Thursday, November 12, 2015

Drug Prices, Manufacturer Rebates, and the Risk to Channel Economics

Here’s a Drug Channels Zen koan for you: When does a price increase not increase the price?

This riddle came to me while reviewing the excellent new Pharmaceutical Research and Manufacturers of America (PhRMA) slide deck called Prescription Medicines: Costs in Context. (Free download.) The slides argue—persuasively, I believe—that pharmaceuticals have been undervalued as a source of health benefits and unfairly maligned as the key driver of costs.

One important slide, reproduced below, is definitely worth your time. Despite the growth in drug list prices, manufacturers are experiencing limited growth in net revenues, which deduct payer rebates. As the data show, this difference has grown sharply over the past two years. I also present data from a separate Medicaid analysis, which tells a similar story.

Meanwhile, drug list price increases are boosting revenues at drug channels companies—pharmacies, wholesalers, and PBMs. These intermediaries are still compensated on gross (not net) revenues. I wonder: Will the growing gross-to-net disparity make current channel economic arrangements unsustainable for wholesalers and pharmacies?


The chart below appears on page 25 of the new PhRMA deck. It shows a growing gap between invoice price growth and net price growth. In 2014, for example, invoice prices rose by $26.3 billion, up by 13.5%. Manufacturers’ sales rose by only $10.3 billion, or 5.5%. The growing divergence between the blue and green bars indicates that manufacturers are retaining a smaller share of their price increases.

[Click to Enlarge]

A new Medicaid and CHIP Payment and Access Commission (MACPAC) report provides further evidence of growing gross-to-net disparity in the Medicaid program. In 2014, Medicaid was the fastest-growing payer of outpatient prescription drugs.

Check out the instructive chart below from MACPAC’s Trends in Medicaid Spending for Prescription Drugs presentation:

[Click to Enlarge]

In this chart:
  • Gross Expenditures = payments to pharmacies
  • Net Expenditures = payments to pharmacies minus federal and state supplemental rebates
For 2014, Medicaid’s gross fee-for-service spending on prescription drugs was $21.4 billion. Net spending, however, was only $8.0 billion—a 63% discount from gross spending. Over time, the discounts have grown larger. In 2007, net spending was only at a 33% discount from gross spending.


The PhRMA slide deck highlights the factors driving the growing gross-to-net disparity. Here’s my summary of the four most important points:
  • PBM consolidation. About three-quarters of all store-based retail prescription claims are now processed by three pharmacy benefit managers (PBMs): Express Scripts, the Caremark PBM business of CVS Health, and the OptumRx business of UnitedHealthcare. Bigger PBMs can drive a harder bargain for formulary position.
  • Generic drugs. In 2014, the generic dispensing rate (GDR)—the percentage of prescriptions dispensed with a generic drug instead of a branded drug—was 88%. (This figure includes branded generics.) Even when a traditional brand doesn’t have a generic equivalent, there are often multiple therapeutic alternatives that are generic products.
  • Deeper mandatory discounts. The Affordable Care Act increased a pharmaceutical manufacturer’s mandatory Medicaid rebates. For single-source (non-generic) drugs, the Unit Rebate Amount (URA) increased, from 15.1% of a product’s average manufacturer price (AMP) to 23.1% of its AMP. AMP was also redefined in a way that likely increased its value. (FYI, AMP is still TBD.) 


The PhRMA and MACPAC reports highlight an intriguing challenge to conventional channel economics.

Within the U.S. distribution and reimbursement system, manufacturers’ rebates to PBMs and other third-party payers do not flow through wholesale or retail channels. The key transactions for brand-name drugs are based on the Wholesale Acquisition Cost (WAC) list price, not net selling price. Distribution channel participants don’t even know the true net price (after third-party payer rebates) of a brand-name drug.

Consider a manufacturer’s relationships with its wholesalers. As I discuss in How Wholesalers Profit from Brand-Name Drug Inflation (But Perhaps Not As Much As You Think), drug makers generally compute fees as a percentage of a brand-name drug’s list (gross) price.

Let’s say that a wholesaler earns fees equal to 3.0% of a manufacturer’s gross sales. For products paid by Medicaid, the manufacturer’s net price will be 63% below this gross price. In this scenario, this fee equates to 8.0%* of net sales—more than two and half times the fee computed on gross sales.

Similarly, pharmacies are typically reimbursed for brand-name prescriptions using methodologies based on list prices, such as the “average wholesale price (AWP) minus” approach. Is it appropriate for pharmacy gross margins to be computed as a percentage of a drug’s list price, when the payer is paying much less for the drug? Using the Medicaid figures, a pharmacy’s brand-name prescription gross margin of 5.0% equates to more than 13% of the drug’s net price.**

Now imagine the fees and margins for a product purchased by a 340B-covered entity at penny pricing, i.e., a nearly 100% discount. Yikes!


Drug list prices are under incredible public scrutiny, even as manufacturers offer deeper behind-the-scenes discounts. I wonder if the growing gross-to-net disparity will ultimately upend the conventional channel arrangements.

Alas, I don’t have the answers today. As Master Oogway once said: “Yesterday is history. Tomorrow is a mystery. Today is a gift. That's why it is called the present."

* For math nerds: 3.0% ÷ [8.0/21.4] = 8.0%
** More nerdery: 5.0% ÷ [8.0/21.4] = 13.4%

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