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Monday, July 24, 2006

The Part D direct negotiations movement

Last Thursday, House Democratic Leader Nancy Pelosi and other senior House Democrats asked for a floor vote on direct negotiations between the US government and drug manufacturers for Medicare Part D. (Read the press release here.) The Senate rejected similar amendments to the Medicare act last November by a 51-48 vote and in March 2005 by 50-49.

The Democrats are making Part D “reform” into a major theme of the 2006 elections. Our charter at Drug Channels includes examining the effects of policy on the pharmaceutical supply chain, so I’ll defer comment on the political angles.

Nevertheless, a direct negotiations scenario is certainly possible. This shift could have dramatic consequences for manufacturers in the areas of channel strategy, pricing, and trade account management. Wholesalers, retailers, and PBMs should also be paying close attention to the strategic business implications as the “cost of the channel” becomes more prominent and visible.

A Direct Negotiations Scenario
Let me sketch a few factors (beyond political posturing) that could favor a direct negotiations scenario:
  • The government will be paying almost half of the entire US prescription drug budget within a few years via Medicaid and Medicare. Yikes!
  • The tab for Part D, an unfunded expenditure from general revenues and premiums, is likely to force some uncomfortable trade-offs among non-entitlement budget spending. According to the 2006 Medicare Trustees Report, Part D costs are projected to increase at an average annual rate of 11.5 percent from 2006 to 2015.
  • A steady drumbeat of research studies (Example One and Example Two) purport to show how much could be saved with direct negotiations. (No hate mail, please – these are examples, not endorsements.)
  • A Democratic Congress and/or President Hilary Clinton
I assume that you agree that we can assign a non-zero probability to the direct negotiations scenario.

How much should we pay for the drug channel?
Currently, pharmacy reimbursement levels for Medicare Part D are determined by the marketplace through network contracting negotiations between pharmacies and Medicare PDPs, not set by CMS.

I believe that a direct negotiations scenario will migrate CMS Part D reimbursement to an “average price plus” model. In my post from early May, I noted that government reimbursement for pharmaceuticals is moving away from “discount off list” (AWP minus). Consider:

  • Medicare Part B now reimburses outpatient drugs to providers at Average Sales Price (ASP) plus 6 percent.
  • Starting in January, Medicaid’s reimbursement to retail pharmacy for generic drugs will be the to-be-defined Average Manufacturer Price (AMP) plus 250 percent. (See my June 8 post for more on AMP.)
Key point here: An “average price plus” model does not claim to measure actual pharmacy or provider acquisition costs for drugs. Instead, these models use actual manufacturer transaction prices plus a drug channel cost factor. Dr. McClellan voiced his support for these models in his comments to last summer’s OIG comparison of AMP to AWP and WAC. (See pages 24 to 26 of this OIG report.)

Some uncomfortable questions
It’s beyond the scope of my blog to write about all of the strategic implications here. (Hey, that’s my real job!) But here are a few questions to ponder:

  1. A “price plus” approach effectively caps the total compensation that can be earned by wholesalers, retailers, providers, or anyone else handling the product after it leaves the manufacturer’s factory. Who will win if wholesalers and retailers begin competing for the fixed (and probably lower) channel margin?
  2. Prescription pharmacy is 69% of CVS’ revenue and 66% of Walgreen’s revenue, making the government responsible for at least a third of top line at the biggest chains. Will this accelerate pharmacy consolidation, reduce margins, or both?
  3. The next round of fee-for-service negotiations will be coming up in the next 18 months. How much will/should a manufacturer compensate the drug channel to perform activities that become uneconomic in a “price plus’ reimbursement model?
  4. How will the relative attractiveness of alternate distribution models, such as third-party logistics providers, change once drug channel margins are subject to more scrutiny?
Direct negotiation is just a scenario – for now.

P.S. A few people wrote to ask me about the meaning of disambiguation, which I used in the title of my last post. For the record, disambiguation means “clarification that follows from the removal of ambiguity.” See? This blog really does make you more perspicacious!

Wednesday, July 19, 2006

Superb disambiguation from the Washington Times

I bemoaned the truthiness of last week’s Senate vote on importation in my last post.

As a follow-up, read this great editorial from today's Washington Times called “Counterfeit drugs and border security.” My favorite sentence:

“Banning Customs enforcement is tantamount to giving terrorists a free pass to flood America with fake and dangerous drugs.”

Sadly, that statement is all too true.

Saturday, July 15, 2006

Cosmic irony in the drug supply chain

Last week provided cosmic irony of epic proportions for anyone concerned about the safety and security of the U.S. pharmaceutical supply chain.

Let’s begin on solid ground. On Tuesday, the Congressional Subcommittee on Criminal Justice, Drug Policy and Human Resources (or CSCJDPHR, to its friends) held another hearing on pharmaceutical supply chain security. (Written testimony is available for your reading pleasure here.)

The following quotes caught my eye:
  1. Kevin Delli-Colli, Deputy Assistant Director, Financial & Trade Investigations Division, Office of Investigations, U.S. Immigration and Customs Enforcement, Department of Homeland Security (Wow – he must have an extra large business card!) said: “To date, ICE investigations have not revealed any instances in which smuggled, counterfeit pharmaceuticals were destined for the legitimate U.S. supply chain; rather, trafficking organizations have created an illicit, unregulated supply chain that is filled with counterfeit, adulterated, misbranded and unsafe drugs which are distributed directly to consumers, who in most instances are drug abusers.”
  2. Carmen A. Catizone, Executive Director of the National Association of Boards of Pharmacy noted “…the reckless actions of local, state, and federal public officials who ignore public health and safety in order to promote the illegal importation of drugs as a item of political pandering.”
But on the very same day that this evidence-based testimony was being heard, the U.S. Senate voted 68-32 to make it easier for Americans to import cheaper prescription medications from Canada.


The Senate exhibited the worst kind of truthiness* when it deliberately avoids troublesome facts about the dangers of personal importation. Even more ironic is the fact that Part D is already displacing Canada, as evidenced by Minnesota’s illegal importation program.

Sometimes I really get scared about the way that policy gets made in this country.

* For those who have never seen Stephen Colbert, truthiness is defined as “…the quality by which a person purports to know something emotionally or instinctively, without regard to evidence or to what the person might conclude from intellectual examination.”

Friday, July 14, 2006

A busy week for wholesalers!

Wow! This turned out to be a big news week for your friendly neighborhood pharmaceutical distribution expert. The big three wholesalers all made interesting business moves. A few highlights:

  • McKesson sells its acute care (hospital) distribution business to Owens & Minor. Not a surprise given previous announcements, but does make me wonder if their alternate site/physician business next?
  • AmerisourceBergen acquires another Canadian wholesaler. I had the pleasure of speaking on “The Future of Independent Pharmacy” at ABC’s trade show in sunny Las Vegas this week. (Regrettably, I had to fly like an eagle and missed the Steve Miller Band’s performance on the final night.)
  • Cardinal Health announces an agreement to manufacturer Tamiflu, then takes a page from McKesson’s playbook and buys a small healthcare technology company.
  • More intriguingly, Cardinal quietly filed an 8-K announcing a $395 million share repurchase from “an unaffiliated third party.” This share repurchase is part of a new $500 million share repurchase program approved Board on June 28. (They bought back $500M in Q2.) While I can’t tell you what this means for the stock price, it does strike me as an admission that the company is not yet ready to invest in some of its underperforming businesses. Big divestitures to come?

IMO, 2007 will be a make-or-break year for drug wholesalers. I’ll post as news develops, but please feel free to email me comments or questions anytime.

P.S. Watch out for wholesaler earnings, coming soon (ABC: July 25; MCK: July 27; CAH: August 3).

Wednesday, July 05, 2006

Another $0.02 on Pedigree and Generics

Here's some follow-up to my two most recent posts on pedigree and generic competition.

H.B. 371 signed by Gov. Bush (posted June 27)

As predicted, the Florida press is spinning Gov. Bush’s move as a blow to supply chain security. (Readers of this blog know that I disagree.) I'm actually a bit surprised by the muted responses given the hyperventilating editorials that were written after HB 371 was modified. Anyway, here are two articles:

Tough drug law may lack teeth,” Orlando Sentinel

Gov. Bush signs bill weakening safeguards against fake drugs,” Sun Sentinel

Winners and Losers in the Zocor Wars (posted June 25)

As reported in the Wall Street Journal, Pfizer plans to zocor its generic competitors by lowering the price of branded Zoloft upon patent expiration. Pfizer also announced that they will pursue a similar strategy in Switzerland.

To me, these actions suggest a new era of brand/generic competition. A 1998 CBO study found that the average market share of 21 generic drugs launched from 1991 to 1993 was 44% after one year.

Tempus fugit. Blockbuster generics now get 80%+ substitution within one month. Consider this example from Medco’s latest drug trend report:

“Allegra is a widely used nonsedating antihistamine with market sales of $1.3 billion in 2004. By October 2005 (the first full month following generic availability), the brand-name product lost 84% of its overall market share to the new generics—81% at retail
and 95% at mail.”

In other words, PBMs are shortening the life cycle for branded drugs, thereby lowering total drug costs for payers and generating higher incremental profits for themselves (see my previous post).

Here's the irony – brand manufacturers paid rebates to PBMs of more than $6 per prescription in 2003 (per the FTC report). Sure, a majority of those payments get passed back to payers. Manufacturers' newfound aggressiveness on generic pricing is a clear signal that PBMs remain the true power players of the drug channel.

Now, if only I could figure out how to get these (censored) snakes off my (censored) blog...