Thursday, December 06, 2018

Five Industry Trends for U.S. Drug Wholesalers in 2019

Modern Distribution Management recently published my article 2018 MDM Market Leaders | Top Pharmaceuticals Distributors. It is an excerpt from our 2018–19 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 2019. Click here to download a free overview of the full 2018-19 report.

P.S. I’ll be discussing these and other topics next week in my keynote address at CBI's 14th Life Sciences Trade and Channel Strategies. Hope to see you there!

INDUSTRY TRENDS FOR DRUG WHOLESALERS

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. Slower brand-name drug inflation and generic deflation will reduce wholesalers’ profit and could reshape the fundamental compensation models.

Wholesalers will benefit from the expected growth in demand for prescription pharmaceuticals and the corresponding increase in drug spending. However, organic growth in drug distribution revenues appears to be slowing, due partly to slower brand-name inflation and generic drug deflation. Brand-name inflation has slowed significantly since 2014. Brand-name drug prices seem likely to increase even more slowly over the coming years.

A continued slowdown in brand-name inflation will result in a corresponding slowdown in wholesalers’ revenues and profits. Fees from distribution service agreements with brand-name drug manufacturers are still computed as a percentage of a brand-name drug’s Wholesale Acquisition Cost (WAC) list price.

For the past few years, wholesalers’ profits and revenues have also suffered due to deflation in generic drug prices. For 2018, deflation in oral solid generic pills remained relatively steady. We expect that generic deflation will continue but stabilize at a more moderate pace.

2. Wholesalers face unprecedented challenges to their business model, due to scrutiny of channel intermediary margins and the prospect of market disruption from Amazon.

Proposed changes to the pharmaceutical industry could trigger fundamental changes to wholesalers’ business models and compensation structure. (See The Trump Drug Pricing Plan: Short Term Reprieve, Long Term Disruption.) For the first time, a serious government policy effort exists to remove or decrease the reliance on list price as a component of intermediary compensation. (See A System Without Rebates: The Drug Channels Negotiated Discounts Model.)

The ultimate impact on wholesalers is unclear at this time. Some of the factors motivating these political efforts are also making pharmaceutical manufacturers question the current system of wholesaler compensation. It’s not clear, however, whether wholesalers can alter their agreements with manufacturers to maintain equivalent dollar profits if brand price inflation slows or brand list prices decline. See Building a New Drug Wholesaler Compensation Model: What Happens as Brand Inflation Slows?

Since the previous edition of our report, there has been widespread speculation about Amazon’s intentions for competing in the prescription pharmaceutical industry. (See Amazon Buys PillPack: Six Pharmacy and Drug Channel Implications.) We believe that Amazon will not attempt to operate a wholesale distribution company that would sell to other pharmacies. Note that Amazon has made no public announcements about its future plans.

3. Pharmacy industry consolidation continues to pressure wholesalers’ margins, shift revenues among wholesalers, and require wholesalers to make greater investments in smaller pharmacies.

The U.S. pharmacy industry’s market structure for both traditional and specialty prescriptions remains highly consolidated. (See The Top 15 U.S. Pharmacies of 2017: Market Shares and Key Developments For The Biggest Companies.) 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. Larger, more consolidated customers extract deeper sell-side discounts and more favorable terms from wholesalers.

Consequently, wholesalers are investing more to sustain the businesses of smaller, independent pharmacies. The past few years have seen an uptick in expenses associated with wholesaler services for these pharmacies. These services include pharmacy services administrative organizations (PSAOs), which negotiate on behalf of smaller pharmacies with pharmacy benefit managers (PBMs) payers. See McKesson Leads Another Round of PSAO Consolidation.

Pharmacy consolidation has not proved entirely negative for the wholesale industry. It has also created opportunities for wholesalers to become key distribution partners for large retail chains. Wholesalers and retailers have also deepened their relationships via generic purchasing consortia. (See Meet The Power Buyers Driving Generic Drug Deflation.)

4. The specialty pharmacy boom continues to drive the pharmacy industry’s revenue growth and alter wholesalers’ business and pricing strategies.

Pharmacy industry revenues are shifting from traditional brand-name drugs to specialty drugs. We project that in 2022, specialty drugs will account for 47 percent of the pharmacy industry’s revenues.

Wholesalers’ revenues from specialty pharmacy drugs are growing, but this has been a mixed blessing for wholesalers. These products generally have lower profit margins compared with traditional drugs. Market share for dispensing specialty drugs is concentrated with the largest specialty pharmacies—which are also wholesalers’ least profitable customers. (See The Top 15 Specialty Pharmacies of 2017: PBMs and Payers Still Dominate.)

Wholesalers are attempting to alter the downward margin pressure with a variety of strategies, including differential pricing for specialty drugs and attempts to alter manufacturers’ channel strategies. See A Lesson from McKesson: How Specialty Pharmacy Growth Is Hurting Wholesalers.

5. The buy-and-bill market is still a bright spot for wholesalers, though vertical integration and regulatory changes have created an uncertain outlook for these segments.

Specialty distributors and full-line wholesalers are still the main channels for provider-administered drugs. Over the past 10 years, however, wholesalers have had to adapt as care has shifted from community physician practices to hospital outpatient facilities.

Vertical integration between hospitals and physician practices has eroded specialty distributors’ business with community-based physician practices. (See Specialty Distributors’ Customer Mix Changes As Physician Buy-and-Bill Fades.) Acquisitions of physician practices are shifting care from community practices to hospital outpatient facilities. (See Updated Part B Data: Hospitals Are Displacing Physician Offices Even Faster Than We Thought.)

The U.S. Department of Health & Human Services (HHS) has begun to implement policy options that will affect the Medicare Part B program. These policies will have mixed impacts on drug wholesalers.

The biosimilar market remains underdeveloped, limiting wholesalers’ ability to profit from biosimilars over the next few years. (See Remicade: A Case Study in How U.S. Pricing and Reimbursement Curb Adoption of Biosimilars.) Consistent with our analysis in the previous edition of this report, we expect that biosimilars will deliver minimal benefits for wholesalers within the next few years.

For a deep dive into how wholesalers make money and a look at the latest financial benchmarks, check out our 2018–19 Economic Report on Pharmaceutical Wholesalers and Specialty Distributors.

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