Tony Soprano and Drug Diversion

A court injunction against an online Canadian drug seller highlights a fundamental problem with importation – and also lets me give you a peek into the interconnected world of pharma industry blogs.

Walk with me through the blogosphere

The New Jersey State Attorney General just shut down www.Medications4less.com, a reseller of Canadian drugs. See State Sues Mercer County Business Offering Canadian Prescription Drugs Over the Internet.

I picked up the story from Ed Silverman’s Pharmalot blog post. Ed apparently has a T-1 connection plugged into his arm because he published an amazing 33 posts yesterday, putting guys like me to shame. (Ed provides a real service to the industry by posting real news throughout the day, every day.)

I posted a comment on Ed’s blog with a link to this glowing newspaper profile about Medications4less. Very amusing in hindsight!

The mystery blogger at Pharm-Aid picked up my comment in New Jersey Vetoes Drug Importer. (BTW, I like many posts on Pharma-Aid but do not provide a link on my Industry Blogs list because the blogger remains anonymous.) Mr. Mystery pointed to a post by John Mack on Pharma Marketing Blog in which John contends that the risk of counterfeits via importation is nothing more than a “negative scare tactic.”

My point, and I do have one…

The problem with importation is not that all drugs from Canada are counterfeit. Instead, the problem is that importation is diversion – selling products intended for one market into another market. In the case of importation, diversion is an opportunity to arbitrage price differences between products sold at different prices in different countries.

Unfortunately, while diverted or resold products are not necessarily counterfeits, all counterfeits enter via diversion in the secondary market. Let me be clear: Drug diversion is the entry point for every case investigated by the FDA involving counterfeit drugs going into legitimate pharmacies. Even Tony Soprano has finally figured out that diversion of adulterated drugs could be a sweet deal. (Thanks again, Ed!)

This brings me back to Medications4less. I wrote about the risks of internet pharmacies in February after getting a troubling email from a college student. (See A Sad Tale.)

Unfortunately, the proposed importation bill (S.242) before the U.S. Senate would enable copycat websites by legalizing diversion from countries with very low scores on the Corruption Perceptions Index. You heard me right – S.242 will make importation legal from Bulgaria (#57) and Romania (#84)! (See my recent posts for some real-world examples of the dangers: Importation Illusions; Greece is the Word; Importing Chinese Counterfeits .)

Bottom line: (a) Don't buy Fosamax from Tony Soprano, and (b) Read pharma blogs.

Trends for Wholesale Distribution

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The report took me a year to write and includes survey data from 1,300 wholesaler-distributors and manufacturers. It covers B2B distribution trends in almost every sector of the economy (not just healthcare), so there is stuff about construction, industrial, MRO, and retailing, to name just a few. Nonetheless, I believe that readers of Drug Channels will benefit from benchmarking the healthcare supply chain against other industries.

Please note that my work with healthcare and pharmaceutical manufacturers precludes me from any business consulting assignments with wholesalers of healthcare or pharmaceutical products.

Thanks for reading this small bit of self-promotion. We now return to our regularly scheduled programming…

Will US logistics deals be illegal?

Yesterday, the UK’s Office of Fair Trading (OFT) announced its intention to study the pharmaceutical wholesaling market in light of Pfizer’s new distribution arrangement with Alliance Unichem. (See OFT's statement on Distribution of medicines in the UK.)

However, you probably don't realize that a similar arrangement in the U.S. between a manufacturer and a wholesaler would probably be illegal if the proposed importation bill (S.242) before the U.S. Senate becomes law. Trade relations and commercial relations executives should pay attention because importation legislation explicitly limits the way a manufacturer can structure its U.S. distribution agreements. (CYA Notice: I'm not a lawyer. Read the disclaimer at the bottom of this page!)

I have been following international drug channels for some time, most recently in A New Era for Distribution. OFT's statement explaining the rationale behind the study states:

“The pharmaceutical wholesaling sector is undergoing significant change, the competition implications of which are unclear. As of 5 March 2007 Unichem Limited has become the sole logistics service provider to Pfizer Limited. This represents a fundamental change to the workings of this sector and has prompted widespread concern among pharmacists, dispensing doctors and competing wholesalers. Other pharmaceutical manufacturers are also considering similar changes to their distribution arrangements.”

In my opinion, Pfizer has at least two legitimate objectives for their deal with Unichem:

1. Lower the risk of counterfeit products entering the supply chain
2. Recapture lost revenue from parallel importing

Given these reasons, I believe that the proposed importation legislation would make it illegal for Pfizer to set up a sole logistics provider relationship in the U.S.

In particular, the actions listed as “Unfair and Discriminatory Acts and Practices” in S.242 are clearly modeled upon manufacturers' strategies for managing parallel trade in the EU. (See the section beginning on line 13 of page 74 of S.242 Pharmaceutical Market Access and Drug Safety Act of 2007.) IOW, manufacturers will also have little choice about whether to do business with known US importers or non-US exporters.

Keep in mind that the importation bill is co-sponsored by all three Presidential candidates from the Senate – McCain, Clinton, and Obama. Iraq and the Medicare “direct negotiations” movement will keep the Senate busy this term, but look for action on importation in late 2007 and 2008.

Consolidation End-Game for Wholesalers

The consolidation end-game is underway among pharmaceutical wholesalers.

Today, AmerisourceBergen (ABC)announced that it is acquiring Bellco Health, a privately held wholesaler with about $2 billion in sales. (See AmerisourceBergen to Acquire Bellco Health.) You may recall that regional wholesaler Harvard Drug Group was acquired by private equity firm H.I.G. Capital in January 2007.

Companies such as Bellco and Harvard Drug Group disproportionately service independents and smaller chains. (Bellco also has a big dialysis business.) Loyal readers of Drug Channels know that I’ve been forecasting Trouble Ahead for Independent Pharmacies even as the overall drug market grows. Today’s WSJ article about the Deficit Reduction Act provides a good summary of the perceived hit to independents from AMP-based reimbursement. Check out last my post on Fred’s to read more about AMP's Impact on Pharmacy Profits.

Industries do not consolidate forever (even drug wholesaling). Given the limited number of possible buyers and the heightened risk of a distress sale, I expect that the remaining regional wholesalers will be looking for a reasonable exit strategy, too.

AMP's Impact on Pharmacy Profits

Fred’s is a general merchandiser that operates 683 stores and 283 pharmacies in 15 states throughout the Southeast. Pharmacy is about one-third of its $1.8 billion in revenues.

Why should you care about Fred’s?

Because Fred’s included the following statement in its 2007 earnings guidance: “The impact from the federally approved Average Manufacturer's Price (AMP) program is expected to become effective on June 1, reducing Fred's 2007 gross profit by approximately $4.0 million.”

As far as I know, this is the first hard dollar estimate of AMP's profit impact. (Cool!) I did a few quick calculations based on their overall earnings estimates and FY2006 results. I won’t bore you with the math, but the company is forecasting that the first 8 months of AMP will:

• Reduce pharmacy gross profit dollars by 3.6 percent
• Reduce pharmacy gross margin by one percentage point, i.e., 100 basis points

Ouch! While Fred’s faces some unique challenges (Katrina, TennCare cuts, etc.), we have a credible estimate of AMP’s potential profit impact on a publicly traded retail pharmacy. Neither CVS nor Walgreens have provided a similar level of precision to date.

Now you know why the AMP Battle Rages On. But unlike Mountain Dew's AMP, I somehow doubt that pharmacies will feel a boost of energy on June 1 from CMS' AMP.

AMP Battle Rages On

In January, I identified Lobbying for Pharmacy Profits as a key theme for 2007. The message is clearly getting through to our elected officials judging by yesterday's story in Drug Store News stating:

"In a bipartisan gesture, 46 senators co-signed a strongly worded letter March 13 asking CMS acting administrator Leslie Norwalk to hold off on the new Medicaid reimbursement plan until the agency had established a clearer definition of the AMP of a drug."

Ironically, Tuesday's Wall Street Journal article (Why Generic Doesn't Always Mean Cheap) highlights the perception challenge facing the pharmacy lobby. As readers of this blog know by now, profits on generic drugs subsidize the retail and wholesale distribution of much more expensive branded products. Recall that dollar-profit disparities between brand and generic dispensing created the need for AMP in the first place. (See The Attack on Generic Profits in Drug Channels for background.)

Manufacturers and drug wholesalers are also on a collision course over generics, especially if the next round of fee-for-service agreements leads to tighter payment structures for wholesalers. The big 3 -- AmerisourceBergen (NYSE:ABC), Cardinal Health (NYSE:CAH), and McKesson(NYSE:MCK) -- have been relatively quiet on this issue lately, but I expect that importation legislation will make the conflict clear. I wrote about this issue a couple of weeks ago in Generics=Channel Strife?.

While you ponder these strategic matters, I'm sure that the AMP fanatics (you know who you are!) will surely enjoy reading the comments submitted to CMS regarding the proposed AMP legislation. They can be found on an obscure web page buried deep within the CMS site: Electronic Comments on CMS-2238-P (If the link doesn't work, go to CMS' main electronic comments page and search for Docket ID CMS-2238-P.)

I'll post some thoughts on the massive amount of AMP comments in a week or two. In the meantime, you can get ready for March Madness by filling in The Onion's comphrehensive NCAA basketball bracket.

Wholesaler LBO Time

I can't leave for the weekend without highlighting this news story:

KKR Offers 9.7 Bln Pounds for Alliance Boots

• "Private-equity group Kohlberg Kravis Roberts & Co. and Alliance Boots PLC executive Stefano Pessina said Friday they had made a friendly takeover approach to the health and beauty company for 1,000 pence a share, or about $18.71 billion . . . Alliance Boots was created following the merger of U.K. health and beauty retailer Boots Group PLC and pan-European drugs distributor Alliance UniChem PLC in July."

So, who's next? The good folks at Starshak Winzenburg send me a monthly update on distribution stocks. Here is the enterprise value of the Big 3 US wholesalers according to their March 2007 Distribution News issue:

• AmerisourceBergen (NYSE:ABC) = $9.9B
• Cardinal Health (NYSE:CAH) = $29.2B
• McKesson (NYSE:MCK) = $15.4B

Today's move by KKR may also make you re-consider the last paragraph of my February post Trouble Ahead for Independent Pharmacies. Any takers?

Import Battle Heats Up

The Senate held hearings Wednesday titled Policy Implications of Pharmaceutical Importation for U.S. Consumers. Drug Imports Battle Heats Up Again, noted the Associated Press.

IMHO, Billy Tauzin did a very good job laying out the main drawbacks to importation in his testimony before the Senate:

1. Importation opens our borders to drugs from anywhere in the world and there is no plausible way of limiting importation to Canada or Western Europe;
2. Safety testing, inspections, chain of custody requirements and other attempts to “guarantee” safety provide no assurances that imported drugs will be safe;
3. Projections of potential cost-savings from importation are very small and the largest beneficiaries are arbitrageurs;
4. Importation is not free trade, it is price controls which lead to delays and denials in patients’ access to medicines; and
5. There are better, safer alternatives for patients to access needed medicines, including the Partnership for Prescription Assistance (PPA) and Medicare Part D for seniors and the disabled.

Astute readers of my blog will realize that I concur with all of these key points. His testimony is worth reading, especially because the footnotes cite most of the legitimate research on the subject. (Yes, distribution geeks like me always read footnotes!)

Where's the Beef?

Unfortunately, I fear that the legislative decision may be made based on politics rather than facts. Senator Dorgan's post-hearing press release states:

• "I think we need to introduce a little price competition into the marketplace," said Dorgan. "There is no reason American consumers ought to be paying the highest prices in the world for prescription medicines."

Now, see if you can fill-in the blanks behind Senator Dorgan's comments in his Feb. 21 press release, just a scant 2 weeks ago:

• “Recent reports show that Canadian [products] are crossing the border without required health certificates and identification,” said Dorgan. “[Federal agency ending in DA] does not need to be expanding importation of Canadian [product], when it can’t even enforce the current regulations.”

The correct answers:
[products] = cattle; beef
[Federal agency ending in DA] = USDA

'nuff said.

Chips and Fish?

In case you missed the news, Kodak has applied for a patent on a digestible RFID tag. (Read the edible radio patent application.) The IT editor at Industry Week cleverly refers to the tag as the trackable part of your nutritious breakfast.

I'm sure that this invention has many valuable uses in diagnosis and treatment of disease. Personally, I can't help wondering about the new meaning of "end-to-end" security for the pharmaceutical supply chain ...

Pfizer wins again

As expected, the high court in Britain will not stop Pfizer's distribution arrangement with Alliance Unichem.

• Original post: A New Era for Distribution
• News Story: Drug wholesalers fail to block Pfizer deal in UK

Since I won't be attending the HDMA business partner exchange meeting that starts next week, I want to offer a few comments on this outcome then and predict what it might mean for the US.

Drug manufacturers have been trying to regain control over their distribution channel in Europe for some time. Glaxo won some notable legal victories last September that paved the way for Pfizer's UK agreement, as I predicted in A Partial Win for Glaxo Means More Change for EU Drug Channels.

Pfizer has been very active over the past few years in asserting its legitimate commercial interests to engage in strategic channel management. Today's high court decision is the second victory against wholesalers in a week for Pfizer. Recall that Pfizer successfully prevented Danish wholesaler Nomeco from selling a generic version of Lipitor.

For now, these attempts are not needed in the US because manufacturers have much more control over the larger wholesalers. US wholesalers still derive a majority of their gross margin from the buy-side via fee-for-service agreements and payment terms.

In contrast, wholesaler sell-side margins are regulated or fixed in most EU countries. Some countries, such as France, even regulate the maximum discounts to these margins that wholesalers can offer to pharmacy customers. As a result, I estimate that manufacturers only control about 25% of the larger wholesalers' gross margin versus 90%+ in the US.

PREDICTION: The likelihood of EU-style channel management efforts in the US will increase if US wholesalers begin to derive a greater proportion of their buy-side margins from activities that are not controlled or compensated by branded manufacturers. (This is the underlying theme of my Generics=Channel Strife? post).

Check back in 12 months and see if my prediction comes true.

P.S. BTW, I received many emails on Thursday's post (Generics=Channel Strife?), most of which asked for clarification or a customized analyses. If you are not one of my advisory consulting clients, I'd prefer that you post your question as a public blog comment. Naturally, you can also feel free to inquire about the services offered by your friendly neighborhood blogger...

A New Era for Distribution

We seem to be entering a new era for the pharmaceutical distribution channel – one in which the regulatory “rules of the game” become more important than ever for marketplace success.

Back in September, I wrote about Pfizer’s UK drug distribution deal with Alliance UniChem. (See Pfizer's UK Deal: Change is Here!.) As I noted, Pfizer, has two legitimate objectives for this deal:

1. Lower the risk of counterfeit products entering the supply chain
2. Recapture lost revenue from parallel importing

Now, a group of UK distributors is seeking an injunction against this new strategy on the eve of its introduction next Monday. (See Drug wholesalers go to court to block Pfizer deal). I don’t know enough about UK law to handicap the outcome.

But in reading this article, it strikes me that we are seeing more wholesaler-to-wholesaler conflicts playing out in the legal and public policy realm. Last year saw secondary wholesalers successfully block the FDA’s implementation of the PDMA with a Federal injunction. (It's Official: PDMA is Back On Hold). RxUSA, the wholesaler who lead that effort, is simultaneously pursuing legal actions against McKesson, many manufacturers, and the HDMA. There was also friction surrounding Florida’s pedigree law between the large drug wholesalers, secondary drug wholesalers, and med/surg wholesalers. (See H.B. 371 signed by Gov. Bush ).

I’m not ready to draw a firm conclusion about all of this activity yet. But I wonder if we are now at an inflection point for the drug distribution industry.

Generics=Channel Strife?

Will generics be the next battleground between branded drug makers and their wholesalers?

Pay attention to Pfizer’s latest victory against generic Lipitor in Denmark. Here’s the summary:

“Pfizer Inc., the world's largest drugmaker, said Friday a court in Denmark blocked the sale of a generic version of the company's best-selling drug, the cholesterol-reducer Lipitor. The company said the Bailiff's Court in Copenhagen issued a preliminary injunction against the country's largest drug wholesaler Nomeco AS, preventing it from selling a generic version of Lipitor made by Indian drugmaker Ranbaxy Laboratories Ltd.” (Full story: Pfizer gets court injunction against generic Lipitor wholesaler in Denmark)

Note that Pfizer’s victory is against Nomeco (the wholesaler), not Ranbaxy (the manufacturer).

Will this type of conflict spill over to the U.S.? Consider the following three points:

1. The U.S. is moving toward reimportation legislation. There are bills before both the House and Senate. In Europe, wholesalers are big winners from importation because they absorb most of the price differences between countries. (See Importation Illusions.)Thus, importation legislation could be very good for the big wholesalers (AmerisourceBergen (NYSE:ABC), Cardinal Health (NYSE:CAH), and McKesson(NYSW:MCK)) as they would have the opportunity to become a legitimate conduit for imported products.
2. Wholesalers generate more profits from generics than branded drugs. Generic drugs now subsidize the distribution of much more expensive branded pharmaceuticals. (First noted back in May Will unbundling crush pharmacy profits?)
3. Intellectual property protection for pharmaceutical companies is under attack around the world. Keep an eye on a crucial case in India in which Novartis is defending its Gleevec patent. If they lose, then the world will have a new source of generics long before most U.S. patents expire. (See Novartis files suit against India ruling on drug patents.) The New England Journal of Medicine just published an article that argues in favor of India’s attempt to seize the patent. (See Taking TRIPS to India.)

Taken together, these three points suggest the potential for friction in manufacturer-wholesaler relationships due to the potent interaction of generics and importation legislation. I'll be curious to see if any manufacturers address this issue in the next round of wholesaler agreements.