Drug Channels delivers timely analysis and provocative opinions from Adam J. Fein, Ph.D., the country's foremost expert on pharmaceutical economics and the drug distribution system. Drug Channels reaches an engaged, loyal and growing audience of nearly 100,000 subscribers and followers. Learn more...

Monday, November 24, 2008

The Future of AWP: Ask Again Later

Last week’s legal developments don’t make the future of Average Wholesale Price (AWP) much clearer, despite my use of a magic 8-ball.

McKesson Corp (MCK) settled its pending class action suit for $351 million and set aside a further $143 million reserve for certain future claims. See McKesson Agrees To Settlement In Pricing Suits.

Meanwhile, NACDS and FMI filed another brief in opposition to the controversial proposed First Databank settlement, although they overstate their arguments in a few places. Expect this battle to heat up over the next month as we get closer to the hearing about First Databank’s settlement.

McKesson: Without a Doubt

McKesson’s trial was scheduled to begin in December. You can view a presentation of selected evidence in the Plaintiffs’ Illustrative Exhibits in Support of Motion for Class Certification, which includes apparently damaging emails involving some familiar companies. Just keep in mind that this information was cherry-picked by the plaintiffs, so it is presented out of context and therefore may not be reliable.

Naturally, the settlement terms include “an express denial of liability of any kind.” (Read McKesson’s official statement.) The lead lawyer from the firm that filed the class action actually wrote a blog post about the settlement with his spin.

The settlement gives us some insight into litigation calculus. Conceptually, the settlement amount should be less than the sum of:
  • future legal costs, plus
  • the expected loss, where the expected loss = Probability of Losing * Total Damages.

If we assume $20 million in future legal costs and take the plaintiff’s original estimated damages of $5 billion, then the $351 million settlement implies a 6% probability of losing the case. Put another way, McKesson settled even though the numbers suggest a more than 90% chance of winning.

First DataBank: Cannot Predict Now

Read AWP: Dead Parrot or Just Resting? for my detailed overview about First Databank’s plans to unilaterally roll back the AWP for all drugs to 1.20 and discontinue publishing the Blue Book AWP data. This post is still valid because the next phase is a fairness hearing scheduled for mid-December.

Pharmacy groups object to the First DataBank settlement because a roll-back would translate into lost dollars for pharmacies that get reimbursed based on AWP. The National Association of Chain Drug Stores and the Food Marketing Institute recently filed a new brief and economic report opposing the amended June settlement.

Dr. Mosteller’s economic report (starting on page 21) highlights many issues that I have covered in my blog over that past few years, such as the reality that reimbursement relationships will be restructured to maintain dollar-based economic arrangements regardless of the benchmark. See PBMs and AMP (November 2007) or my original comments on the AWP settlement (October 2006).

Ask Again Later

The latest legal brief from NACDS and FMI perhaps overstates the Life Without AWP (LWAWP) issue when it says “no one has any idea as to what type of pricing benchmark will succeed it.” What, don’t they read Drug Channels?!? I’ve spent the past three years talking about a few likely candidates, including Wholesale Acquisition Cost (WAC), Average Manufacturer Price (AMP), and cost plus (a la Wal-Mart).

One final thought that has been nagging at me. Pharmacies were apparently not involved in the alleged decision to increase the WAC-to-AWP mark-up from 1.20 to 1.25. But didn’t pharmacies benefit from the allegedly inflated AWPs? I can’t seem to find any motions offering to refund any “overpayments.” I’ll keep looking…


Thanks to the concerned readers who inquired about the lack of posts last week. Alas, I was swamped with (paid) work, including a day testifying as an expert to a jury. I can’t write more about my expert testimony except to say that I had a lot of fun. You may rely on it.

Wednesday, November 12, 2008

CVS Escalates the Generic Price War

Did anyone else notice the recent move by CVS Caremark (CVS) to offer a discount generic program?

Walgreens caved into Wal-Mart last June when it reversed course and started promoting the Walgreens Prescription Savings Club. See my post Walgreens’ $4.33 Surrender to Wal-Mart.

Now it’s CVS pharmacy's turn, but with the added confusion that the company also runs one of the largest mail order pharmacies. If we put aside the spin, the new program sounds like a logical pre-emptive strike against anticipated share losses. Translation: an old-fashioned, race-to-the-bottom price war!

A barrier has been breached with CVS’ entry into the discount retail generics game. Sorry to be the bearer of bad news, but it’s inevitable that this war will suck a lot of margin from the pharmacy and PBM industry over the next few years.


On Monday, CVS launched its new Health Savings Pass, which allows customers to buy 90 day supplies of over 400 generics for $9.99 (after paying an enrollment fee of $10). Tom Ryan said the following on CVSOctober 30 earnings conference call: “Let me be clear, I told you that we haven’t seen a material share loss due to our competitor’s $4 generic program and that’s still the case today.”

OK, let’s assume that he includes all types of retail pharmacy within the definition of “competitor.” So we can conclude that the generic programs of Wal-Mart (WMT), Walgreens (WAG), Kroger (KR), et al are apparently not having a material effect on CVS’ retail sales.

Why give up the generic margin? Mr. Ryan offered the following explanation, which I have parsed into two separate components:

  • “We’re in the middle of an understated [sic] difficult economic crisis to say the least. People are struggling with healthcare costs more than ever before especially the under and un-insured. We felt it was the right time to offer a differentiated affordable option.”
  • Given the enrollment fee and the fact that we expect some share gain and increased foot traffic we think the RX Health Savings Pass shouldn’t cost us more than $0.01 or so per share on an annual basis.”

Sorry, but I don’t follow the logic about market share gains with the uninsured and under-insured in the first statement. Third-party payers represented 95.3% of CVS Caremark's retail revenue in 2007 (per their 10-K). The retail chain has never historically competed on price.

The second statement is more telling. Sure, the enrollment fee will help maintain loyalty as consumers try to amortize the fixed annual cost over their scripts. The $10 per customer will also provide some (non-reimbursement related) cash flow to cushion their loss of generic margin.


Frankly, I’m puzzled by the fit between the new generic program and the legacy Caremark mail order business. Mail order becomes less attractive if a 90-day mail script is the same (or more than!) three 30-day retail scripts. Perhaps CVS Caremark is counting on additional front-end sales to balance out lost mail margin, but I have trouble making the math work. Maintenance Choice, which is apparently gaining some marketplace traction, relies on a similar internal retail-versus-mail profit tradeoff.

I’m curious to hear from Drug Channels readers. What’s happens next in the retail pharmacy industry?

Thursday, November 06, 2008

New Details on WMT-CAT Pharmacy Deal

A just-published article in Drug Benefit News provides new details about the Wal-Mart’s (WMT) $0 generic co-pay program with Caterpillar (CAT). Neal Learner, managing editor of DBN, did a superb job of reporting details on the program that I have not seen in any other publication. Here’s the link: Caterpillar/Wal-Mart Rx Drug Pilot Scraps Use of Average Wholesale Price, Uses Drug Cost-Plus Pricing
Anyone involved in the pharmacy channel – pharmacies, pharmacy benefit managers (PBMs), insurers, payers, drug wholesalers – should be paying attention to the Wal-Mart/Caterpillar arrangement. Pharmacy channel margins on generic drugs will be increasingly seen as a mechanism to control total drug spending. As a result, I expect even more adoption of cost-plus reimbursement models as Wal-Mart continues to challenge the pharmacy industry's traditional economic model.
This arrangement can best be described as a “preferred network” versus an explicitly “restricted network.” Members have a zero-dollar co-pay at Wal-Mart, but can choose to fill their prescriptions at other retail pharmacies for the normal $5 generic copay. See my original analysis of the deal (WMT + CAT: Pharmacy's Future?) for a summary of implications for the pharmacies and PBMs.
AWP is an endangered benchmark. Todd Bisping, pharmacy benefit manager at Caterpillar, describes AWP as a “flawed methodology.” I agree. See my June overview AWP: Dead Parrot or Just Resting? for more.
Wal-Mart’s reimbursement is explicitly cost-plus versus the more traditional list price-minus. The new pricing methodology is “based on Wal-Mart’s actual invoice prices on drugs.” Note that Wal-Mart’s invoice price for generics should generally be below a generic manufacturer’s Average Manufacturer Price (AMP) because of Wal-Mart’s buying power.
Payers recognize that retail pharmacies need to make a profit. Mr. Bisping notes Wal-Mart’s reimbursement includes “some money for their overhead and any margin they have to make.” It’s not clear from the article whether the margin is expressed as a percentage (basis point) mark-up, a fixed dispensing fee per script, or some combination. We also don’t know the magnitude of these profits, although Wal-Mart has been willing to accept lower margins on generic drugs than traditional chain and independent pharmacies. See Wal-Mart Redux.
This program incorporates a new benefit design strategy. Mr. Bisping states: “We felt that by negotiating directly with the pharmacy, that we could make price matter as well as choosing the pharmacy that we think will provide the best service for our employees.” This deal turns traditional benefit design on its head. Normally, those of us with third-party coverage generally pay an identical co-payment regardless of our pharmacy’s efficiency or cost structure. In contrast, the members share in the cost-savings associated with using a lower-cost channel. I explained these economics in January’s post Wal-Mart's PBM Game Plan.
PBMs get disintermediated from an important financial flow. Wal-Mart’s strategy explicitly cuts outs the PBM rather than making Wal-Mart into a PBM. Caterpillar’s PBM (RESTAT) apparently has a fairly transparent pricing model, so there were fewer business issues compared to a traditional PBM.
When generic dispensing rates (GDR) were 20%, payers did not pay much attention to the costs or margins associated with generic drugs. But GDRs are now 70% and rising, which means that pharmacy channel costs and margins will be increasingly seen as a mechanism to control drug spending. The coming wave of generics will focus even more attention on hidden economics of the channel (retail pharmacy, drug wholesalers, and PBM mail order).
Nonetheless, there are some tricky policy and benefit design issues associated with tightening generic margins. You may want to re-read Generic Drug Profits: Too High or Appropriate Incentive?, in which I highlight the powerful economic incentives for rapid generic substitution that are created when the pharmacy channel earns higher profits.
My really tough question remains unanswered: At what level of drug channel profits could payors still encourage rapid generic substitution while not “overpaying” for generics? Wal-Mart seems intent on challenging the pharmacy industry to answer this question in a new way.

Wednesday, November 05, 2008

My 2009 Economic Forecast

Congratulations to President-elect Obama on his impressive and historic victory! Whether you are happy or sad about the outcome, I’m sure you share my relief that the longest presidential election campaign in history is finally over. Only 1,460 shopping days until election day 2012.

As we turn our attention to the year ahead, I want to let you know about my 2009 Economic Forecast for Wholesale Distribution webcast next week on Thursday, November 13, at 2:00 PM EST. Some Drug Channels readers may want to sign up even though the event is not specifically about the pharmaceutical industry.

On this webcast, I will give you a working familiarity with just about every major macroeconomic issue that’s currently in the news. You will also get a 30+ page report with detailed, written commentary on every slide. The event is being supported in part by IBM Corporation.

Some of the topics that I’ll cover include:

  • U.S. Macro Economic Outlook, including GDP and Employment
  • The credit crunch and the bailout
  • Exports, Commodity Prices, and the Dollar
  • B2B Industry Outlook for Manufacturing, Construction, and Retail industries
  • 2009 Forecasts for 19 Wholesale Distribution Sectors (drug wholesalers are one of these 19 sectors)

And now for something completely different

Why am I doing this webcast?

Well, only 75-80% of my time is spent on pharmaceutical supply chain and pharmacy economics issues – consulting, research projects, speaking engagements, litigation expert work, etc. I spend the balance of my time as a business economist/consultant focusing on general supply chain economics for a wide range of business-to-business markets. You can read a sample of my macroeconomics writing on my other (non-pharma) blog:

Of course, you Drug Channels readers are my favorites. Just don’t tell the readers of Distribution Trends!

I’ll return to my regularly scheduled programming in the next post. In the meantime, enjoy the hypnotic ad below and feel free to email me any economic questions that you’d like me to address on next Thursday’s webcast.

Monday, November 03, 2008

Get Ready for Part D Reform

The USA Today published an apparently exclusive analysis last Thursday showing that Medicare drug plan spending drops $6B in 2008, driven by ever-increasing generic dispensing rates. No matter how tomorrow's election turns out, there will be serious reform efforts aimed at the Part D prescription benefit in the coming year despite this good news on costs.

So, how will Part D reform happen? On the eve of the Presidential election, here are some initial thoughts on three likely options for reducing Part D. The impact on manufacturers, insurers, pharmacies, and wholesalers will range from trivial to world-changing, depending on how Part D reform happens.

As a bonus, I’m including a special Presidential election photo of my wife's great Halloween costume at the bottom.


Here are three useful background resources:

It’s especially important to understand that CMS does not pay directly for any drugs nor does it reimburse pharmacies for filling Part D scripts. Instead, CMS pays a monthly per-enrollee prospective payment to plan administrators – stand-alone prescription drug plans (PDPs) or Medicare Advantage Prescription Drug plans (MA–PDs). These plans perform functions similar to, but not precisely the same as, a pharmacy benefit manager (PBM).

One benefit of today’s structure is the choice created with a competitive system with over 1,800 plans. There is substantial variation in deductibles, cost sharing, and coverage in the gap. The biggest perceived downside is the fragmentation of buying power among the many plans.

Senator Obama wants to “Allow Medicare to negotiate for cheaper drug prices” (Source). “Direct negotiations” has a simple, populist appeal that is hard to ignore. But this approach faces an extraordinarily large hurdle because the entire Part D program would have to be reconstructed to make it work. I think the program is too popular and entrenched at this point. Nonetheless, a majority of pharmacists support direct negotiations according to a recent Drug Topics poll.

Keep in mind that Senator McCain is no fan of Part D either, saying recently: “The prescription drug benefit was the wrong solution to the wrong problem.” (Source) He voted against the bill that created the Medicare Part D benefit and is a long-time critic of the pharmaceutical industry. Senator McCain claims not to favor direct negotiations because it would give the government a bigger role in setting prices.


Given the predilections of both candidates and the fiscal realities of Medicare, I believe that Part D will be reformed over the next few years regardless of who wins tomorrow. Here are my pre-election picks for realistic ways that the system will change, from smallest to greatest impact on the drug channels system:

1) Set up a Medicare Part D Rebate Program. The Medicaid Drug Rebate Program requires a drug manufacturer to have a national rebate agreement with the government for outpatient drugs dispensed to Medicaid patients. States can negotiate additional rebate agreements, too. So when “dual eligibles” – beneficiaries eligible for both Medicaid and Medicare Part D – were moved into Part D, manufacturer rebates declined. House Oversight and Government Reform Committee Chairman Henry Waxman (D-CA) highlighted this issue in a July 2008 report called Medicare Part D: Drug Pricing and Manufacturer Windfalls, which claims that the discrepancy in pricing between Medicaid and Part D “produced a windfall worth over $3.7 billion for drug manufacturers in the first two years of the Medicare Part D program.” A Part D rebate program would be much simpler to administer than “direct negotiations” and would be most politically viable by starting with dual eligibles.

2) Create a Government-run PDP. Another option would be to create a Government-run prescription drug program, an idea that I wrote about in November 2006. (See CMS as a PDP: A Part D compromise?) Medicare beneficiaries could have the option, but not the obligation, to enroll in a national plan based on directly negotiated prices. The current system of private PDPs could remain, in effect putting the government into competition with private plans. Two weeks ago, Avalere Health published a framework for thinking through this possibility called Mapping the Route: Approaches to Scoring a Government-Run Part D Plan. It’s a nice piece of work and worth reading for a high-level overview of the benefits and pitfalls of this approach.

3) Use Average Manufacturer Price (AMP) to Control Spending. CMS is currently collecting AMP data from manufacturers for use in the Medicaid rebate program. What if CMS requires Part D PDPs to adopt AMP-based methodologies for pharmacy reimbursement? Or mandates the use of AMP-based Federal Upper Limits (FUL) for both brands and generics in Part D? Long time readers may recall my post Part D + AMP = Trouble from last year. True, there are some AMP hurdles to overcome and the pharmacy industry will fight hard, but AMP would provide private insurers with a logical methodology to limit prescription spending.


I focus on the business impact of public policy in Drug Channels, so I’ll be keeping an eye on these options as they develop. As a brief summary, the first option above would be least disruptive to the pharmacy and drug wholesale industry because it would mirror the Medicaid program. Any additional savings would be paid as rebates and bypass the retail pharmacy supply chain.

The other two options would have much more significant effects. For example, the use of AMP within the Part D program would benefit pharmacies with the lowest cost of operations and a willingness to operate on a cost-plus basis. This is an important part of Wal-Mart's pharmacy strategy and has prompted new announcements by both CVS and Walgreens. More to come later this week.



I’m sure all Americans will appreciate my wife’s excellent Halloween costume, regardless of your political leanings. As you can see, she dressed up as … Tina Fey?