The Part D direct negotiations movement

Last Thursday, House Democratic Leader Nancy Pelosi and other senior House Democrats asked for a floor vote on direct negotiations between the US government and drug manufacturers for Medicare Part D. (Read the press release here.) The Senate rejected similar amendments to the Medicare act last November by a 51-48 vote and in March 2005 by 50-49.

The Democrats are making Part D “reform” into a major theme of the 2006 elections. Our charter at Drug Channels includes examining the effects of policy on the pharmaceutical supply chain, so I’ll defer comment on the political angles.

Nevertheless, a direct negotiations scenario is certainly possible. This shift could have dramatic consequences for manufacturers in the areas of channel strategy, pricing, and trade account management. Wholesalers, retailers, and PBMs should also be paying close attention to the strategic business implications as the “cost of the channel” becomes more prominent and visible.

A Direct Negotiations Scenario
Let me sketch a few factors (beyond political posturing) that could favor a direct negotiations scenario:

• The government will be paying almost half of the entire US prescription drug budget within a few years via Medicaid and Medicare. Yikes!
• The tab for Part D, an unfunded expenditure from general revenues and premiums, is likely to force some uncomfortable trade-offs among non-entitlement budget spending. According to the 2006 Medicare Trustees Report, Part D costs are projected to increase at an average annual rate of 11.5 percent from 2006 to 2015.
• A steady drumbeat of research studies (Example One and Example Two) purport to show how much could be saved with direct negotiations. (No hate mail, please – these are examples, not endorsements.)
• A Democratic Congress and/or President Hilary Clinton

I assume that you agree that we can assign a non-zero probability to the direct negotiations scenario.

How much should we pay for the drug channel?
Currently, pharmacy reimbursement levels for Medicare Part D are determined by the marketplace through network contracting negotiations between pharmacies and Medicare PDPs, not set by CMS.

I believe that a direct negotiations scenario will migrate CMS Part D reimbursement to an “average price plus” model. In my post from early May, I noted that government reimbursement for pharmaceuticals is moving away from “discount off list” (AWP minus). Consider:

• Medicare Part B now reimburses outpatient drugs to providers at Average Sales Price (ASP) plus 6 percent.
• Starting in January, Medicaid’s reimbursement to retail pharmacy for generic drugs will be the to-be-defined Average Manufacturer Price (AMP) plus 250 percent. (See my June 8 post for more on AMP.)

Key point here: An “average price plus” model does not claim to measure actual pharmacy or provider acquisition costs for drugs. Instead, these models use actual manufacturer transaction prices plus a drug channel cost factor. Dr. McClellan voiced his support for these models in his comments to last summer’s OIG comparison of AMP to AWP and WAC. (See pages 24 to 26 of this OIG report.)

Some uncomfortable questions
It’s beyond the scope of my blog to write about all of the strategic implications here. (Hey, that’s my real job!) But here are a few questions to ponder:

1. A “price plus” approach effectively caps the total compensation that can be earned by wholesalers, retailers, providers, or anyone else handling the product after it leaves the manufacturer’s factory. Who will win if wholesalers and retailers begin competing for the fixed (and probably lower) channel margin?
2. Prescription pharmacy is 69% of CVS’ revenue and 66% of Walgreen’s revenue, making the government responsible for at least a third of top line at the biggest chains. Will this accelerate pharmacy consolidation, reduce margins, or both?
3. The next round of fee-for-service negotiations will be coming up in the next 18 months. How much will/should a manufacturer compensate the drug channel to perform activities that become uneconomic in a “price plus’ reimbursement model?
4. How will the relative attractiveness of alternate distribution models, such as third-party logistics providers, change once drug channel margins are subject to more scrutiny?

Direct negotiation is just a scenario – for now.

P.S. A few people wrote to ask me about the meaning of disambiguation, which I used in the title of my last post. For the record, disambiguation means “clarification that follows from the removal of ambiguity.” See? This blog really does make you more perspicacious!

Superb disambiguation from the Washington Times

I bemoaned the truthiness of last week’s Senate vote on importation in my last post.

As a follow-up, read this great editorial from today's Washington Times called “Counterfeit drugs and border security.” My favorite sentence:

“Banning Customs enforcement is tantamount to giving terrorists a free pass to flood America with fake and dangerous drugs.”

Sadly, that statement is all too true.

Cosmic irony in the drug supply chain

Last week provided cosmic irony of epic proportions for anyone concerned about the safety and security of the U.S. pharmaceutical supply chain.

Let’s begin on solid ground. On Tuesday, the Congressional Subcommittee on Criminal Justice, Drug Policy and Human Resources (or CSCJDPHR, to its friends) held another hearing on pharmaceutical supply chain security. (Written testimony is available for your reading pleasure here.)

The following quotes caught my eye:

1. Kevin Delli-Colli, Deputy Assistant Director, Financial & Trade Investigations Division, Office of Investigations, U.S. Immigration and Customs Enforcement, Department of Homeland Security (Wow – he must have an extra large business card!) said: “To date, ICE investigations have not revealed any instances in which smuggled, counterfeit pharmaceuticals were destined for the legitimate U.S. supply chain; rather, trafficking organizations have created an illicit, unregulated supply chain that is filled with counterfeit, adulterated, misbranded and unsafe drugs which are distributed directly to consumers, who in most instances are drug abusers.”
   
2. Carmen A. Catizone, Executive Director of the National Association of Boards of Pharmacy noted “…the reckless actions of local, state, and federal public officials who ignore public health and safety in order to promote the illegal importation of drugs as a item of political pandering.”

But on the very same day that this evidence-based testimony was being heard, the U.S. Senate voted 68-32 to make it easier for Americans to import cheaper prescription medications from Canada.

Huh?

The Senate exhibited the worst kind of truthiness* when it deliberately avoids troublesome facts about the dangers of personal importation. Even more ironic is the fact that Part D is already displacing Canada, as evidenced by Minnesota’s illegal importation program.

Sometimes I really get scared about the way that policy gets made in this country.

* For those who have never seen Stephen Colbert, truthiness is defined as “…the quality by which a person purports to know something emotionally or instinctively, without regard to evidence or to what the person might conclude from intellectual examination.”

A busy week for wholesalers!

Wow! This turned out to be a big news week for your friendly neighborhood pharmaceutical distribution expert. The big three wholesalers all made interesting business moves. A few highlights:

• McKesson sells its acute care (hospital) distribution business to Owens & Minor. Not a surprise given previous announcements, but does make me wonder if their alternate site/physician business next?
  
• AmerisourceBergen acquires another Canadian wholesaler. I had the pleasure of speaking on “The Future of Independent Pharmacy” at ABC’s trade show in sunny Las Vegas this week. (Regrettably, I had to fly like an eagle and missed the Steve Miller Band’s performance on the final night.)
  
• Cardinal Health announces an agreement to manufacturer Tamiflu, then takes a page from McKesson’s playbook and buys a small healthcare technology company.
  
• More intriguingly, Cardinal quietly filed an 8-K announcing a $395 million share repurchase from “an unaffiliated third party.” This share repurchase is part of a new $500 million share repurchase program approved Board on June 28. (They bought back $500M in Q2.) While I can’t tell you what this means for the stock price, it does strike me as an admission that the company is not yet ready to invest in some of its underperforming businesses. Big divestitures to come?

IMO, 2007 will be a make-or-break year for drug wholesalers. I’ll post as news develops, but please feel free to email me comments or questions anytime.

P.S. Watch out for wholesaler earnings, coming soon (ABC: July 25; MCK: July 27; CAH: August 3).

Another $0.02 on Pedigree and Generics

Here's some follow-up to my two most recent posts on pedigree and generic competition.

H.B. 371 signed by Gov. Bush (posted June 27)

As predicted, the Florida press is spinning Gov. Bush’s move as a blow to supply chain security. (Readers of this blog know that I disagree.) I'm actually a bit surprised by the muted responses given the hyperventilating editorials that were written after HB 371 was modified. Anyway, here are two articles:

“Tough drug law may lack teeth,” Orlando Sentinel

“Gov. Bush signs bill weakening safeguards against fake drugs,” Sun Sentinel

Winners and Losers in the Zocor Wars (posted June 25)

As reported in the Wall Street Journal, Pfizer plans to zocor its generic competitors by lowering the price of branded Zoloft upon patent expiration. Pfizer also announced that they will pursue a similar strategy in Switzerland.

To me, these actions suggest a new era of brand/generic competition. A 1998 CBO study found that the average market share of 21 generic drugs launched from 1991 to 1993 was 44% after one year.

Tempus fugit. Blockbuster generics now get 80%+ substitution within one month. Consider this example from Medco’s latest drug trend report:

“Allegra is a widely used nonsedating antihistamine with market sales of $1.3 billion in 2004. By October 2005 (the first full month following generic availability), the brand-name product lost 84% of its overall market share to the new generics—81% at retail
and 95% at mail.”

In other words, PBMs are shortening the life cycle for branded drugs, thereby lowering total drug costs for payers and generating higher incremental profits for themselves (see my previous post).

Here's the irony – brand manufacturers paid rebates to PBMs of more than $6 per prescription in 2003 (per the FTC report). Sure, a majority of those payments get passed back to payers. Manufacturers' newfound aggressiveness on generic pricing is a clear signal that PBMs remain the true power players of the drug channel.

Now, if only I could figure out how to get these (censored) snakes off my (censored) blog...

H.B. 371 signed by Gov. Bush (UPDATED)

H.B. 371, the controversial bill that modifies Florida's pedigree law, was signed by Governor Bush today. Despite all of the hyperbole, H.B. 371 actually brings Florida closer to the requirements of the PDMA, which takes effect on December 1. (See my previous post for more on the FDA’s PDMA decision.)

The altered pedigree requirements of HB 371 may not make good local news sound bites, but they make good supply chain sense. Manufacturers will need to take greater responsibility for monitoring and protecting their products. This will be a boon for channel commerce vendors, but unpleasant news for pedigree and RFID companies.

What Really Happened in Florida

Basically, products moving through a one-step channel (Manufacturer-Wholesaler-Customer) are subject to different pedigree requirements, while products moving through a two-or-more step channel (Manufacturer-Wholesaler-Wholesaler-Customer) will require a standard pedigree with lot number, transaction dates, etc.

Narrowing the scope of full pedigree makes it more likely that we can catch the bad guys. A fundamental rule of economics is that life is full of tradeoffs. While theoretically desirable to track every product all the time, the time and attention devoted to the effort would take focus away from the real problems in the secondary market. (If you slept through your college Econ 101 course, I recommend Gregory Mankiw’s Principles of Economics featuring his classic “Ten Principles of Economics.”

Frequent flyers in an airport security line have probably thought about tradeoffs. I personally fly almost 150,000 miles per year. I buy tickets with a corporate credit card. I’m happy to put my luggage through the x-ray machine and walk through metal detector. But think about it: every minute that TSA spends making me take my shoes off or pulling me aside for special screening is a minute that will not be spent searching more likely suspects.

Why doesn’t the TSA let me submit to additional “licensing” each year so that I can avoid the indignity of the shoe removal? In a nutshell, that’s what H.B. 371 does for the drug supply chain. Wholesalers in the one-step channel now submit to more stringent licensing and certification requirements, but are presumed innocent for the purposes of pedigree. In other words, they still have to walk through the metal detector but no longer have to remove their shoes.

Winners and Losers

The extra costs and burdens of a two-or-more step channel provide an incentive for more direct purchases from manufacturers. If other states adopt the Florida HB 371 approach (or just accept the PDMA standard), then more volume will be flowing through the one-step channel. So, either:

• The large wholesalers (MCK, CAH, ABC) will pick up volume from (secondary) physician distributors such as PSS and Henry Schein, which have small volumes of Rx product in their mix, or
• Manufacturers will compensate wholesalers for fulfillment to secondary distributors --another area of possible margin expansion for wholesalers.

OTOH, the effect could be negative if manufacturers begin selling directly to more distributors. This may happen in some situations, but most pharma manufacturers do not want to handle too many more customers. [ADDENDUM: PSS World Medical just announced their intention to buy more products directly.]

As a result of the legislative changes, manufacturers will also have a greater responsibility to monitor this one-step wholesaler channel. The big winners from this approach will be channel commerce software vendors such as Edge Dynamics, which can turn wholesaler data about order flow, inventory levels, and customer shipments into actionable product security monitoring. (Fee-for-service agreements compensate wholesalers for providing data to drug makers in the form of EDI transaction documents.)

And as I understand the technology, enterprise systems such as Edge can then provide a tool for meeting the FDA’s goal of “secure business practices” in a way that data aggregation and reporting systems can not. Manufacturers with enterprise-level software can perform real-time analyses of the channel data to evaluate the suitability of wholesaler orders, balance inventory levels in the channel, prevent leakages into the secondary market, and limit unauthorized distribution. I presume that all transactions can be archived and available for auditing or use by law enforcement personnel.

On the other hand, pedigree and RFID vendors should start lowering their forecasts. The greatest demand for pedigree technology will be from smaller wholesalers and retail pharmacies with a wholesale license. These companies are least able to pay for technology, suggesting that pedigree technology vendors will have to create very inexpensive, easy-to-deploy solutions. Full enterprise pedigree systems will not take off but remain a niche market.

I also view this news as a blow to the RFID software and hardware vendors who have piled into the market. The FDA’s decision to lift the PDMA stay was widely (mis)interpreted as a mandate for RFID, which is was not. But RFID is not the same as pedigree. It is simply a means to an end, like all technologies.

Despite all of this reasoning, I fully expect hyperventilating opinion pieces to start spewing forth from the Florida media. I’ll post the more ludicrous ones as they appear.

Winners and Losers in the Zocor Wars

This week saw a new addition to the Dictionary of Pharmaceutical Business Strategy:

zocor (v)

1. To cause damage or pain to oneself that results in greater harm to a rival
2. To make a move that worsens one's short-term strategic advantage while simultaneously impairing a competitor's long-term advantage
   
   Example: Lighting McQueen chose to zocor himself in the Piston Cup Championship, thereby making winner Chick Hicks look ruthless and self-centered.

As reported by Heather Won Tesoriero at the Wall Street Journal, Merck will be selling Zocor at a lower price than the generic to major managed care companies, accelerating the market price decline of simvastatin.

Before PBMs and payers open the champagne for simvastatin's new lower pricing, they should consider the possible long-term effects on their business model if other pharmaceutical manufacturers decide to zocor their generic competitors.

Let's look at the winners and losers from this week's news.

Teva and Ranbaxy: Losers

Patents grant market exclusivity for a limited period of time, providing pharmaceutical manufacturers such as Merck with incentives to innovate by allowing them time to recoup their investment in R&D. The Hatch-Waxman Act provides an analogous 180-day period of marketing exclusivity for the first generic drug manufacturer to file an Abbreviated New Drug Application (ANDA).

Merck's pricing strategy now makes the 180 day exclusivity periods enjoyed by Teva and Ranbaxy worth a lot less. As the WSJ notes, "Merck's pricing strategy could set off a bidding war among generics manufacturers, which likely will have to slash their prices to maintain a foothold in the market for simvastatin, the generic name for Zocor."

Dr. Reddy's: Loser

Dr. Reddy's, whose authorized generic launched on Friday, will now end up with a lower market price than they expected when they signed up. I wonder how Merck's "partner" feels about this!

Merck: Winner

Unlike Merck's strategy, empirical research has found that pharmaceutical manufacturers typically increase prices after generic entry. (Click here to download a classic article on the topic.) This is a price discrimination story. Physicians or patients who are loyal to the brand are also less price sensitive, so the counter-intuitive, but logical, strategy is to extract as much revenue as possible during the period of generic penetration.

By pursuing the opposite strategy, Merck is accelerating the loss of sales for a $4.4 billion blockbuster. Since they would have lost the sales anyway, they get to capture extra revenue dollars that would have gone to the generic manufacturer.

PBMs: Winners or Losers?

The short-term effect of Merck's move is clearly beneficial because the market price of simvastatin will decline faster, consistent with FDA research showing a correlation between more generic competition and lower prices relative to a brand. Thus, PBM stocks rallied this week after falling in May when the original 180 day exclusivity period was announced.

However, the real risk comes from the long-term competitive effect on future ANDA filings. Will generic manufacturers be deterred in the future by the threat (real or implied) that the brand name competitor will reduce the value of the 180-day exclusivity period?

The FTC is currently studying the alleged anti-competitive effects of authorized generics such as Dr. Reddy's simvastatin. From the FTC's Federal Register notice in March:

"Many generic manufacturers assert, however, that in the long run, consumers will be harmed because an expectation of competition from authorized generics will significantly decrease the incentives of generic manufacturers to pursue entry prior to patent expiration. For a generic manufacturer, the additional competition from an authorized generic may result in significantly less profit during the period of 180-day exclusivity than if the generic manufacturer had no authorized-generic competition during that time."

PBMs have been able to deliver substantial value to payers through generic substitution and estimate that each 1 percentage point increase in generic fill rate decreases plan sponsors' pharmacy spend by 1 percent. (Click here for more details.) Gun-shy generic manufacturers will do long-term harm to PBM's ability to keep delivering savings.

So, is a dollar of savings today worth more than the chance that there won't be a dollar tomorrow? This is the real unknown behind Merck's strategy. I'll reserve public comment until I see the FTC's report.

Ka-Chow!

One more thing on Walgreen's

Today’s WSJ has a fascinating article about Walgreen’s success with Part D called “Getting an ‘A’ in Part D.”

My dead canaries post speculated on merger possibilities between chains and PBMs. This article provides some further supporting evidence. The WSJ article states:

“Part D reimbursement rates -- which are set by insurance companies but reviewed by the government -- vary widely but are usually so low that many independent pharmacies worry they will be put out of business. . . .Some small pharmacies, unable to pay their employees, already have closed their doors. Others are refusing to honor insurance plans with the lowest reimbursement rates.”

In other words, independents and small chain have to (a) play ball at lower rates, (b) lose business by turning away customers, or (c) shut down.

However, the tables are turned for a chain with strong store loyalty and a high share of outlets in a given geographic market. Leveraging countervailing power against payers allows the channel to extract adequate compensation for access to customers, creating another advantage under Part D for larger players.

These battles can continue indefinitely, as happens in many U.S. distribution channels. Walgreen’s role as PBM for UnitedHealth’s plan illustrates the alternative approach of vertical consolidation between channel and payer. No mandatory mail order here!

Walgreens' Future: I see dead canaries

Walgreens announced that it will not fill prescriptions for Midwest Health Plan, a small HMO based in Michigan. On the merits, this is not really big news. There are many other companies managing Medicaid plans in Michigan, so this is not a market-disrupting move. Walgreens is a distant third in the Detroit area behind CVS and Rite-Aid.

But I look at this small news item as another dead canary in the coming war for control of the last mile (last counter?) in the pharmacy supply chain -- and perhaps a harbinger of a future chain pharmacy /PBM merger.

Before you accuse me of starting a market-moving rumor (if only!), let's look at retail pharmacy today:

• Pharmacy continues to grow as a percent of sales at the large chains. (70% of sales CVS and 65% at Walgreens.) This trend will continue because both the prices and utilization of drugs are growing faster than band-aids, lipstick, candy, cigarettes, soda, and all the other CPG stuff in the front of the store. (Come to think of it, you'll be a good candidate for prescription drugs if you spend enough in the front-end of a pharmacy.)
• The big 3 PBMs now process more than half of all retail store prescriptions, effectively turning chain stores into a PBM-managed fulfillment channel. Add in Medicare Part D, and it sure looks like chains are losing control of their destiny.
• The channel is rapidly consolidating. Combined pharmacy sales for Walgreens and CVS were $56 billion in 2005, meaning these two chains accounted for 30% of all non-mail order retail prescriptions last year.

Both CVS and Walgreens are trying to grab market share as quickly as possible. Normally acquisition-shy Walgreens bought venerable regional chain Happy Harry's. CVS is looking for more acquisitions now that it has digested the Sav-On and Osco drugstores.

My take: retail chains want to control access to patients and gain the power to tax anyone who wants access, such as HMOs, PBMs or manufacturers. A more powerful downstream channel can demand that suppliers defray its costs, especially when higher margin content is delivered through lower margin channels. (For example, slotting fees for new products paid by CPG manufacturers in the supermarket industry.)

Walgreens continues to signal a willingness to rumble. GM and Walgreens parted ways last year when GM removed Walgreens from the pharmacy network for its 1 million employees and retirees. (Recall that the UAW and GM moved its members into mandatory mail order for chronic meds in 2004.) Walgreens also won't fill prescriptions for state employees in Ohio. In the Midwest Health Plan situation, Walgreens didn't get additional compensation to make up for Medicaid cuts, so they flexed their muscles.

Fear of the channel's power led Merck to buy Medco, but that was a poor fit because the businesses are so fundamentally different. Plus, everyone was skeptical about conflicts of interest when a manufacturer controls the formulary. ("Acquiring the hen house" strategy?)

But a retail/PBM combination seems much more logical to me. I estimate that the drug channel (wholesalers, retailers, PBMs, insurers) accounts for 30 cents of every U.S. retail pharmacy dollar. Managing drug costs will require directing consumers to the most efficient pharmacy channels. PBMs do this by dispensing via mail order, a highly profitable business (see my previous post. And don't forget that Walgreens and CVS have small PBM and mail order businesses, allowing them to learn how to connect these operations to their core.

The combined market cap of Medco, Caremark, and Express Scripts is roughly the same as Walgreens market cap. If PBM P/E ratios return to pre-2005 levels, they will be tempting targets for the retail chains.

Added bonus: Few pharma manufacturers are prepared for this scenario, in part because the Trade Relations department handles pharmacies while a separate Managed Markets/Contracting department deals with PBMs.

P.S. Any investment bankers reading this column should feel free to send me 1% of their fee if they do one of these deals.

FDA blind to the supply chain’s evolution

In a marvelous fluke of timing, the new FDA report on counterfeiting was released in the middle of last week’s Healthcare Distribution Management Association conference in Phoenix. The biggest news was the FDA’s decision lift the stay on the long-delayed PDMA, which is 172 days from implementation as of today.

I was at the HDMA meeting in Phoenix and talked with executives from the major drug makers and their wholesalers. The general consensus from my conversations is that the FDA made a good decision. (This post was almost called “HDMA OK with FDA Play on PDMA Stay.”)

I agree. The PDMA’s view of pedigree is much more sensible than the “all transactions, all the time, no matter what, or you’re in trouble, Buster” approach of Florida’s pedigree law. Hopefully, Gov. Bush will sign HB 371 before July 1 and inject some business reality into the Florida law. (BTW, the more I learn about HB 371, the more I like it.)

Nevertheless, I was extremely disappointed that the FDA did not acknowledge how much free market innovation has already improved the safety and security of the US drug distribution channel.

Page 25 of the original 2004 FDA report states: “For government efforts against counterfeit drugs to be successful, drug producers, distributors, and dispensers will have to take effective actions to secure their business practices.”

And guess what? The industry responded, driven as much by business concerns as by regulatory threats. Wholesalers such as AmerisourceBergen and Cardinal Health publicly renounced secondary market sourcing, the HDMA tightened its membership requirements, and major pharmacy chains such as CVS committed to secure sourcing.

In addition, manufacturers signed fee-for-service agreements with their wholesalers that limit product leakage into the grey market, closing a significant entry point for counterfeiters. Drug makers literally pay for greater product security by purchasing data from wholesalers to monitor orders, inventories, and product movement in real-time. Perhaps the FDA forgot to read my HBR article from last August or even the letter submitted by CVS.

But instead of encouraging further innovation in commercial practices, the FDA chooses to scold the industry for not meeting its unrealistic timeline behind track-and trace.

I laughed out loud when I read this zinger on page 11: “The technology vendors uniformly told us that their RFID and e-pedigree solutions and technologies are ready to go, but manufacturers, wholesalers, and retailers are slow to implement them.”

Don’t they recognize that a track-and-trace infrastructure can not be built without the solid foundation of secure business practices for the distribution channel? I guess it’s easier to blame companies for not spending enough money on premature solutions than to understand the real-world complexity of having 160,000 unique points of drug dispensing.

The U.S. drug distribution system has made enormous progress in reducing counterfeits by implementing new, more secure business practices. The FDA’s “disappointment” at RFID progress should have been tempered with acknowledgment of how far we have come in the past three years and a clear call for further innovation in channel management.

And if the FDA really cared about counterfeits, they would immediately prohibit all personal importation of drugs. Or did they already forget one of the conclusions reached by HHS’ Task Force on Drug Importation:

So-called “track and trace” technologies, such as radio-frequency identification (RFID) and sophisticated bar coding, can provide effective monitoring of a drug’s movement from the point of manufacture and through the U.S. distribution chain. Although these new and emerging technologies are promising, until they are fully adopted internationally they cannot be adequately relied upon to secure the safety, efficacy, and integrity of the global market to safely import prescription drugs into the U.S.

Should I start saving up for an at-home RFID scanner instead of a plasma TV?

McClellan and the magic AMP

Mark McClellan recently announced that CMS will postpone release of Average Manufacturer Price (AMP) data until later this year. Current AMP calculations were originally scheduled to be released on a website July 1. (The full text of his remarks is available from CMS here.) Note that an article on the speech inaccurately reported that CMS will be delaying the implementation of AMP-based reimbursement, which I do not believe that McClellan has the power to do.

This decision was prompted by a little-noticed OIG report released last week. Main conclusion: “Existing requirements for determining certain aspects of AMPs are not clear and comprehensive, and manufacturers’ methods of calculating AMPs are inconsistent.”

The best part of this report is the appendix with letters from pharmacy, wholesale, and manufacturer trade associations. (Where was PCMA?) My mind was reeling at the complex (and often contradictory) guidance provided by different parts of the drug channel. We can now look forward to some intense lobbying over the proper definition of AMP.

Regardless of the ultimate definition, I see AMP ultimately having a much bigger impact than many people expect. Here are a few predictions:

• Private payers will migrate to AMP-based pharmacy reimbursement.
• PBMs will find their profit model under pressure as payers gain visibility into spreads.
• Wholesalers, Retailers, and PBMs will battle for a fixed generic profit pie. (See my earlier post on generics.)
• “Class of trade” pricing difference will become standardized across manufacturers.
• Manufacturers will increase direct sales to self-warehousing pharmacy and mass market chains. See my September 2005 paper “Preparing for the Future of Retail Pharmacy Supply Chain” for my rationale.
• Manufacturers will reduce or eliminate prompt pay discounts by shifting this channel compensation to fees.

Suffice to say, I see AMP triggering some significant changes in business practices and sparking new competitive battles in the pharmaceutical industry. How come no one else is talking more about the follow-on impact of AMP?

The 3PL vs. Wholesale battle heats up

Some big news yesterday should make drug makers and their wholesalers sit up and take notice.

OTN just announced that UPS Supply Chain Solutions will be handling distribution for their oncology network. This is a MAJOR win for UPS, which opened a new facility for this purpose last year.

I think the UPS agreement also signals some broader risks for wholesalers. As forward-buying profits and other forms of indirect compensation fade away, drug wholesalers will increasingly find themselves on a collision course with logistics companies and large retail chains for control of the pharmaceutical supply chain. Logistics companies offer manufacturers much more control versus a traditional wholesale channel.

This move highlights the further integration of oncology care and specialty products distribution. Wholesalers either have to own their customer or risk disintermediation. Take a look at the intertwined channel arrangements at the top five community oncology GPOs:

• ION, the largest community oncology GPO, has an exclusive distribution arrangement with Oncology Supply. Both organizations are part of AmerisourceBergen’s Specialty Group.
• Onmark switched its business from McKesson to CAH in April. Onmark is part of OTN, the oncology distribution business owned by Bristol until last year. Three weeks later, Onmark’s parent company OTN acquired 80% ownership in Cardinal Health’s oncology distribution business.
• US Oncology ended its distribution agreements with Cardinal last year in favor of self-distribution.
• Matrix Oncology, a smaller GPO, is supplied by CuraScript. Both companies are part of PBM Express Scripts.
• In April, McKesson acquired National Oncology Alliance, one of the smaller GPOs in the market.

Self-distribution, whether by a large chain pharmacy or an oncology GPO, provides greater control along with new opportunities for supply chain integration. (See my September 2005 white paper for a deeper analysis of retail chains.)

Two big unknowns for this channel:

1. Genentech has narrowed the distribution channel for its blockbuster drugs Avastin, Rituxan, and Herceptin. Will other biotech manufacturers follow?
2. What will payors do now that specialty drug costs are going up more than 3 times the rate of overall spend?