Sunday, May 28, 2006

Closing down the secondary market

In my most recent post on the Florida pedigree situation, I pointed out that HDMA makes a very reasonable point regarding the ease of forging paper pedigrees.

As if on cue, a drug diverter pled guilty to five counts of conspiracy for selling stolen drugs and admitted that " sell the prescription drugs, he created fraudulent pedigree documents..." The press release from the U.S. DOJ has all the sordid details.

I believe that the introduction of Inventory Management Agreements (IMAs) and Fee-for-Service agreements have dramatically reduced this type of activity. Drug makers now literally pay for greater product security by compensating U.S. wholesalers not to stockpile drugs. The more sophisticated companies also pay wholesalers for data to enable real-time analyses of orders, inventories, and product movement. Enterprise-class software is being used by manufacturers such as Bristol-Myers Squibb to gain never-before-available insights into the location of inventory.

IMO, the practical effect of these manufacturer investments has been to limit product leakage into the grey market, closing a significant entry point for counterfeitors. The large wholesalers and retailers have all vowed to stop purchases from the secondary market, but it is comforting to know that manufacturers can validate these pledges from their channel.

Nevertheless, the secondary market exists as long as there are willing buyers exist for products with questionable pedigrees. See The Ghost in the Machine, a recent overview of secondary wholesalers from Pharmaceutical Commerce magazine. Scary stuff to consider the next time you get a prescription filled.

(While I'm thinking of it, I recommend that you check out Pharmaceutical Commerce, an excellent publication focusing on the business aspects of drug channels. Full disclosure: I am on the editorial board.)

Monday, May 22, 2006

Pedigree: Making best into the enemy of good.

In case you missed the news, a last-minute addition to HB371, which dealt with cancer drug donations, creates a loophole that allows wholesalers to avoid Florida's paper pedigree requirements.

There is a less to this loophole than meets the eye. Some states -- Arizona, Indiana, Texas -- have already adopted the concept of a "normal distribution channel" to focus pedigree on where it is needed the most. Kevin Nicholson of NACDS summarized the logic of this argument in his presentation at the FDA's RFID meeting in February. The largest wholesalers and chain pharmacies within the normal channel have already moved away from secondary market sourcing.

Nevertheless, the curious timing of this provision is generating substantial editorial protest about Florida's Prescription for Peril, calls for Governor Jeb Bush to veto the revised bill, and commentary from Stephanie Feldman, who participated in the events described in the excellent book Dangerous Doses. Keep in mind that Florida enacted its strict paper pedigree requirements after a rash of blatantly egregious criminal behavior in the state.

The Healthcare Distribution Management Association (HDMA) makes the very compelling argument that "Paper pedigrees will provide a false sense of security" because paper can be easily forged. The Florida requirement also puts the cost and implementation burden onto the backs of an already profit-squeezed wholesale industry. Although the news articles above highlight HDMA's backroom maneuvering, HDMA has been attempting to make pedigree workable. (For example, see HDMA's August 2005 implementation suggestions.)

Nevertheless, the distribution industry should be careful not to portray an image of "electronic pedigree or nothing." Such a tactic will be perceived to be as reminiscent of Voltaire's statement that "The best is the enemy of the good."

On the other hand, everyone (including the FDA) needs to get real about pedigree, de facto or actual. RFID is not a magic bullet and will also lull us into a false sense of security. The complexity of today's drug channels should make all of us very skeptical about technological fairy tales spun by the vendors and consultants who will profit from further RFID mania. (I will comment further on RFID when the FDA issues their counterfeit drug update report later this month.)

Don't believe me? Read this story about a Texas pharmacy. I'm sure that they received paper pedigrees and may even have been willing to buy an RFID scanner.

Personally, I believe that existing technology linkages, combined with the adoption of secure business practices of the kind enabled by Edge Dynamics, can make the drug channel safer and more secure today. But that's a subject for another post...

Tuesday, May 16, 2006

Will unbundling crush pharmacy profits?

Last week's Wall Street Journal article on CareMark's generic dispensing business ("Selling Generic Drugs by Mail Turns Into Lucrative Business") missed a major point about drug channels today. Profits on generic drugs now subsidize the retail and wholesale distribution of much more expensive branded products.

Many industries built on cross-subsidies are changing -- newspapers (classified ads support news gathering), TV (commercials subsidize TV production). It looks like pharmacy channels are next.

The "channel" (wholesalers, retailers, PBMs, etc) accounts for roughly 1/3 of U.S. retail pharmacy spending of $250 billion.

  • Due to inventory management and fee-for-service agreements, drug wholesalers now generate much less profit from branded pharmaceuticals. We estimate that wholesalers generate 11% of revenues from generics, but that generics equal 52% of wholesaler gross profits.
  • As the WSJ article notes, generic mail scripts are much, much more profitable for PBMs than a branded script filled in the retail network. This is well-known and not a secret to anyone who reads a PBM press releases.
  • Last year's FTC study found that: -- Large retail chains generate 63% more dollar profit per prescription from generics vs. brands -- PBMs generate 83% more dollar profit per prescription from generics by mail vs. brands.
The cross-subsidy of branded distribution by generic profits is under attack, which is creating stress in the US distribution channel for pharmaceuticals. Government reimbursement for pharmaceuticals is swiftly migrating toward methods that use actual transaction prices to approximate pharmacy acquisition costs. Medicare Part B is now ASP + 6%. The Medicaid reimbursement formula in last year's budget bill will shift to AMP+250% for generics. Medicare Part D could be next.

The WSJ article had a negative slant on the relative profitability of generics because it downplayed the cross-subsidies at work. Plus, it ignored the fact that a PBM’s customers (large corporations) presumably are sophisticated enough to understand the trade-offs in pricing a basket of goods.

These tradeoffs are found in any multi-line intermediary. For example, Barnes & Noble sells bestsellers at cost (40% off) but probably makes “obscene” profit margins on the little chocolates and gift books placed next to the register


  • Will the anticipated publication of AMP data expose the true profit models of the channel, encouraging payers to ask for unbundled pricing?
  • Higher generic profits have encouraged everyone in the health care system (except manufacturers) to push generic substitution. Will removing so-called “unreasonable” profits on generics start to tilt the balance back to branded manufacturers? Perhaps we should be careful what we wish for.
  • What is the future of retail pharmacy? 90%+ of retail prescriptions are processed through third-parties (PBMs, MMA, etc.) who effectively control the pharmacy’s margin. Now, the one most important remaining source of profit (generics) is under attack.
  • As noted above, pharmacy reimbursement is moving to ingredient cost plus a fixed margin for the channel. Could this model next move to Part D if we get a Democratic Congress and a Democratic President?

Stay tuned...

Wednesday, May 10, 2006

US wholesalers look to Europe

I wonder if we will soon see the merger between a US and a European drug wholesaler. Three large pan-European wholesalers have emerged through consolidation. With Alliance Unichem now tied up with Boots, there are at least two logical large targets. Total share of the Big EU 3 is ~50%, so there is room for further consolidation.

This article (Cardinal puts Europe on its drugs radar) provides the clearest statement that I have seen on Cardinal's intention to move into drug distribution outside of North America. Given the international experience of Cardinal's new CEO, we could be on the verge of a truly global wholesaler.

I also note Michael Long's addition to AmerisourceBergen's Board. Long is a senior executive at Arrow Electronics, an electronic components distributor that moved aggressively into Europe in the early 1990s through a string of acquisitions. The most recent Board member added prior to Long was Henry McGee, who was responsible for HBO's video "... expansion into the international market with the start up of an HBO Video Label in the United Kingdom." Interesting.

For wholesalers, the EU market is more stable than the US market for at least 4 key reasons:

  1. The EU retail pharmacy industry remains highly fragmented due to legal restrictions and cultural preferences, limiting direct distribution and making wholesalers the preferred channel for pharmacies. For example, pharmacy chains are legally prohibited in Germany, France, and Spain
  2. Manufacturers have a much smaller influence over EU wholesaler gross margins. Wholesaler sell-side margins (to pharmacy customers) are regulated or set in most EU countries. Some countries, e.g., France, also regulate the discount % from these margins that wholesalers can offer to pharmacy customers.
  3. Wholesalers own their customers. The Big 3 wholesalers have forward integrated into the more profitable pharmacy business, giving them a guaranteed customer based for the wholesale business. At the large end, Alliance Unichem is in the process of merging with the Boots chain in the UK. Cardinal has done this in a more limited way via Medicine Shoppe.
  4. Wholesaler can benefit from parallel trade, a legal source of profit in European channels that is virtually impossible for manufacturers to control. Wholesalers absorb most of the price differences between countries.)

Despite these favorable dynamics, I'm not sure that top management at US wholesalers will be willing to jump through all of the regulatory and political hoops required. Nevertheless, the challenging competitive position in the US may leave them no choice.