Thursday, December 07, 2017

Five Industry Trends for U.S. Drug Wholesalers in 2018

Modern Distribution Management recently published my article 2017 MDM Market Leaders | Top Pharmaceuticals Distributors. It is an excerpt from our 2017–18 Economic Report on Pharmaceutical Wholesalers and Specialty Distributors.

Below, I republish the section of the article highlighting five significant industry trends affecting the U.S. drug wholesaling industry. I think Drug Channels readers will enjoy this summary as we look toward an eventful 2018. Click here to download a free overview of the full report.

Many of the trends highlighted below have been headwinds for the wholesalers. They may help you understand why H.D. Smith sold its drug wholesaling business to AmerisourceBergen. Note that H.D. Smith did *not* sell its interest in the TripleFin business and Arete Pharmacy Network.


Here are five significant industry trends that will substantially impact the drug wholesaling industry in the coming years. Many of these issues are headwinds for the wholesalers. The profit declines and negative trends partly explain why, when compared with last year’s report, the stocks of the largest public wholesalers are valued at a steeper discount to the overall stock market average.

1) Revenue growth will continue to slow as brand-name drug inflation declines. Profits from brand-name drugs will remain under pressure.

Wholesalers will benefit from growth in demand for prescription pharmaceuticals and the corresponding increase in drug spending.

Wholesalers will gain from the expected price increases of brand-name drugs. However, drug prices seem likely to increase more slowly than they have in the past. Slower growth in brand-name drug prices will be negative for wholesalers, because wholesalers can profit from drug price inflation. (See McKesson’s Profit Shortfall: How Wholesalers Benefit From Rising Drug List Prices.)

The pharmacy market's evolution will continue to pressure wholesalers' sell-side profit margins for brand-name drugs. The U.S. pharmacy industry's market structure for both traditional and specialty prescriptions is now highly consolidated. (See The Top 15 U.S. Pharmacies of 2016.) The top tier of dispensing pharmacies – CVS Health, Walgreens Boots Alliance, Express Scripts, Walmart, Rite Aid and UnitedHealth Group – account for more than 40 percent of wholesalers' combined U.S. drug distribution revenues. These customers provide lower profit margins for wholesalers.

This concentration will likely increase, as evidenced by the Walgreens-Rite Aid transaction and the Prime Therapeutics-Walgreens combination. The retail pharmacy industry has entered a new period of hypercompetition that is forcing pharmacies to reduce their prescription profit margins. (See Latest Data on Pharmacy Market’s Evolution: The Real Story Behind the Retail vs. Mail Battle.) The pressures on pharmacy profits will also force wholesalers to reduce margins to support their customers.

2) Wholesalers' profits from generic drugs will remain below historical levels due to generic deflation and pharmacy negotiations.

Wholesalers' gross margin percentage for generic drugs is much higher than the margin for brand-name drugs. This partly reflects wholesalers' improved bargaining position in the channel. Although wholesaler revenues are linked most closely to sales of brand-name drugs, the majority of wholesalers' gross profits comes from generic drugs.

Over the past four years, prices of generic drugs have been highly volatile. Wholesalers initially profited from generic drug inflation from 2013 to 2015. However, generic deflation, combined with lower gross margins, has significantly reduced wholesalers’ total gross profits from generic drugs in 2016 and 2017. (See Generic Deflation Roils the Channel – And Will Get Worse.)

As we predicted in last year's report, wholesalers experienced significant margin pressure on generic drug sales, because pharmacies required bigger discounts to remain competitive. Independent pharmacies – wholesalers’ most profitable customers – have used their own buying groups to extract wholesalers' reduced buy-side generic costs to be passed down the channel to smaller pharmacies as sell-side discounts. (See Cardinal Health’s Unhappy Profit Surprise: The Coevolution of Pharmacy Buying Groups and Wholesaler Economics.)

3) Wholesalers will be forced to alter conventional pricing and contracting approaches to address profit challenges of specialty pharmacy drugs.

Pharmacy industry revenues are shifting from traditional brand-name drugs to specialty drugs. We project that in 2021, specialty drugs will account for 42 percent of the pharmacy industry’s revenues. (See Our Exclusive 2021 Outlook for Specialty Pharmacy Prescription Revenues.)

Wholesalers face three interrelated shifts in business mix: (1) specialty drugs are increasingly dispensed by a small number of large specialty pharmacies (per The Top 15 Specialty Pharmacies of 2016), (2) specialty pharmacies do not purchase higher-profit generic drugs from wholesalers, and (3) many specialty drugs are being launched by larger manufacturers, which pay lower fees than smaller manufacturers. All three shifts are negative for wholesalers' profits.

Drug wholesalers have attempted to counter the downward margin pressure by raising prices to some specialty pharmacy customers with "net pricing" terms. These reduce the cost-minus discount available to smaller pharmacies and certain other customers.

Wholesalers have also been attempting to alter their distribution service agreements with manufacturers. They want to limit a manufacturer's ability to add new specialty and biosimilar products to existing full-line wholesale agreements.

4) Multifaceted partnerships will secure wholesalers' role with certain channels.

The sometimes underappreciated supply alignment among the largest wholesalers, largest PBMs and largest retail chains has strengthened since the previous edition of our report. Despite the profit pressures described above, wholesalers have secured their role for broadly distributed traditional drugs.

Retail chains continue to shift away from self-warehousing in favor of direct-store deliveries from a wholesaler. As retailers eliminate self-warehousing capabilities, full-line wholesalers become virtually impossible to displace for traditional drugs dispensed by retail pharmacies.

Wholesalers and retailers continue to partner via generic purchasing consortia. We estimate that in 2017, the four largest consortia will account for almost 90 percent of total U.S. generic drug purchases from manufacturers. (See Section 2.3.3. of our new report.) The scale of these combinations has shifted generic purchasing into the wholesale channel, increasing wholesalers' share of generic channel volume. When (if) Amazon enters the pharmacy market, it will likely get started by purchasing via wholesalers.

Wholesalers will also benefit from overall market growth in provider-administered specialty products. The largest group purchasing organizations (GPOs) for physician practices are owned by the largest specialty products distributors. Such ownership creates barriers to direct sales by manufacturers. A distributor with a GPO also has access to multiple discounts, such as the combined value of GPO administrative fees and distributor discounts.

5) Wholesalers will still be unlikely to profit from biosimilars over the next few years.

Biosimilars – biological drugs that are highly similar to an FDA-approved biological product – seem poised to deliver only minimal benefits to wholesalers. Consistent with our analysis in previous reports, we continue to expect biosimilars to deliver only minimal near-term benefits for wholesalers.

During the time since we issued last year's report, the FDA has approved three patient-administered, pharmacy-dispensed biosimilars for sale in the U.S. However, regulatory uncertainty and legal challenges from manufacturers of biological reference products have delayed the launch of these products. We expect that even if these products launch, payers, PBMs and prescribers will control access and product selection. (See What’s In, What’s Out: The New 2018 CVS Health and Express Scripts Formulary Exclusion Lists.) For wholesalers, pharmacy-dispensed biosimilars will therefore have profit and channel profiles akin to those of specialty brands, not those of fully substitutable generic drugs.

Growth in provider-administered biosimilars will be more positive for wholesalers and specialty distributors than will growth in biosimilars covered under a patient's pharmacy benefit. A wholesaler can profit when it can force competition among manufacturers of different biosimilars for the same reference products. However, buy-and-bill reimbursement dynamics will pose barriers to the rapid substitution of provider-administered biosimilars. This will limit these favorable opportunities for wholesalers. (See Remicade: A Case Study in How U.S. Pricing and Reimbursement Curb Adoption of Biosimilars.)

For a deep dive into how wholesalers make money and a look at the latest financial benchmarks, check out our our 2017–18 Economic Report on Pharmaceutical Wholesalers and Specialty Distributors.

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