Wednesday, June 11, 2014

Profits in the 2014 Fortune 500: Manufacturers vs. Wholesalers, PBMs, and Pharmacies

Time once again for my annual review of the latest Fortune 500 list. These data will help you “follow the dollar” and understand how drug channel intermediaries make money.

Below, I explore the profitability and shareholder returns of the largest drug wholesalers, chain pharmacies, pharmacy benefit managers (PBMs), and pharmaceutical manufacturers. Thanks to consolidation, the 2014 Fortune 500 list contains only eight drug channels companies—AmerisourceBergen, Cardinal Health, CVS Caremark, Express Scripts, McKesson, Omnicare, Rite Aid, and Walgreens.

Below are my five observations from comparing these companies with the Fortune 500’s 12 pharmaceutical manufacturers and a separate survey of independent pharmacies. So, buy a vowel and enjoy a spin on Drug Channels' Wheel of Fortune 500!


Here's our exclusive Drug Channels summary of the eight drug wholesalers, drugstore chains, and PBMs on the 2014 list.

[Click to Enlarge]

Here’s a companion table of the 12 largest pharmaceutical manufacturers on Fortune's 2014 list.

[Click to Enlarge]

Methods and sources are at the bottom.

OBSERVATION #1: Drug Channels companies are bigger than manufacturers.

Drug channel companies have higher revenues than pharmaceutical manufacturers, so they rank higher on the Fortune 500.This results from quadruple-counting of prescription revenues within the channel.

In 2013, median revenues for the eight drug channel companies were $95.1 billion, up 1.4% vs. 2012. Median revenues for the manufacturer group were $17.5 billion.

Six of the drug channel companies rank in the top 50 of the Fortune 500 list, while the highest ranking manufacturer (Johnson & Johnson) reached only #39. The revenues of the 12 largest pharmaceutical manufacturers on the Fortune 500 list range from $67.2 billion (Pfizer) to $5.5 billion (Celgene).

Note that the Fortune 500 rankings are based on sales revenues, which artificially inflates the topline of a channel participant. Here's a reminder of how single prescription can hypothetically be counted as revenue by four different Fortune 500 companies:
  • Manufacturer A sells a pallet of WonderDrug to Wholesaler B. Manufacturer A reports the net revenue from the sale on its income statement.
  • Wholesaler B sells a case of WonderDrug to Pharmacy C. Wholesaler B reports the net revenue from the sale on its income statement.
  • Pharmacy C dispenses a WonderDrug prescription to a patient. Pharmacy C is reimbursed via a combination of the patient's copayment and reimbursement from PBM D. Pharmacy C reports the revenue from the prescription on its income statement.
  • PBM D reports the reimbursement paid to Pharmacy C as "Network Revenue" on its income statement.
OBSERVATION #2: Drug channels companies have much lower return on sales.

When their profits are measured by Return on Sales, profits of wholesalers, PBMs, and pharmacies are a small fraction of manufacturers’ profits. But when these profits are measured by Return on Assets, channel company profitability is about one-quarter that of pharmaceutical manufacturers.

As you can see in the table above, Return on Sales (ROS; profit as percent of revenues) was in the low single digits for all companies in this group, regardless of their position in the channel (pharmacy, wholesaler, or PBM). In 2013, the average ROS for the Drug Channels group was a mere 1.3%, a decline from 2012's average of 1.5%.

In 2013, the drug manufacturers’ average profit as a percentage of revenues was a much more robust 21.4%. Thus, the ROS for the manufacturers was more than 16 times the ROS for drug channel companies.

OBSERVATION #3: When measured by Return on Assets, drug channels companies’ profitability looks much better.

ROS is a flawed measure of profitability for channel intermediaries due to the revenue double-counting. A more meaningful metric is Profits as a % of Assets, a.k.a., Return on Assets (ROA).

ROA relates ROS to the balance sheet assets required to generate an income statement profit. The biggest part of a drug channel company's balance sheet is current assets (cash, product inventory, or accounts receivable). For example, the value of product inventories and accounts receivables are more than 80% of the big three wholesalers’ current assets. (See Exhibit 34 of the 2013-14 Economic Report on Pharmaceutical Wholesalers and Specialty Distributors.) In contrast, the biggest assets of a pharmaceutical manufacturer tend to be long-term, such as intangible assets, goodwill, and physical plant, property and equipment.

The profitability of companies in the Drug Channels universe looks much more attractive this way. In 2013, the group median was 2.9% (range: -0.6% to +6.4%). In a refreshing change, Rite Aid did not have a negative ROA. Congrats!

The ROA figures for drug channel companies now look closer to those of the pharmaceutical manufacturers, whose median profit as a percentage of assets was 10.6% in 2013. The manufacturer-to-channel ratio is only 3.2X for ROA, which is a higher than last year’s ratio.

The difference reflects partly the innovation/risk premium associated with the expensive, risky, and time-consuming business of drug discovery. Pharmacies, wholesalers, and PBMs wouldn’t exist unless manufacturers created valuable and innovative drugs.

OBSERVATION #4: Independent pharmacies have higher profitability than the eight largest drug channels companies, including PBMs.

The 2013 NCPA Digest provides the following data for independent pharmacies in 2012 (the most recent year available):
  • Average ROS = 2.9%
  • Average ROA = 14.2%
Private pharmacies don’t manage based on the same return metrics as a public company. However, the independent pharmacy data continue to show a Profit as a % of Assets exceeding that of the public companies.

OBSERVATION #5: In 2013, investors made more money from Drug Channels companies.

In a reversal of recent trends, investors earned higher returns from the drug channels groups than from drugmakers. The drug channels group also outperformed manufacturers over the past 10 years.

Investment returns reflected last year's strong stock market performance. Here is the median Total Return to Investors in 2013 as reported from Fortune's list:
  • 8 Drug Channels companies: +65.8% (range: +30.1% to +272.1%)
  • 12 Drug Manufacturers: +34.8% (range: +7.3% to +115.3%)

  • For consistency, all data are taken from Fortune's measurement of key financial metrics. A link to the methodology appears on the Fortune 500 main page. (Sorry, no direct link.)
  • I include only those drug channel companies that earned a majority of their revenues from pharmaceuticals. This criterion excludes other retail formats with pharmacies (supermarkets and mass merchants). I do not separate the revenues from each company's various lines of business.
  • Using data from the 2013 NCPA Digest, the ROA for independent pharmacies is computed as: Average Operating Income / Estimated Average Total Assets.
  • Warning: The new Fortune 500 list is a quirky web 3.0 site that doesn’t work well on Chrome, now the most popular web browser. Thanks, clueless 22-year old web designers!


  1. Dr. Fein,
    Thanks for this summary and analysis. I have a question regarding using the methodology of comparing profitability as a function of assets between different types of businesses.

    For example, in 2013 WAG reports $72B in Revenue, $2.45B in Profits, and holds $35B in Assets (approximately $2B reported as goodwill). Whereas, ESRX reports $104B in Revenue, $1.85B in Profits, and holds $53.5B in assets (approximately $29B as goodwill and another $14B reported as other intangible assets, in other words ESRX estimates $43B worth of value from estimations from its contracts, etc.). Since the publicly available data that is reported in the annual 10K is limited, it is hard to break down how WAG and ESRX evaluate their asset values. While it may make sense for WAG to calculate inventory and value of their 7k pharmacies, it is harder to understand how ESRX assigns the asset value for their contracts. Do they estimate the value based off what they could sell each contract for? Do they assign a value based on the number of members in the contract?

  2. Here's what Express Scripts says about intangible assets (a href=''>from page 38 of its 2013 10-K):

    "Other intangible assets include, but are not limited to, customer contracts and relationships, deferred financing fees and trade names. Deferred financing fees are recorded at cost. Customer contracts and relationships are valued at fair market value when acquired using the income method. Customer contracts and relationships related to our 10-year contract with WellPoint, Inc. (“WellPoint”) under which we provide pharmacy benefit management services to WellPoint and its designated affiliates (“the PBM agreement”) are being amortized using a modified pattern of benefit method over an estimated useful life of 15 years. Customer contracts and relationships intangible assets related to our acquisition of Medco are being amortized using a modified pattern of benefit method over an estimated useful life of 2 to 16 years. The customer contract related to our asset acquisition of the SmartD Medicare Prescription Drug Plan is being amortized over an estimated useful life of 10 years. All other intangible assets, excluding legacy ESI trade names which have an indefinite life, are amortized on a straight-line basis, which approximates the pattern of benefit, over periods from 5 to 20 years for customer-related intangibles, 10 years for trade names and 2 to 30 years for other intangible assets."

    That's perfectly clear, right?

  3. To paraphrase Jack Nicholson's character in "A Few Good Men" that is crystal clear, LOL.

    I only have a limited accounting background and experience with GAAP, but I do know enough about accounting to know how business can legally manipulate accounting for their benefit. For the sake of debate I pose the question:

    "What are other ways to measure the winners/losers in drug channels?"

    Your points about independent pharmacies are absolutely right, an independent pharmacist can show a "loss" but actually pay him/herself a huge bonus and write off as part of wages. Also, your points about NCPA's methodology of assessing self-reported survey data make it very tough to say how well independents are doing. However, given the numbers that we have available (NCPA digest and Fortune 500 lists based on publicly available data) it appears on a ROA basis, Independent pharmacists are doing better than drug channel companies.

    (PS: I really love your blog, definitely helps spur discussion and debate around pharmacoeconomics)

  4. Huh?

    "PBM D reports the reimbursement paid to Pharmacy C as "Network Revenue" on its income statement."

    Really? That doesn't sound correct at all. PBM D gets money (their revenue) from Plan Sponsor E (who could be Manufacturer A, Wholesaler B, Pharmacy C or PBM D or someone else) and Manufacturer A. What's paid to Pharmacy C would be an expense or COGS depending on how they categorize the different parts of the payment.

  5. Sorry, Seedy, you are wrong.

    From Express Scripts' 2013 10-K, page 40:

    "Revenues from the sale of prescription drugs by retail pharmacies are recognized when the claim is processed. When we independently have a contractual obligation to pay our network pharmacy providers for benefits provided to our clients’ members, we act as a principal in the arrangement and we include the total prescription price (ingredient cost plus dispensing fee) we have contracted with these clients as revenue, including member co-payments to pharmacies."

    Same for Caremark.

  6. Sorry Adam, you're wrong. You're misinterpreting that statement. They're telling you WHEN they recognize the income, not where it's from. The sale "by a retail pharmacy" creates a liability for their client and they recognize that revenue at that point in time. (Instead of recognizing it when they finally get the check from Plan Sponsor E.)

    Also, it's a bit misleading to count co-payments as revenue when that money never passed through their fingers...

  7. I'm not arguing for or against the accounting treatment of these revenues. I'm telling you what's really going on. A PBM includes revenues paid to "network pharmacies" as part of its revenues, when the claim is paid.

    Check the Express Scripts 10-K, page 42. In 2013:

    - Network revenues (Includes retail pharmacy co-payments) = $63.2 B

    - Home delivery and specialty revenues = $37.6 B

    'nuff said.

  8. Not 'nuff said.

    You're (any the PBMs in the 10-K) saying (maybe implying is a better term) that their revenue is coming from "network pharmacies" and it is not. Think about it, Express Scripts collected $63.2B from network pharmacies? Not likely. They collect that from their clients, the plan sponsors.

    From ESI 10-K pg 36: "We earn tangible product revenue from the sale of prescription drugs by retail pharmacies in our retail pharmacy networks..."

    But that doesn't mean that they collect revenue from their "retail pharmacy networks". They're just reporting the sequence of events that lead to revenue.

  9. Sigh.

    That's what I say in the article above: "PBM D reports the reimbursement paid to Pharmacy C as 'Network Revenue' on its income statement."

    My statement is accurate, especially as a way to understand the Fortune rankings. I still don't know why you have been debating my original statement.

    I let the conversation continue to educate other readers. There's nothing else to say. It is what it is.