Wednesday, December 02, 2009

Will Caterpillar trigger a pharmacy price war?

Here’s a follow-up thought to CAT Rolls Out Preferred WAG-WMT Pharmacy Network.

Will Caterpillar (NYSE:CAT) allow Wal-Mart (NYSE:WMT) and Walgreens (NYSE:WAG) to compete on price within the network?

If so, Caterpillar will reap even bigger savings than initially projected at the expense of pharmacy profits at Wal-Mart and Walgreens.

Why? As Caterpillar rolls out its preferred pharmacy network, it seems clear that almost all of the prescription drug market share will be split between Wal-Mart or Walgreens.

Consider two scenarios.

Scenario A: If the co-payments charged by a Participating Provider are fixed by contract, then there will be no price competition. Wal-Mart and Walgreens will compete on service, convenience and location. This is the traditional pharmacy industry model.

Scenario B: A Participating Provider can opt to charge lower co-payments in a bid to attract incremental traffic. The in-network co-payments are simply maximum amounts—Caterpillar Upper Limits (CUL), if you will.

If this is a CUL model, then fans of game theory (anyone?) will recognize a classic two-player Prisoner’s Dilemma with two basic strategies:

  • Cooperate (Don’t Discount Co-Payments)
  • Defect (Discount Co-Payments)
In the simplest version of the game, each company fares best in cell A. (Click to enlarge the figure.)

Either company can improve its market share position by discounting the co-payments, but at the cost of reduced per-prescription revenues (shown as “$ per Rx”). If only one company discounts (no competitive reaction), then it wins market share at the expense of the other but only has to discount a little bit as shown in cells B and C.

The dilemma is the temptation to defect, pushing both companies into cell D.

Given Wal-Mart’s historical behavior in retail markets, what do you think will happen?

How will Walgreens react? Here's an eye-catching quote on the future of cost-plus, direct-to-payer deals (source).

Hal Rosenbluth, president of Walgreen’s health and wellness division, said he’s discussing similar deals with about 50 companies. “It’s a new model,” he said. “What you lose in margin, you make up in volume.”


  1. Game over. Between the commoditization of generics to drive overall store volume and this net pricing solution, patient choice by quality of service and the incentive to provide proactive clinical patient services is dumped in the dust bin.

    Note this Q&A from CAT.

    17. I count on my local pharmacist to answer questions and provide direction and
    advice on my prescriptions, especially new ones that I am unfamiliar with. How
    do I know I will get the same quality customer service at a Walmart or Walgreens
    Walmart’s and Walgreens’ pharmacists are held to the same professional standards as
    all other pharmacists. If you ever have questions or need advice, they can assist you.

    I guess all pharmacists, doctors, hospitals, are equal because they are held to the same professional standards. NOT.

    A recent discussion with a district manager for one of the above-mentioned pharmacy chains around the under/over-supply of pharmacists (answer – Over): When coupled with the cost-cutting (read understaffing) that will result from the future price war you discuss in your piece...the logical conclusion is that pharmacists at those chains, or for that matter, all dispensing pharmacists should run for cover.

    With all the "fat" wrung out of the system, it’s likely that the retail model of pharmacy practice as we know it will soon be dead. I'm already thinking out alternatives as I see the steadily eroding operating margins in my independent practice threaten our very existence. There will likely be some very lean years until new models (e.g. clinical pharmacist at group medical practice sites) takes hold. The shame is that the dispensing function provides an excellent opportunity to work on patient training and adherence counseling. A decoupled service looses that frequency of contact.
    PS When retail goes, so goes the PBM model.

  2. Wow, very thought provoking post. Nicely done.

  3. Adam, not so fast....

    For years and years every 3rd party contract would have a clause which would discuss how the discounting of copays was forbidden. And this was not just within the pharmacy world.

    Anticompetitive? Maybe...but the thought behind the payor community was that by discounting the copays would lead to increased utilization and bingo. And ultimately more costs are brought upon the group with these programs.

    Sure, there have been a few providers who push the envelope and have programs to get around the discounting copay regs, such as buy 10 Rx's and get a free turkey on your 11th...or the like.

    Yet overall, the big national guys have followed the no discounting copay parameters, and simply have given up the margin on the AWP discount or dispensing fee side.

    I could be wrong, but I don't envision this happening.

    Take care.

  4. I agree with "not so fast."
    I thought the copay was already at zero for in-netork generics.

    Caterpiller will not allow them to lower copays on non-prefered high cost tier 3s and even tier 2s are questionable as it erodes the patient incentive for free low cost generics which is Caterpillars goal.

    Please clarify if I am missing something.