Summer Reading

Dear Drug Channels readers,

I’m going to take a break from blogging in July and August.  

But never fear -- there's no need to lounge around reading Danielle Steel novels! Below are seven recommended books on the pharmaceutical and pharmacy industry.  

Alas, there are no good books to recommend on pharmacy economics or the pharmaceutical supply chain -- the core topics of my Drug Channels blog. I’ll get around to writing that book one of these days.  

I’ll be back after Labor Day unless some major news event compels me to write sooner. In the meantime, send me an email if I’ve missed your favorite book and I’ll add it to the list.

Have a great summer!
Adam

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Dangerous Doses – Great book, especially if you want understand why Florida passed a pedigree law. The book is somewhat outdated because industry changes have addressed many of the secondary market problems described in the book. Nonetheless, it is perhaps the most readable and suspense-filled book on my list. Highly recommended for fans of drug channels! 

Skin in the Game: How Putting Yourself First Today Will Revolutionize Health Care Tomorrow – An intermittently interesting look at the concepts behind consumer-directed healthcare movement, notable because it is co-authored by John Hammergren, Chairman of the Board, President, Chief Executive Officer of McKesson (MCK). Kudos to Mr. Hammergren for avoiding the usual self-aggrandizing CEO puffery, although there's too much filler that sounds like it was written by the large research team credited in the preface. Given the tone of this book and the importance of health care in the 2008 election, I am quite surprised that Mr. Hammergren has not donated any of his considerable personal wealth to a political candidate since he made a $1,000 contribution in 2000 to John Kerry. (Search OpenSecrets.org if you don’t believe me.) NOTE: See updated information about Mr. Hammergren's contributions in my comment below.

 
Protecting America's Health: The FDA, Business, and One Hundred Years of Regulation – This is a fascinating look at the evolution of the pharmaceutical industry and the history of U.S. drug regulation. Be warned – there are some shameful events in the industry’s past, but the book maintains a (mostly) even-handed perspective. The author conveys historical events in a lively and interesting way, so the book is an entertaining way to get an historical perspective on the politics and science of drug regulation.

The Business of Healthcare Innovation – A solid analysis of key commercial issues in the four major business sectors developing innovative healthcare products - pharmaceuticals, biotechnology, medical devices, and information technology. Each sector receives a chapter-length analysis that includes market structure, key players, product development, commercialization, alliances, business strategy, and growth prospects. Thoughtful executives will be grateful for the book's solid research foundation and unwavering focus on practical business strategy issues. (You can read my full review on Amazon.) 

Pharmaceutical Economics and Policy – This book provides an academic look at the economics of the pharmaceutical manufacturing industry. Read it to get grounded on some fundamental principles behind the industry and to better understand the strategies that pharmaceutical companies pursue. The book is quite dense, so I advise you to dip into it as a reference rather than trying to read it straight through, i.e., this is not beach reading. There are also many helpful references to reputable academic research about the drug industry. 

Marketing Channels (7th Edition) – This MBA-level textbook is a must-own for any executive who thinks strategically about the way in which customers buy their company's products. While not specific to the pharmaceutical industry, many of the general principles apply to companies within U.S. drug channels -- pharmacies, wholesalers, PBMs, payors, salespeople, etc. I can personally vouch for the validity of their insights into channel strategy since I co-taught an executive education program at The Kellogg School with two of the co-authors, one of whom was on my PhD dissertation committee. (You can read my full review on Amazon.) 

Guide to Federal Pharmacy Law – Alright, I’ll admit that this one is for hard-core pharmacy industry analysts only. I have used it as a reference on certain distribution issues, although the book does not cover every relevant topic and can be out-of-date on fast-moving topics such as pedigree. As a non-lawyer, I enjoy reading the author’s analyses of individual pharmacy law cases.

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.

AWP: Dead Parrot or Just Resting?

Multiple people have emailed me in the last two weeks with variations on essentially the same question: Is Average Wholesale Price (AWP) no more? Has it ceased to be? Has it expired and gone to meet its maker? Bereft of life, does AWP rest in peace? If it wasn’t nailed down in many contracts, would it be pushing up the daisies? Has AWP rung down the curtain and joined the choir invisible?

In other words, is AWP an ex-benchmark?

Definitely. Maybe. Perhaps not. Here’s a quick update along with links to some helpful resources.

OUR STORY SO FAR

First Databank allegedly increased the spread between Wholesale Acquisition Cost (WAC) and Average Wholesale Price (AWP) from 1.20 to 1.25 on certain drugs in 2002. Many people first became aware of the situation through an October 2006 front-page story in the Wall Street Journal (How Quiet Moves by a Publisher Sway Billions in Drug Spending).

U.S. District Judge Patti B. Saris gave preliminary approval to a legal settlement in June 2007. There were two important elements of the settlement with regard to the publication of AWP:

• The WAC-to-AWP spread would be rolled back to 1.20 (if an NDC’s spread was higher) for all drugs
• FDB would stop publishing AWP no more than 2 years after the final court order

Since AWP is still widely used as a drug reimbursement benchmark for pharmacies, this proposed settlement affected the economics of many providers that were not involved in the lawsuit or settlement. In particular, pharmacy associations objected to the proposed class settlement, including the Pharmaceutical Care Management Association (PCMA), the National Community Pharmacists Association (NCPA), the National Association of Chain Drug Stores (NACDS) and the Food Marketing Institute (FMI).

In January 2008, Judge Saris rejected the original settlement and requested that the parties come back with a new settlement plan. An amended settlement was filed in June 2008 in which First Databank would roll back the AWP-to-WAC markup only for the subset of about 1,400 drugs identified in the original complaint, among other actions.

However, the amended (and still unapproved) settlement does not require First Databank to stop publishing AWP or roll back AWP on all drugs. Nonetheless, FDB has announced that it will unilaterally roll back the AWP for all drugs to 1.20 and discontinue publishing the Blue Book AWP data independent of the litigation. (See the June 2 letter on its website.) So the outcome would be the same (no more published AWP) although the currently proposed settlement does not technically require the demise of AWP.

Meanwhile, San Francisco and Connecticut have both filed suit against McKesson (MCK) regarding the company’s alleged role in the 2002 increase in the WAC-to-AWP spread. (See Connecticut sues McKesson on racketeering charges.)

MY TAKE:

1. AWP may not be quite dead yet, but it is certainly pining for the fjords (as discussed in the video below). For instance, other AWP lawsuits unrelated to FDB have created legal “speed limits” for the WAC-to-AWP markup. (See Judge Saris on Fictitious AWPs.)
2. Alternative list price benchmarks, such as WAC, are likely to become more common. Example: the Department of Defense’s TRICARE contract that I discuss in Big WAC Attack.
3. Where possible, pharmacy reimbursement relationships will be structured to maintain dollar-based economic arrangements regardless of the benchmark. Medco Health Solutions (MHS) discussed this issue in November. (See PBMs and AMP.)
   
4. Computed (non-list price) benchmarks such as Average Manufacturer Price (AMP) could one day become the norm for retail pharmacy, but the legal and publication status of AMP makes the timing very uncertain. (See my many posts on AMP for more.)

RESOURCES

• FDB AWP Communications
• FDB/Medi-Span AWP Settlement Website
• Hagens Berman Sobol Shapiro (court documents)

AND NOW FOR SOMETHING COMPLETELY DIFFERENT

Special thanks to John Cleese and Michael Palin for this video overview of AWP’s legal status:

IMS Recounts, but Independents Still Growing

In April, I wrote The Myth of Fading Independents to highlight the surprising growth by independent pharmacies shown in IMS Health’s (RX) 2007 channel distribution data. However, IMS recently confirmed to me that 2007’s growth in purchases by independent pharmacies was overstated. My recalculation shows that independents still grew last year, but much more slowly than originally reported.

WHAT HAPPENED?

IMS’ National Sales Perspectives (NSP) reports sales *into* each distribution channel tracked by IMS. In other words, the data represent product purchases from wholesalers or manufacturers, not retail pharmacy sales to patients. (See the original post and comments for further details.)

In a comment on my original post, I hinted that a data reclassification may have artificially boosted the 2007 figures and made the historical comparison misleading. Well, it turns out that IMS shifted sales to Cardinal Health (CAH)’s Medicine Shoppe pharmacy franchises from “chains” to “independents” in January 2007.

To be fair, IMS claims to have issued a product information bulletin (PIB) to its customers at the time of the switch.

However, IMS neglected to restate the historical data reported publicly on its website, which meant that growth by independents was overstated and growth by chains was understated. To further confuse the reported numbers, IMS apparently did not make a comparable adjustment in the data on number of prescriptions.

THE REVISED 2007 GROWTH RATES

An IMS insider recently shared the official adjustment factors for 2007 with me. The chart below presents my computation of the data on a historically comparable basis, i.e., I count Medicine Shoppe with “chains” to be consistent with previous data. (I included the 2006 growth rate for comparison.)

In contrast to my original post, purchases by mail order grew the fastest in 2007, followed by chains. Independents grew by only 2.5 percent (versus 8.4 percent in the original post). Perhaps one bright spot for independents is that the growth rate declined at a slower rate.

TIME TO RESTATE

In my opinion, IMS should now restate the historical data to create a comparable time series of channel distribution data. It was irresponsible for IMS to publish the data without clarification. Analysts and consultants like me follow these top-line data. These data are also used as inputs for statistical publications by NACDS and HDMA.

IMS has recently suffered some embarrassing public data disputes with Novartis, Millennium Pharmacueticals, and other drug makers. In contrast, their goof-up on channel sales seems to derive from sloppiness rather than faulty data.

Let’s just be thankful that there were no hanging chad.

Drug Channel Profits in the Fortune 500

Since the Fortune 500 rankings were published last week, I thought it would be fun to look at the revenues and profitability of the ten companies on the list that participate in the pharmacy supply chain. (Hey, everyone needs a hobby!) The financial data also give me an opportunity to address critics who have accused me of being insensitive about the profits of pharmacies and wholesalers. I also look at average investment returns, which have been higher for the channel than for manufacturers.

TEN COMPANIES

Here are the ten wholesalers, pharmacies, and PBMs companies that I found on the Fortune 500 list along with rank and links to the financial data as reported by Fortune:

• McKesson (MCK): 18
• Cardinal Health (CAH): 19
• CVS Caremark (CVS): 24
• AmerisourceBergen (ABC): 28
• Walgreen (WAG): 40
• Medco Health Solutions (MHS): 51
• Express Scripts (ESRX): 135
• Rite Aid (RAD): 142
• Omnicare (OCR): 386
• Longs Drug Stores (LNG): 453

I only include companies that earned a majority of their revenues from pharmaceuticals. This criterion excludes other retail formats with pharmacies (supermarkets and mass merchants). I also do not separate the revenues from each company’s various lines of business. I'd be analyzing the original company data if this were a consulting project, but I'll stick to Fortune's admittedly crude metrics for the blog.

Keep in mind that the Fortune 500 rankings are based on sales revenues, so there is substantial double-counting in this list. For instance, revenue from the same prescription could be counted at least three times by companies on this list if:
(1) the drug is sold by a wholesaler to a pharmacy;
(2) the drug is sold by a pharmacy to a consumer; and
(3) the pharmacy receives reimbursement for from a PBM.

For comparison, there are nine pharmaceutical manufacturers on the Fortune 500 with revenues ranging from $61 billion (Johnson & Johnson) to $12.7 billion (Schering-Plough).

PROFITS

As you can see in the table below, Return on Sales (ROS; profit as percent of revenues) was in the low single digits for all companies in this group, regardless of their position in the supply chain (retail pharmacy, wholesaler, or PBM). The median for my Drug Channels group is 2 percent.

(CLICK TO ENLARGE TABLE)

By contrast, median profit as a percentage of revenues was 16 percent of revenues for the nine drug manufacturers (range: -12% to 21%). Thus, the manufacturer-to-channel ratio is 8X.

However, ROS only tells us part of the profitability story because it ignores the balance sheet assets required to generate an income statement profit. A more meaningful comparison relates ROS to the assets required to generate those operating profits, so the table above includes Profits as a % of Assets, which I will call Return on Assets (ROA).

The profitability of companies in the Drug Channels universe looks much more attractive on this basis, as my friends on Wall Street know. The group median is 5% (Range: 0% to 11%). Again, there is no clear pattern related to supply chain position.

The ROA figures are closer to the pharmaceutical manufacturers, whose median profits as a percent of assets is 9 percent (Range: -5% to 13%). The manufacturer-to-channel ratio is now only 1.8X (versus 8X for ROS) reflecting a risk-return tradeoff. The additional profitability for manufacturers can be considered an innovation/risk premium. Discovering and developing new medicines is expensive, risky, and time consuming. Obviously, the ratio could vary over time, although I just relied on the single year data provided by Fortune.

INVESTMENT RETURNS

Investment returns for the Drug Channels group were higher last year as measured by the average Total Return to Investors for 2007 reported in Fortune’s list:

• 10 Drug Channels companies: 15.2% (Range: -49% to 104%)
• 9 Drug Manufacturers: 3.5% (Range: -32% to 38%)

2007 appears not to be an outlier. The drug channels had a higher average 10 year total return than manufacturers. The channels group has a wider range for both time periods, in part reflecting a greater diversity of business models compared to manufacturers.

SO, WHAT HAVE WE LEARNED?

1) By a conventional metric (revenues), many drug channel participants are substantially larger than the manufacturers.

2) A frequently cited metric of profitability (Profit as % of Revenues) makes drug channels companies look worse than a more appropriate metric such as Profit as % of Assets.

3) Investors earned greater average total returns from the drug channels group last year and over the past 10 years compared to the manufacturers group.

Will these returns hold up in 2008? Well, if I knew the answer to that question with certainty, then I’d be retired on a Caribbean island instead of pecking out another blog post for you!

The Myth of Fading Independents

May 27, 2008: Please see IMS Recounts, but Independents Still Growing for important information about the data in this post.
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Time to test yourself at the college of pharmacy knowledge!

Q: According to IMS, which of the following pharmacy channels had the fastest rate of growth in 2007?
a. Chain Stores
b. Mail Order
c. Supermarket
d. Independent

Contrary to what you may have heard, the answer is … Independents! In fact, independents grew more than 5 times as fast as chains.

Nope, this is not another April Fool’s joke. I was surprised, too, especially given the heated rhetoric around the “debilitating consequences” of Part D, Wal-Mart’s “predatory pricing,” and the “devastating impacts” of AMP.

Looks like your friendly neighborhood blogger will once again have to be the bearer of … good news???

JUST THE FACTS

When IMS released the final 2007 data in March, they noted that the U.S. pharmaceutical market experienced its lowest growth rate since 1961. (See IMS Health Reports U.S. Prescription Sales Grew 3.8 Percent in 2007, to $286.5 Billion.)

However, growth varied by channel. Below is a chart showing the 2007 growth rates for the four major retail pharmacy channels. You can check my math with IMS Health’s 2007 Channel Distribution by U.S. Sales report.

The data come from IMS National Sales Perspectives, which reports sales into each distribution channel tracked by IMS. In other words, the data represent product purchases from wholesalers or manufacturers, not retail pharmacy sales to patients.

As I understand the data, NSP purports to represent sales at invoice pricing, not sales at a list price such as Wholesale Acquisition Cost (WAC). For example, contract pricing, such as a discounts processed via wholesaler chargebacks, should be reflected in the IMS NSP measures of price. However, rebates paid by the manufacturer directly to an insurer or PBM (Pharmacy Benefits Manager) would not be reflected in these data. (A similar principle was embedded in the AMP Final Rule.)

SHAKEOUT TIME

Like it or not, US retailing continues to become more concentrated and increasingly dominated by chain stores, warehouse clubs, home centers, and big box superstores. Consumers are fueling this trend by consolidating their purchases and shopping at fewer, larger stores. Low prices and self-service ("How can you help you?") now dominate.

Consider the massive consolidation occurring at the top end of the pharmacy market. The biggest six dispensers – CVS Caremark (CVS), Walgreens (WAG), Rite-Aid (RAD), Medco (MHS), Express Scripts (ESRX), and Wal-Mart (WMT) – fill more than half of all scripts today.

Retail pharmacy is now undergoing a similar shakeout that will leave us with fewer, but larger, independents. There are half as many independent pharmacies today as there were 15 years ago. Yet by my calculations, the average independent pharmacy today fills 50% more prescriptions than the average independent 15 years ago.

Meanwhile, the aggregate number of pharmacies has barely budged in the past twenty years because new competitive channels – supermarkets, mail, and mass merchants – have filled the gap. As I pointed out last July, consumers of independent pharmacies still have access to many pharmacies within a reasonable driving distance. Yes, I recognize that patients in some rural communities may have an access issue if their local independent closes. If that’s true, then the solution is targeted support for pharmacies in at-risk markets, not blanket protections for all pharmacies in all markets.

And contrary to the claims of doom, Medicare Part D has been neutral to positive for independents. Re-read January’s Pharmacy Profits & Part D, in which I analyze the relationship between pharmacy size and profitability for independents under Part D. The second comment on this Part D post (apparently from a pharmacist) reads: “What the data is basically saying is that the system is going to weed out the pharmacies that are not running efficiently, or not filling a high enough volume of prescriptions.” 'Fraid so.

Put all of these pieces together and you can understand the surprising resilience of the surviving independents in the IMS data.

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One of my consulting advisory clients recently told me that he values my opinions because I’m a “tough, cynical hard-ass.” Believe it or not, I took his comment as a compliment. My job is to tell people the hard facts – even when the news is good!