fee cut for 18 months. Perhaps Congress will feel generous since they voted on Thursday to delay seven new Medicaid regulations.

Just in case, NACDS sent a letter to Congress that asks for joint passage of the AMP bills along with unrelated bills about e-prescribing in Medicare. I presume the unstated motivation is to link the purported savings from e-prescribing to the extra costs of the Medicaid AMP increase.

NOT THE END

So, we are not very close to resolution, which is perhaps a small net benefit to pharmacies. I’ll occasionally check in on our old friend AMP but will primarily turn my attention to other topics until some big news breaks.

Wrestling with AMP

CMS won’t appeal the preliminary injunction against the full implementation of the Average Manufacturer Price (AMP) Final Rule. So, there’s still No AMP for You, at least until CMS regroups. But stay tuned because industry insiders are now rallying behind a Senate bill that will fix AMP once and for all.

AMP-Mania XI

Gosh, it’s hard to believe that the AMP Injunction is already 11 weeks old!

Drug Topics recently ran a cover story called Bracing for a Showdown, which has a useful background on the AMP story from the pharmacists’ perspective. I pop up in paragraph 51 (out of 53) to scare the daylights out of pharmacists by stating:

“Pharmacists are being exposed to economic realities that they haven't faced before that are removing protections that protected them from fundamental economic realities. Retail pharmacy is now experiencing what has happened in other retail sectors over the past 25 years. Pharmacies need to get big, get focused, or get out.”

TOTAL NONSTOP ACTION

NCPA has posted its two most recent submissions to CMS related to the Final Rule:

NCPA’s Comments on CMS’ Final AMP Rule

Appendix to NCPA Comments

The Appendix is by far the more interesting document because it attempts to support NCPA’s claims that roughly half of all independent pharmacies will vanish due to AMP. Rather than rebutting the statistically shaky claims in the Appendix document on the blog, I will simply suggest that you re-read my Pharmacy Profits & Part D post as well as the comments to that post.


I wonder if the Editors of Drug Topics secretly agree with me about the exaggerated claims of harm from AMP. They chose to illustrate the showdown using the metaphor of professional wrestling – a “simulated sport and performing art.” (!)

S.1951 TAGS IN

I recently had the opportunity to ask Kathleen Jaeger, President and CEO of the Generic Pharmaceutical Association, about the future of AMP. She told me that there will be a coordinated legislative push this Spring for S.1951 (a.k.a. The Fair Medicaid Drug Payment Act of 2007). The first volley was sent Tuesday by NACDS with this letter to Senate and House leaders.

This bill, which has been referred to the Senate Finance Committee, has 42 co-sponsors, including Senator Barack Obama (but not Senators McCain or Clinton). I covered the key points from this bill in Last Ditch Effort for S.1951 last November, when there was an attempt to get movement before the Winter Recess.

CMS has not even bothered to update its own page on FUL since the injunction, so the momentum remains with the pharmacy industry. As scholar and philosopher "Rowdy" Roddy Piper, Ph.D., once said: "Just when you think you know the answers, I change the questions."

The Price Might Be Right

I just read an interesting new report about drug price comparison web sites run by 10 U.S. states. But the wide variations in pharmacy prices for a common, high volume generic make me wonder about the efficiency of the pharmacy market and the value of apparent transparency.

10 STATES, MANY PROBLEMS

The Center for Studying Health System Change just released a study called State Prescription Drug Price Web Sites: How Useful to Consumers? I’m not familiar with the organization, but I found the report to be very useful.

Consumers in 10 states can compare the price of selected prescription drugs at different pharmacies. These sites provide the retail pharmacy price, which is usually measured as the “usual and customary price” charged to Medicaid. In theory, these prices could help uninsured or underinsured consumers shop around for lower prices.

Unfortunately, the data provided by these sites are apparently not always usable. The report documents some predictable problems, including:

• Infrequent and incomplete updates of price data
• Few reporting pharmacies
• Small number of drugs reported
• Inconsistent use of modern web search tools

SHOPPING FOR SIMVASTATIN

Florida has a one of the better sites and is highlighted in the new report.

Just for fun (!), I compared the pharmacy prices listed on the Florida site (http://www.myfloridarx.com/) for simvastatin (generic version of Zocor) 40 MG tablet. I searched pharmacies in Hialeah, FL, which is an urban market included in the new report.

Prescription price data was available for 40 out of 70 pharmacies:
Average = $115.54
Range: $9.70 to $221.43

Since I’m a wild and crazy guy, I also dug up Florida’s Maximum Allowable Cost (MAC) data, which tells me the maximum ingredient cost reimbursement to a retail pharmacy for filling a Medicaid script. MAC data for Florida’s Medicaid program are also available online here, although not in a consumer friendly format. (I love the Internet!)

There are 40 NDCs on the Florida MAC list for simvastation 40 mg. Price per tablet is $1.8995 per tablet, so a 30-day script is $56.99. Florida’s Medicaid dispensing fee was $4.23, making total pharmacy reimbursement $61.22 for this script.

Now here is something interesting: the cash price at three chains is *below* the MAC reimbursement from Medicaid. The Hialeah list included 8 Walgreens (WAG) pharmacies ($59.99), 3 CVS pharmacies ($54.59), and 1 Wal-Mart (WMT) pharmacy ($54.54). In other words, Medicaid pays more than a cash pay customer.

Correction (2/20/08): Medicaid does not pay more than a cash customer at a given pharmacy because the pharmacy can not be reimbursed by Medicaid for more than its Usual & Customary charge. However, an uninsured cash-pay customer buying at Walgreens would pay less than Medicaid would pay to a pharmacy with a U&C above the Medicaid reimbursement rate. Thanks to Marc for the clarification. See the comments below for more details.

THE MYTH OF TRANSPARENCY

While Florida’s site does a reasonable (but incomplete) job in comparing retail prices, a payer or consumer would still not have a clue about the allocation of revenue and profits associated with a simvastatin prescription.

The retail pharmacy price from an individual script gets divided between the manufacturer, the wholesaler, the pharmacy, a health plan, and/or the third-party managers who oversee the whole process. It’s almost impossible to know how various rebates, discounts, and reimbursement structures have influenced the drug’s cost to an individual pharmacy. Publication of Average Manufacturer Price (AMP) data, which would provide one data point for actual acquisition cost, is off the table for now. (Granted, this mystery and complexity allows people like me to earn a living by understanding the inner workings of this system.)

Healthy competition is one factor that can allow a free market to provide the benefits of transparency. For example, consumer involvement in Medicare Part D is lowering costs and changing behavior. (See Part D and Generics.) However, the wide and apparently persistent variations in pharmacy prices for a common, high volume generic make me wonder whether consumers are getting the true benefits of market competition among pharmacies.

No AMP for You!

Well, pierce my ears, and call me drafty!

On Friday, U.S. District Court Judge Royce Lamberth granted an injunction that will prevent CMS from adopting the AMP-based reimbursement formula for generic prescriptions in Medicaid until he has reportedly “had an opportunity to fully review the new payment plan.” CMS will also not be permitted to post Average Manufacturer Price (AMP) data on the Internet as planned.

The injunction stemmed from a lawsuit brought by NACDS and NCPA against CMS. (See the NCPA’s Legal Proceedings page for links to the case documents.) In Analysis of AMP Lawsuit Odds last month, I incorrectly predicted that the injunction would not be granted. (Thanks a lot, Arnie Becker!) Naturally, I will be happy to refund your subscription fee to Drug Channels.

Here are some initial reactions to the injunction:

CMS was over confident. One interesting revelation from this lawsuit was the fact that CMS intended to publish the AMP data in “mid-December.” The comment period for a related portion of the AMP rule closes on January 2, 2008, leaving very limited time for detailed challenges or data analyses. Last week, I attended a conference in which one speaker (a DC lawyer) said: “CMS feels very strongly that what they’ve done is correct.” Their Memorandum of Opposition did not even bother to rebut the marketplace impacts outlined in the expert report submitted by NACDS and NCPA.

Pharmacy lobbyists won the PR battle. NACDS and (especially) NCPA repeatedly claimed that AMP was only about “access for low-income patients.” They currently claim that the DRA (by itself) will lead to the closure of 10,000 to 12,000 pharmacies. These claims have been asserted and repeated without evidence even when objective reality provides factual reasons to doubt the claims. It helps that AMP is unloved and unwanted by almost everyone. I honestly wonder whether pharmacy advocates genuinely believe their own claims. There’s a useful lesson in doublethink propaganda here.

Pharmacies get a (small) profit reprieve. The larger chains, such as CVS and Walgreens (WAG), have not publicly quantified the impact of AMP, although the effect would not have been very large. Keep in mind that the DRA will only reduce retail pharmacy revenue by half of one percent annually – hardly the difference between poverty and riches (and hardly enough to sink 12,000 pharmacies).

Manufacturers will incur higher short term costs. Based on the latest timeline, manufacturers have already reported October 2007 AMPs using the new definition. If so, then manufacturers may need to run two parallel systems (Old AMP and Final Rule AMP) until the lawsuit is resolved. Manufacturers may even need to recalculate and resubmit their recent AMP data based on the old calculations.

The post-AWP future looks hazier. Average Wholesale Price (AWP) is still the primary benchmark for determining pharmacy reimbursement despite its well-known shortcomings and the short lifespan. I have previously suggested that AMP seemed to be a likely candidate for a replacement benchmark, especially for Part D plans. Payers and PBMs will be keeping a close eye on this case.

The government gets beaten (again). Last December, the FDA was successfully blocked from implementing the pedigree requirements of the Prescription Drug Marketing Act. (See No PDMA for you!) I wonder if these successes will increase the chances of a December 2008 injunction against the California Board of Pharmacy regarding e-pedigree.

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I'll post again after I've digested the Injunction. In the meantime, I now need to revise my 2007 Year in Review!

Part D and Generics

I wonder if branded drug makers are having second thought about the Medicare Part D benefit.

On one hand, Part D has demonstrably improved access and reduced out-of-pocket costs for seniors with no drug coverage. (See PhRMA’s September 2007 study.) Part D has also slowed drug diversion from Canada, which improves patient safety.

However, the much-maligned “donut hole” also appears to be encouraging greater generic substitution. Check out a new OIG report called Generic Drug Utilization In The Medicare Part D Program., which examines 341 million prescriptions paid by Part D in the first half of 2006. During the first six months of the Part D program:

• Generic drugs were dispensed 88 percent of the time when generic substitutes were available


• 56 percent of all drugs dispensed were generics

Hey, whadda ya know? People respond to incentives. Under Part D, seniors have strong incentives to keep their total drug costs below the lower end of the donut hole ($2,250). As a result, more seniors are trying to get the biggest bang for their buck by accepting generic substitution as well as shopping around at pharmacies.

Ironically, the donut hole may ultimately end up hurting brand manufacturers by accelerating already-rapid generic substitution rates. (Good New York Times article on this topic: Strategies to Avoid Medicare’s Big Hole). According to the Times, CMS estimates that generic dispensing rates are now 61.5%.

This unexpected dynamic could slow momentum for dramatic changes to the Part D program. Democrats perpetually chatter about using “direct price negotiations” with manufacturers to fund the elimination of the donut hole. Although the structure of the Part D benefit makes such negotiations virtually impossible to implement, brand manufacturers will likely feel much more pricing pressure from Part D plans.

The next few years will see an enormous wave of new generics. In 2006, Part D cost the Federal Government $47 billion in 2006, which is $13 billion less than the original estimate of $59 billion. Generic drug substitutions were a prime contributor to the 2006 reduction and lowered future cost estimates. Look for further reductions in the estimated cost of Part D, especially if Average Manufacturer Price (AMP) gets linked to Part D.

Ironically, I learned over Thanksgiving that my own grandmother was one of the few seniors who hit the donut hole. Why? Grandma told me that “she doesn’t believe in generics” because “they are just not as potent.” (I'm not making this up!) She insists on paying for brands even though her own pharmacist said that she is wasting her money.

Don’t worry – I thanked her on behalf of all branded manufacturers.

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BONUS: Boomer humor

Click here to see a very funny animation aimed at readers who are (or will soon be) eligible for Part D!

Big 3 on a Passage to India

The Indian newspaper Business Standard has a fascinating article on the Big 3 wholesalers' search for Indian suppliers. See US big 3 look for new Indian drug suppliers.

The article quotes "informed industry sources" that at least ten tier-II and tier-III Indian pharmaceutical companies with plants in Mumbai, Ahmedabad and Hyderabad are on the radar of AmerisourceBergen (ABC), Cardinal Health (CAH), and McKesson (MCK).

"Over the past few months, McKesson and Cardinal Health have sent executives to India to assess the capabilities of these companies, the sources said."

In a September post, I speculated that wholesalers will be moving closer to production to source generics, possibly even bypassing the generic manufacturers for certain products. The Big 3 are following in the footsteps of wholesalers in other industries and aggressively ramping up their private label programs.

What does this mean?

• More pressure on generic manufacturers -- and more consolidation to come.
• Lower acquisition costs for generic drugs -- and lower AMPs.
• More rapid generic penetration for drugs going off patent.
• Less attention to brands by distribution as the profits from generics grow faster (Wholesalers currently generate more gross profit dollars from generics than brands.)

The Big 6 chain and mail-order pharmacies -- CVS Corp with CareMark (CVS), Express Scripts (ESRX), Medco (MHS), Rite-Aid (RAD), Walgreens (WAG), and Wal-Mart (WMT) -- are the other major customers of generic manufacturers. They currently bypass wholesalers to buy generics except for fill-in and some minimal direct store delivery (DSD).

But as far as I know, the Big 6 are not being as aggressive in looking at India or China. If the Big 3 could source generics cheaply enough, then wholesalers could pick up major generic business from their largest customers.

The AMP Lawsuit Gambit

Yesterday, NACDS and NCPA unveiled their rumored lawsuit against CMS over Average Manufacturer Price (AMP). Despite substantial progress with AMP-related legislation, there was just no practical way that any of the bills could have been passed before the planned publication of AMP data at the end of November.

The associations are now seeking an injunction to block implementation of the definition of AMP in the Final Rule issued in July. I’m skeptical that they will get the injunction, but not very confident in my viewpoint given the vagaries (and my limited knowledge) of the legal issues.

Here are links to the key documents:

• Complaint
• Letter to House and Senate
• Frequently Asked Questions (FAQ)

The complaint focuses on an alleged difference between the statutory definition of AMP in Section 1927 of the Social Security Act and the definition in the Final Rule. The plaintiffs claim: “The statutory definition of AMP is clear and simple.” I strongly disagree with this characterization, although it’s not appropriate for me to provide a point-by-point rebuttal in a public forum. (Sorry, legal mumbo-jumbo fans!)

To be honest, I have no idea whether this gambit will work. I was surprised when secondary wholesalers successfully got an injunction last year against the FDA’s implementation of the pedigree requirements of the Prescription Drug Marketing Act (PDMA), so perhaps history will repeat itself this December.

However, I do want to highlight some comments made in the last November’s PDMA injunction decision by Judge Tomlison. While the circumstances are different, she summarized the following guidelines in making her decision:

• “A preliminary injunction is a drastic and extraordinary remedy that should not be granted routinely.”
• “The Second Circuit has repeatedly held that the irreparable harm requirement is ‘the single most important prerequisite for the issuance of a preliminary injunction.’”
• “Irreparable harm may be found where the moving party makes a ‘strong showing that economic loss would significantly damage its business above and beyond a simple diminution in profits.’”

By these standards, an injunction seems unlikely especially given the relatively minimal impact on pharmacy profits in 2008 and the historical analogy to Average Sales Price (ASP). (Reminder: I’m not a lawyer – please read disclaimer at bottom of page.)

As loyal readers know, I have strongly criticized the fear-mongering and hype associated with AMP. This latest twist adds even more drama to the debate. Who needs Hollywood writers when we have retail pharmacy?

Wal-Mart's Gain is not Walgreen's Pain

I’ve been warning about the attack on generic pharmacy profits since I launched my blog 16 months ago. I even nominated Lobbying for Pharmacy Profits as a trend to watch in 2007.

Wal-Mart’s announcement of its expanded generic drug program and Walgreen’s weak profits are further evidence of this trend. But contrary to some press reports, I don't see a direct cause-and-effect relationship between these two events.

Walgreen’s Pain

Yesterday, Walgreen Co (WAG) announced a rare profit decline driven in part by lower reimbursements on generic drugs. (See Walgreen's Earnings Fall Spurs Concern in Sector.) The company’s stock dropped by 15 percent – a $7 billion loss in market cap.

But as I noted last week, chains such as CVS Corp (CVS) or Walgreens (WAG) are not really vulnerable to Wal-Mart’s program because customers with third-party insurance do not save much versus standard co-pays.

My take: payers and pharmacy benefit managers now recognize the generic profit potential, so they are squeezing pharmacies sooner and harder than ever before.

Wal-Mart's Math

In contrast, Wal-Mart’s program highlights the high generic margins embedded in the pharmacy business model, especially for cash-pay customers. Yet Wal-Mart’s $4 generics program is neither a loss leader nor a “classic bait-and-switch,” as the National Community Pharmacists Association claims.

Still not sure? Then let’s do some math!

OIG reported average pharmacy acquisition costs for a set of generic drugs in its June report Deficit Reduction Act of 2005: Impact on the Medicaid Federal Upper Limit Program. The cost data were collected from the three largest national drug wholesalers plus two regional wholesalers.

Six of the generic drugs in the OIG study also appear on Wal-Mart’s list. Here’s what I found:

Weighted average margin = 24%. These calculations dramatically underestimate Wal-Mart’s actual gross margin because Wal-Mart's product acquisition costs are much lower than the independents, supermarkets, and small chains that buy through wholesalers. (See my January post for background.)

Add in Wal-Mart’s minimal incremental costs of dispensing and it's clear that the $4 generics program could be very profitable.

BTW, these margins are below what retail pharmacies were earning when dispensing generics under Medicaid in 2002. But isn’t that what led to Average Manufacturer Price (AMP) in the first place?

For fun (?), I searched for a few drugs on the New York State Attorney General’s Office Prescription Drug Price Website. Example: the cash-pay, no-insurance price for Metformin 500 mg ranges from $4 at Target or Wal-Mart to more than $50 at many independents. CVS charges $24.89 and Walgreen (WAG) charges $29.99. I checked some online prices and found similar numbers – Drugstore.com charges $39.99.

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Last week, NCPA accused Wal-Mart of "devaluing and destroying the practice of pharmacy." From my perspective, it looks like retail pharmacy is finally facing the consequences of their own business decisions. Wal-Mart is merely targeting an area of excess profits, to the ultimate detriment of less-efficient retail pharmacies. Stay tuned – this will get uglier!

Wal-Mart adds some $4 generics (yawn)

Wal-Mart Stores (WMT) announced an expansion of its (mostly) $4 generic drug program this morning. The 8 AM call was hosted by Dr. John Agwunobi, senior vice president and president for the Professional Services Division, and Bill Simon, executive vice president, chief operating officer, both from Wal-Mart Stores, Inc. The company also published a 4-page fact sheet.

I listened to the call (and even got to ask the final question). There was not much new news here, but here are my initial reactions:

Old news in a new pill bottle
This announcement is much less significant than the September 2006 announcement. Wal-Mart has expanded the list of drugs on their $4/$9 (a new tier) generics list, but is not fundamentally changing the program. Contrary to my earlier expectations, some of the blockbuster generics of brands such as Zocor and Zoloft are still not on the expanded list. No real explanation. They will probably still get some good press, especially because health care is becoming part of the Presidential election.

The program has generated profitable growth for Wal-Mart’s pharmacies.
Wal-Mart confirmed that they have increased pharmacist staffing more slowly than script count growth. In other words, my December 2006 analysis was correct in concluding that the program is generating incremental prescription volume to a typical Wal-Mart pharmacy by leveraging a relatively fixed pharmacy overhead. They stated that this profitable growth is "fully loaded" pharmacy profit, not just gross profit (revenues minus cost of goods).

Loads of of data, but little information
The company claims to have saved consumers $613,581,398.70 (!) as of September 24, 2007. The math was “simple” according to the speakers: They computed the difference between the old sell price and the new price ($4 or $9), and then multiplied it by the number of scripts filled. But this simple math doesn’t really tell us some key numbers, such as incremental script volume or where the scripts came from. They did note that dollar growth comps have been mid-teens for pharmacy, but “script counts are a multiple of that.”

Wal-Mart can still hurt independents where it counts
Last year, NCPA issued a series of blistering press releases, the first of which claimed that Wal-Mart was using a classic bait-and-switch. On this morning’s call, one of the speakers contrasted Wal-Mart’s generics program approach with the strategies of companies that have a “profitable, vested interest in the status quo.” Hmmm, wonder who they are talking about? Don’t forget that generics are much, much more profitable for pharmacies than brands.

What’s up with third-party payers and PBMS?
Chains such as CVS Corp (CVS) or Walgreens (WAG) are presumably not very vulnerable to Wal-Mart’s program because customers with third-party insurance do not save much versus standard co-pays. So I asked the speakers how Wal-Mart’s generic plan is working for patients with third-party coverage. Surprisingly, one of the speakers stated that Wal-Mart always files a claim on behalf of patients, but will often choose not to seek reimbursement. They even mentioned waiving dispensing fees offered by Medicaid. Presumably, Wal-Mart’s total reimbursement (dispensing fee plus their share of the co-pay) is less than a $4 cash payment, plus Wal-Mart gets the payment immediately instead of waiting a few weeks. I'd like to know more, but didn’t get a chance to ask a follow-up question.

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Pharmacists had a generally negative view of Wal-Mart’s program in an October 2006 Drug Topics survey. Any pharmacists care to comment (anonymously, if you want) on Wal-Mart’s latest announcement?

The Real Wal-Mart Effect

Inflation in drug prices has dropped to its lowest rate in three decades, as reported in Helped by Generics, Inflation of Drug Costs Slows from today’s New York Times. Bonus for fans of Drug Channels: I’m quoted in the article.

BLS economists cite the effect of Wal-Mart’s $4 generics program:
A Labor Department economist, Francisco Velez, said his office noted a drop in generic drug prices shortly after the large stores’ promotions began, particularly in the South, where Wal-Mart started its program.

To be honest, I’m not sure how much of the drop is attributable to Wal-Mart versus the overall market penetration of new generics and resulting shorter life cycle of brands. A 1998 CBO study found that the average market share of 21 generic drugs launched from 1991 to 1993 was 44% after one year. Today, blockbuster generics get 80%+ substitution within one month due to the efforts PBMs, wholesalers, and chains. Wal-Mart is a relatively small part of the overall pharmacy market, as I note in the article.

I suspect that the real Wal-Mart effect has been the negative impact of its $4 generic program on supermarkets, independents, and other discount chains.

Exactly one year ago, I correctly predicted that Wal-Mart’s $4 generics would shift generic market share away from independents, particularly in rural counties that have low chain pharmacy penetration. In the article, I discuss the increase in Wal-Mart’s pharmacy traffic due to its $4 generics program, which come from Sloppy reporting about Wal-Mart. (Ironically, my original post is highly critical of the Times!)

Perhaps NCPA should look at the companies competing with independents before blaming Part D and PBMs for the all of the marketplace challenges facing their members.

CAH + AB = ??

Cardinal Health (CAH) and Alliance Boots (AB) just announced an agreement to bring AB’s Almus brand of generic drugs to the U.S. market. See Alliance Boots, Cardinal Health Announce Joint Sourcing and Marketing Agreement.

This agreement could be merely routine – or the beginning of something very significant.

Private Labels Come to Pharma

If Almus is merely another generic supplier to Cardinal, then today’s announcement is only mildly interesting. AB’s success with Almus should not shock anyone who read my new book Facing the Forces of Change®: Lead the Way in the Supply Chain. I found that private label products (products branded by a wholesaler) will be expanding substantially in all industries over the next five years.

The economics are straightforward. A private label generic drug increases profits because the channel captures the margin that would otherwise flow to an upstream generic drug maker. The wholesaler—Alliance Boots in the case—also gains the ability to control the entire profit stream from production to sale, allowing for more flexible internal sales compensation models and higher commissions to drive sales.

Going Global

The big three wholesalers—AmerisourceBergen (ABC), Cardinal Health (CAH), and McKesson Corp (MCK)—already have active private label programs in other parts of their business. In fact, McKesson’s private label EverFRESH toothpaste got caught up in this summer’s tainted food recall after laboratory tests found small amounts of diethylene glycol.

From my point of view, it’s inevitable that wholesalers will be moving closer to production in order to source products for which there is limited brand preference. It’s not a stretch to imagine the combination of a generic manufacturer and wholesaler.

Seen in this light, today’s announcement may signal that Cardinal is gaining a bigger foothold in the global sourcing market. Such a move would give them the opportunity to sell generics in high volume to large pharmacy buyers sourcing directly from generic drug makers. (See CVS' Channel Power.)

Here's another idea to ponder. Alliance Boots recently entered the Chinese market and is planning to enter India. I already warned you over the summer that The British are Coming. So, could this agreement signal the beginning of a more significant relationship between Cardinal and Alliance Boots?

CVS' Channel Power

A new lawsuit gives us a peek into the behind-the-scenes economics of the CVS Corp-Caremark deal and highlights the challenges facing generic drug makers. I have not seen any news stories on this lawsuit yet, so perhaps this story is a Drug Channels exclusive.

In July, CVS filed suit against Prasco, LLC, a company that had a contract to supply generic Allegra to CVS. I posted the complaint online here since it is a matter of public record.

The contract allegedly specified that CVS had a “Most Favored Nation” clause to guarantee than CVS paid the lowest price of any customer, regardless of class of trade. (See paragraph 11.) But paragraph 21 of the complaint states: “As a result of the merger, CVS learned that, contrary the Agreement, Prasco had not, in fact, charged CVS the lowest price offered to any other customer. Instead, CVS learned that Caremark had been charged a lower price than CVS.”

CVS is following a time-tested post-merger purchasing strategy – compare contracts and ask for the best price. They are taking advantage of the fact that generic companies compete for supply contracts and “shelf space” by lowering prices to the biggest customers.

This is one of the reasons that I have been consistently bullish on the CVS-Caremark combination. In fact, CVS reported such strong Q2 financials because they claim to have already reaped their projected $500 million in purchasing power synergies.

Of course, CVS’ synergies are coming at the expense of generic drug manufacturers such as Teva Pharmaceutical Industries (TEVA), Watson Pharmaceuticals (WPI), and Mylan Laboratories (MYL). Generic drug makers now have nine major U.S. customers:

• The Big 3 wholesalers – AmerisourceBergen (ABC), Cardinal Health (CAH), and McKesson (MCK)
  
• The Big 6 largest chain and mail-order pharmacies – CVS Corp with CareMark (CVS), Express Scripts (ESRX), Medco (MHS), Rite-Aid (RAD), Walgreens (WAG), and Wal-Mart (WMT).

Smaller buyers – regional chains, independents, supermarkets, etc. – buy their generic drugs via wholesalers, whereas large customers only buy fill-in and some direct store delivery (DSD) generic drugs via wholesalers. (See my January post on Kmart for more background.)

Exhibit B of the Prasco complaint also demonstrates the power of a big buyer in the generic drug supply chain. “CVS Generic Pharmaceuticals Business Standards” (as of 2004) gives CVS price protection as a generic drug’s price falls. In other words, they can recover any decline in inventory value for products in their distribution centers plus five week’s inventory at store level (apparently without regard for actual store inventories.) This is the opposite of the investment buying by the channel that occurs for branded pharmaceuticals.

All in all, it’s a scary time to be a generic drug manufacturer, but a good time to be a big buyer of generic drugs.

AMP Battle Rages On

In January, I identified Lobbying for Pharmacy Profits as a key theme for 2007. The message is clearly getting through to our elected officials judging by yesterday's story in Drug Store News stating:

"In a bipartisan gesture, 46 senators co-signed a strongly worded letter March 13 asking CMS acting administrator Leslie Norwalk to hold off on the new Medicaid reimbursement plan until the agency had established a clearer definition of the AMP of a drug."

Ironically, Tuesday's Wall Street Journal article (Why Generic Doesn't Always Mean Cheap) highlights the perception challenge facing the pharmacy lobby. As readers of this blog know by now, profits on generic drugs subsidize the retail and wholesale distribution of much more expensive branded products. Recall that dollar-profit disparities between brand and generic dispensing created the need for AMP in the first place. (See The Attack on Generic Profits in Drug Channels for background.)

Manufacturers and drug wholesalers are also on a collision course over generics, especially if the next round of fee-for-service agreements leads to tighter payment structures for wholesalers. The big 3 -- AmerisourceBergen (NYSE:ABC), Cardinal Health (NYSE:CAH), and McKesson(NYSE:MCK) -- have been relatively quiet on this issue lately, but I expect that importation legislation will make the conflict clear. I wrote about this issue a couple of weeks ago in Generics=Channel Strife?.

While you ponder these strategic matters, I'm sure that the AMP fanatics (you know who you are!) will surely enjoy reading the comments submitted to CMS regarding the proposed AMP legislation. They can be found on an obscure web page buried deep within the CMS site: Electronic Comments on CMS-2238-P (If the link doesn't work, go to CMS' main electronic comments page and search for Docket ID CMS-2238-P.)

I'll post some thoughts on the massive amount of AMP comments in a week or two. In the mean