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...

1 comment:

  1. Dr.Fein,

    Not many see the cross-subsidies going on in the PBM and chain drugstore busines models.

    You do..

    And now, we know that Wal-Mart also knows this and is out to squeeze WAG and CVS by putting pressure on the Big 3 to re-balance their business model once again...this time away from mail order generic margins...to maybe, gasp...general, tranparent management fees.


    Larry Abrams