The Future of AWP: Ask Again Later

Last week’s legal developments don’t make the future of Average Wholesale Price (AWP) much clearer, despite my use of a magic 8-ball.

McKesson Corp (MCK) settled its pending class action suit for $351 million and set aside a further $143 million reserve for certain future claims. See McKesson Agrees To Settlement In Pricing Suits.

Meanwhile, NACDS and FMI filed another brief in opposition to the controversial proposed First Databank settlement, although they overstate their arguments in a few places. Expect this battle to heat up over the next month as we get closer to the hearing about First Databank’s settlement.

McKesson: Without a Doubt

McKesson’s trial was scheduled to begin in December. You can view a presentation of selected evidence in the Plaintiffs’ Illustrative Exhibits in Support of Motion for Class Certification, which includes apparently damaging emails involving some familiar companies. Just keep in mind that this information was cherry-picked by the plaintiffs, so it is presented out of context and therefore may not be reliable.

Naturally, the settlement terms include “an express denial of liability of any kind.” (Read McKesson’s official statement.) The lead lawyer from the firm that filed the class action actually wrote a blog post about the settlement with his spin.

The settlement gives us some insight into litigation calculus. Conceptually, the settlement amount should be less than the sum of:

• future legal costs, plus
• the expected loss, where the expected loss = Probability of Losing * Total Damages.

If we assume $20 million in future legal costs and take the plaintiff’s original estimated damages of $5 billion, then the $351 million settlement implies a 6% probability of losing the case. Put another way, McKesson settled even though the numbers suggest a more than 90% chance of winning.

First DataBank: Cannot Predict Now

Read AWP: Dead Parrot or Just Resting? for my detailed overview about First Databank’s plans to unilaterally roll back the AWP for all drugs to 1.20 and discontinue publishing the Blue Book AWP data. This post is still valid because the next phase is a fairness hearing scheduled for mid-December.

Pharmacy groups object to the First DataBank settlement because a roll-back would translate into lost dollars for pharmacies that get reimbursed based on AWP. The National Association of Chain Drug Stores and the Food Marketing Institute recently filed a new brief and economic report opposing the amended June settlement.

Dr. Mosteller’s economic report (starting on page 21) highlights many issues that I have covered in my blog over that past few years, such as the reality that reimbursement relationships will be restructured to maintain dollar-based economic arrangements regardless of the benchmark. See PBMs and AMP (November 2007) or my original comments on the AWP settlement (October 2006).

Ask Again Later

The latest legal brief from NACDS and FMI perhaps overstates the Life Without AWP (LWAWP) issue when it says “no one has any idea as to what type of pricing benchmark will succeed it.” What, don’t they read Drug Channels?!? I’ve spent the past three years talking about a few likely candidates, including Wholesale Acquisition Cost (WAC), Average Manufacturer Price (AMP), and cost plus (a la Wal-Mart).

One final thought that has been nagging at me. Pharmacies were apparently not involved in the alleged decision to increase the WAC-to-AWP mark-up from 1.20 to 1.25. But didn’t pharmacies benefit from the allegedly inflated AWPs? I can’t seem to find any motions offering to refund any “overpayments.” I’ll keep looking…

===

Thanks to the concerned readers who inquired about the lack of posts last week. Alas, I was swamped with (paid) work, including a day testifying as an expert to a jury. I can’t write more about my expert testimony except to say that I had a lot of fun. You may rely on it.

CVS Escalates the Generic Price War

Did anyone else notice the recent move by CVS Caremark (CVS) to offer a discount generic program?

Walgreens caved into Wal-Mart last June when it reversed course and started promoting the Walgreens Prescription Savings Club. See my post Walgreens’ $4.33 Surrender to Wal-Mart.

Now it’s CVS pharmacy's turn, but with the added confusion that the company also runs one of the largest mail order pharmacies. If we put aside the spin, the new program sounds like a logical pre-emptive strike against anticipated share losses. Translation: an old-fashioned, race-to-the-bottom price war!

A barrier has been breached with CVS’ entry into the discount retail generics game. Sorry to be the bearer of bad news, but it’s inevitable that this war will suck a lot of margin from the pharmacy and PBM industry over the next few years.

WHAT CVS SAYS

On Monday, CVS launched its new Health Savings Pass, which allows customers to buy 90 day supplies of over 400 generics for $9.99 (after paying an enrollment fee of $10). Tom Ryan said the following on CVS’ October 30 earnings conference call: “Let me be clear, I told you that we haven’t seen a material share loss due to our competitor’s $4 generic program and that’s still the case today.”

OK, let’s assume that he includes all types of retail pharmacy within the definition of “competitor.” So we can conclude that the generic programs of Wal-Mart (WMT), Walgreens (WAG), Kroger (KR), et al are apparently not having a material effect on CVS’ retail sales.

Why give up the generic margin? Mr. Ryan offered the following explanation, which I have parsed into two separate components:

• “We’re in the middle of an understated [sic] difficult economic crisis to say the least. People are struggling with healthcare costs more than ever before especially the under and un-insured. We felt it was the right time to offer a differentiated affordable option.”
• “Given the enrollment fee and the fact that we expect some share gain and increased foot traffic we think the RX Health Savings Pass shouldn’t cost us more than $0.01 or so per share on an annual basis.”

Sorry, but I don’t follow the logic about market share gains with the uninsured and under-insured in the first statement. Third-party payers represented 95.3% of CVS Caremark's retail revenue in 2007 (per their 10-K). The retail chain has never historically competed on price.

The second statement is more telling. Sure, the enrollment fee will help maintain loyalty as consumers try to amortize the fixed annual cost over their scripts. The $10 per customer will also provide some (non-reimbursement related) cash flow to cushion their loss of generic margin.

CVS VS. CVS

Frankly, I’m puzzled by the fit between the new generic program and the legacy Caremark mail order business. Mail order becomes less attractive if a 90-day mail script is the same (or more than!) three 30-day retail scripts. Perhaps CVS Caremark is counting on additional front-end sales to balance out lost mail margin, but I have trouble making the math work. Maintenance Choice, which is apparently gaining some marketplace traction, relies on a similar internal retail-versus-mail profit tradeoff.

I’m curious to hear from Drug Channels readers. What’s happens next in the retail pharmacy industry?

New Details on WMT-CAT Pharmacy Deal

A just-published article in Drug Benefit News provides new details about the Wal-Mart’s (WMT) $0 generic co-pay program with Caterpillar (CAT). Neal Learner, managing editor of DBN, did a superb job of reporting details on the program that I have not seen in any other publication. Here’s the link: Caterpillar/Wal-Mart Rx Drug Pilot Scraps Use of Average Wholesale Price, Uses Drug Cost-Plus Pricing

Anyone involved in the pharmacy channel – pharmacies, pharmacy benefit managers (PBMs), insurers, payers, drug wholesalers – should be paying attention to the Wal-Mart/Caterpillar arrangement. Pharmacy channel margins on generic drugs will be increasingly seen as a mechanism to control total drug spending. As a result, I expect even more adoption of cost-plus reimbursement models as Wal-Mart continues to challenge the pharmacy industry's traditional economic model.

KEY POINTS

This arrangement can best be described as a “preferred network” versus an explicitly “restricted network.” Members have a zero-dollar co-pay at Wal-Mart, but can choose to fill their prescriptions at other retail pharmacies for the normal $5 generic copay. See my original analysis of the deal (WMT + CAT: Pharmacy's Future?) for a summary of implications for the pharmacies and PBMs.

AWP is an endangered benchmark. Todd Bisping, pharmacy benefit manager at Caterpillar, describes AWP as a “flawed methodology.” I agree. See my June overview AWP: Dead Parrot or Just Resting? for more.

Wal-Mart’s reimbursement is explicitly cost-plus versus the more traditional list price-minus. The new pricing methodology is “based on Wal-Mart’s actual invoice prices on drugs.” Note that Wal-Mart’s invoice price for generics should generally be below a generic manufacturer’s Average Manufacturer Price (AMP) because of Wal-Mart’s buying power.

Payers recognize that retail pharmacies need to make a profit. Mr. Bisping notes Wal-Mart’s reimbursement includes “some money for their overhead and any margin they have to make.” It’s not clear from the article whether the margin is expressed as a percentage (basis point) mark-up, a fixed dispensing fee per script, or some combination. We also don’t know the magnitude of these profits, although Wal-Mart has been willing to accept lower margins on generic drugs than traditional chain and independent pharmacies. See Wal-Mart Redux.

This program incorporates a new benefit design strategy. Mr. Bisping states: “We felt that by negotiating directly with the pharmacy, that we could make price matter as well as choosing the pharmacy that we think will provide the best service for our employees.” This deal turns traditional benefit design on its head. Normally, those of us with third-party coverage generally pay an identical co-payment regardless of our pharmacy’s efficiency or cost structure. In contrast, the members share in the cost-savings associated with using a lower-cost channel. I explained these economics in January’s post Wal-Mart's PBM Game Plan.

PBMs get disintermediated from an important financial flow. Wal-Mart’s strategy explicitly cuts outs the PBM rather than making Wal-Mart into a PBM. Caterpillar’s PBM (RESTAT) apparently has a fairly transparent pricing model, so there were fewer business issues compared to a traditional PBM.

GET READY FOR THE COST-PLUS REVOLUTION

When generic dispensing rates (GDR) were 20%, payers did not pay much attention to the costs or margins associated with generic drugs. But GDRs are now 70% and rising, which means that pharmacy channel costs and margins will be increasingly seen as a mechanism to control drug spending. The coming wave of generics will focus even more attention on hidden economics of the channel (retail pharmacy, drug wholesalers, and PBM mail order).

Nonetheless, there are some tricky policy and benefit design issues associated with tightening generic margins. You may want to re-read Generic Drug Profits: Too High or Appropriate Incentive?, in which I highlight the powerful economic incentives for rapid generic substitution that are created when the pharmacy channel earns higher profits.

My really tough question remains unanswered: At what level of drug channel profits could payors still encourage rapid generic substitution while not “overpaying” for generics? Wal-Mart seems intent on challenging the pharmacy industry to answer this question in a new way.

My 2009 Economic Forecast

Congratulations to President-elect Obama on his impressive and historic victory! Whether you are happy or sad about the outcome, I’m sure you share my relief that the longest presidential election campaign in history is finally over. Only 1,460 shopping days until election day 2012.

As we turn our attention to the year ahead, I want to let you know about my 2009 Economic Forecast for Wholesale Distribution webcast next week on Thursday, November 13, at 2:00 PM EST. Some Drug Channels readers may want to sign up even though the event is not specifically about the pharmaceutical industry.

On this webcast, I will give you a working familiarity with just about every major macroeconomic issue that’s currently in the news. You will also get a 30+ page report with detailed, written commentary on every slide. The event is being supported in part by IBM Corporation.

Some of the topics that I’ll cover include:

• U.S. Macro Economic Outlook, including GDP and Employment
• The credit crunch and the bailout
• Exports, Commodity Prices, and the Dollar
• B2B Industry Outlook for Manufacturing, Construction, and Retail industries
• 2009 Forecasts for 19 Wholesale Distribution Sectors (drug wholesalers are one of these 19 sectors)

And now for something completely different

Why am I doing this webcast?

Well, only 75-80% of my time is spent on pharmaceutical supply chain and pharmacy economics issues – consulting, research projects, speaking engagements, litigation expert work, etc. I spend the balance of my time as a business economist/consultant focusing on general supply chain economics for a wide range of business-to-business markets. You can read a sample of my macroeconomics writing on my other (non-pharma) blog:

• Mostly Bad News in Q3 Snapshot of U.S. Economy
• Commodity Deflation is Closing the Growth Gap
• How Economists See 2009

Of course, you Drug Channels readers are my favorites. Just don’t tell the readers of Distribution Trends!

I’ll return to my regularly scheduled programming in the next post. In the meantime, enjoy the hypnotic ad below and feel free to email me any economic questions that you’d like me to address on next Thursday’s webcast.

Get Ready for Part D Reform

The USA Today published an apparently exclusive analysis last Thursday showing that Medicare drug plan spending drops $6B in 2008, driven by ever-increasing generic dispensing rates. No matter how tomorrow's election turns out, there will be serious reform efforts aimed at the Part D prescription benefit in the coming year despite this good news on costs.

So, how will Part D reform happen? On the eve of the Presidential election, here are some initial thoughts on three likely options for reducing Part D. The impact on manufacturers, insurers, pharmacies, and wholesalers will range from trivial to world-changing, depending on how Part D reform happens.

As a bonus, I’m including a special Presidential election photo of my wife's great Halloween costume at the bottom.

PART D BASICS

Here are three useful background resources:

• MedPAC’s very helpful little primer on Medicare payment basics: Part D payment system
  
• The Kaiser Family Foundation publishes regularly updated fact sheets about the Medicare prescription drug benefit
  
• Pharmacy Profits & Part D, my post on pharmacy economics

It’s especially important to understand that CMS does not pay directly for any drugs nor does it reimburse pharmacies for filling Part D scripts. Instead, CMS pays a monthly per-enrollee prospective payment to plan administrators – stand-alone prescription drug plans (PDPs) or Medicare Advantage Prescription Drug plans (MA–PDs). These plans perform functions similar to, but not precisely the same as, a pharmacy benefit manager (PBM).

One benefit of today’s structure is the choice created with a competitive system with over 1,800 plans. There is substantial variation in deductibles, cost sharing, and coverage in the gap. The biggest perceived downside is the fragmentation of buying power among the many plans.

Senator Obama wants to “Allow Medicare to negotiate for cheaper drug prices” (Source). “Direct negotiations” has a simple, populist appeal that is hard to ignore. But this approach faces an extraordinarily large hurdle because the entire Part D program would have to be reconstructed to make it work. I think the program is too popular and entrenched at this point. Nonetheless, a majority of pharmacists support direct negotiations according to a recent Drug Topics poll.

Keep in mind that Senator McCain is no fan of Part D either, saying recently: “The prescription drug benefit was the wrong solution to the wrong problem.” (Source) He voted against the bill that created the Medicare Part D benefit and is a long-time critic of the pharmaceutical industry. Senator McCain claims not to favor direct negotiations because it would give the government a bigger role in setting prices.

THREE PART D REFORM OPTIONS

Given the predilections of both candidates and the fiscal realities of Medicare, I believe that Part D will be reformed over the next few years regardless of who wins tomorrow. Here are my pre-election picks for realistic ways that the system will change, from smallest to greatest impact on the drug channels system:

1) Set up a Medicare Part D Rebate Program. The Medicaid Drug Rebate Program requires a drug manufacturer to have a national rebate agreement with the government for outpatient drugs dispensed to Medicaid patients. States can negotiate additional rebate agreements, too. So when “dual eligibles” – beneficiaries eligible for both Medicaid and Medicare Part D – were moved into Part D, manufacturer rebates declined. House Oversight and Government Reform Committee Chairman Henry Waxman (D-CA) highlighted this issue in a July 2008 report called Medicare Part D: Drug Pricing and Manufacturer Windfalls, which claims that the discrepancy in pricing between Medicaid and Part D “produced a windfall worth over $3.7 billion for drug manufacturers in the first two years of the Medicare Part D program.” A Part D rebate program would be much simpler to administer than “direct negotiations” and would be most politically viable by starting with dual eligibles.

2) Create a Government-run PDP. Another option would be to create a Government-run prescription drug program, an idea that I wrote about in November 2006. (See CMS as a PDP: A Part D compromise?) Medicare beneficiaries could have the option, but not the obligation, to enroll in a national plan based on directly negotiated prices. The current system of private PDPs could remain, in effect putting the government into competition with private plans. Two weeks ago, Avalere Health published a framework for thinking through this possibility called Mapping the Route: Approaches to Scoring a Government-Run Part D Plan. It’s a nice piece of work and worth reading for a high-level overview of the benefits and pitfalls of this approach.

3) Use Average Manufacturer Price (AMP) to Control Spending. CMS is currently collecting AMP data from manufacturers for use in the Medicaid rebate program. What if CMS requires Part D PDPs to adopt AMP-based methodologies for pharmacy reimbursement? Or mandates the use of AMP-based Federal Upper Limits (FUL) for both brands and generics in Part D? Long time readers may recall my post Part D + AMP = Trouble from last year. True, there are some AMP hurdles to overcome and the pharmacy industry will fight hard, but AMP would provide private insurers with a logical methodology to limit prescription spending.

DRUG CHANNELS IMPACT

I focus on the business impact of public policy in Drug Channels, so I’ll be keeping an eye on these options as they develop. As a brief summary, the first option above would be least disruptive to the pharmacy and drug wholesale industry because it would mirror the Medicaid program. Any additional savings would be paid as rebates and bypass the retail pharmacy supply chain.

The other two options would have much more significant effects. For example, the use of AMP within the Part D program would benefit pharmacies with the lowest cost of operations and a willingness to operate on a cost-plus basis. This is an important part of Wal-Mart's pharmacy strategy and has prompted new announcements by both CVS and Walgreens. More to come later this week.

======

A PRE-ELECTION, POST-HALLOWEEN BONUS PIC

I’m sure all Americans will appreciate my wife’s excellent Halloween costume, regardless of your political leanings. As you can see, she dressed up as … Tina Fey?

Phillies win!! Economy doomed?

Woo-hoooo!!!

The Philadelphia Phillies, the hometown team of your friendly neighborhood blogger, are World Series champions for the first time since 1980! There were loud celebrations in the streets of Philadelphia last night, but few overturned cars and no mass arrests.

Gosh, Adam, what could this mean for the U.S. economic outlook? Funny you should ask!

Two smart-aleck economists at Economy.com put together a sobering analysis called A World Series of Irrational Exuberance, concluding: “The data strongly suggest that a Philadelphia Phillies victory in the current World Series spells bad news for the economic cycle.” Check out this chart from their article:

Oh well. The parade is tomorrow afternoon right outside my office. Stop by if you are in the neighborhood.

Prescriptions and the Economy: A Contrarian View

Last week, the New York Times ran a story on the impact of the economy on prescriptions. (See In Sour Economy, Some Scale Back on Medications.) The article provided many compelling personal stories to illustrate the following macro data trend:

“Through August of this year, the number of all prescriptions dispensed in the United States was lower than in the first eight months of last year, according to a recent analysis of data from IMS Health, a research firm that tracks prescriptions.”

But what if the data are wrong?

I’m not suggesting that the prescription market is booming. However, I have some concerns about the ability of IMS Health to measure a changing retail marketplace with incomplete data, so perhaps the news is not quite as bad as reported.

Here's why. The top six dispensing pharmacies – CVS Caremark (CVS), Walgreens (WAG), Medco Health Solutions (MHS), Rite-Aid (RAD), Wal-Mart (WMT), and Express Scripts (ESRX) – now account for more than half of all retail prescriptions. Yet two of these six do not report sales data to IMS Health.

• As far as I know, Wal-Mart does not sell its prescription records to any third-party data provider.
• At least one of the major mail order pharmacies apparently stopped selling its data to IMS Health in January 2008.

These gaps would not bother me if market share was stable at the top six players because estimation would be a straightforward “fill in the missing number” exercise. But we know that’s not the case, especially when it comes to Wal-Mart.

Wal-Mart does not release any specific data on its pharmacy department, but anecdotal evidence suggests that the company has picked up share in selected regional markets. What do you think is going to happen to Walgreens market share in Peoria, IL, as the Wal-Mart/Caterpillar partnership gets going? Look at a map of Walgreens stores in the Peoria, IL area. Ouch.

The Times gave some lip-service to other explanations for the drop in scripts when briefly noting “…safety concerns over some previously popular drugs and the transition of some prescription medications to over-the-counter sales…” But the main point of the article was to link the economy to the slowdown in script growth.

I suppose it would be unfriendly to mention that most consumer-related metrics of the economy – retail sales, new unemployment claims, etc. – did not start to show signs of recession until this year. Look at the chart in the NYT article again, which shows the monthly year-over-year decline starting in early 2007. Well, this won't be the first time that I've highlighted partisan reporting about the industry by the New York Times. (See Sloppy reporting about Wal-Mart from way back in 2006.)

I’m sure the folks at IMS Health try hard to fill in the gaps, but there’s simply no way for them to do anything but guesstimate when they lack actual data for a significant and fast-changing part of the pharmacy market.

The Walgreens-McKesson Specialty Handoff

Walgreens (WAG) announced the acquisition of McKesson’s (MCK) specialty pharmacy business yesterday in a win-win transaction for two major Drug Channels participants. See Walgreen Co. to Acquire Specialty Pharmacy Business from McKesson Corporation.

The deal makes sense for both parties as long you understand that specialty distributors sell products to physicians, providers and pharmacies, while specialty pharmacies dispense products to individual patients. It also makes a lot more sense for Walgreens than buying Longs Drug Stores (LDG).

GOOD FOR WALGREENS

Walgreens made a good strategic move when it acquired Option Care in July 2007. At the time, I wrote: “Specialty pharmaceuticals are the biggest driver of drug spending right now. There is a lot of money to be made managing the benefits for payers, but that’s only possible by also dispensing these drugs. Thus, Walgreens can continue to grow their small in-house PBM, which is not even ranked in the top 25 based on lives covered. I also think that today's acquisition reduces the likelihood that Walgreens will emulate CVS and acquire a PBM.” (See Walgreens Expands In Specialty from July 2007.)

My conclusion is still valid. Further investment in rolling-up specialty pharmacy fits better with Walgreens than merging with an independent PBM or buying a regional chain with overlapping geography.

The biggest specialty pharmacies are now owned by the big 3 PBMs – CVS Caremark (CVS), Express Scripts (ESRX), and Medco Health Solutions (MHS). Yet the overall specialty pharmacy market is still relatively fragmented, so there is plenty of room for further consolidation. Plus, Walgreens gains further opportunities for disruptive competition with PBMs – a strategic posture that seems to be paying off for Wal-Mart (WMT). (See WMT + CAT: Pharmacy's Future?)

Specialty drugs are also shielded from generics (for now). I expect a pathway for biogenerics to emerge within the next few years, although the strategic logic of the WAG-MCK deal is not affected by this future potential downside.

GOOD FOR MCKESSON

The deal is also a good move for McKesson. Specialty pharmacy is a very small part of the company’s overall specialty business, lacks scale, and is a fundamentally different business than McKesson’s core wholesale distribution operations. The company has wisely jettisoned other non-core businesses, such as the sale of its acute-care med-surg business to Owens and Minor (OMI) in 2006.

McKesson dramatically expanded its specialty distribution business when it acquired OTN/Onmark and combined the businesses under McKesson Specialty. (See my Oct. 2007 post Fresh Consolidation in the Oncology Channel for more on that deal.) McKesson is better off building scale against AmerisourceBergen's Specialty Group (ABC), the current market leader in specialty distribution.

---

Hmmm, I sound really upbeat in this post. Hope I’m not getting soft in my old age!

What Happened at Walgreens?

On October 10, Jeffrey Rein unexpectedly “retired” as Chairman, Chief Executive Officer and a director of Walgreens (WAG). The official press announcement gave no reason for Mr. Rein’s sudden departure. According to a Walgreens spokesman: “the decision ‘does not have anything to do with the Longs proposal’ or with any health, family or ethics issues for Mr. Rein.” (Source: Walgreen CEO Rein Leaves Drugstore Firm.)

Which makes people like me wonder…WTF?

Well, I recently stumbled across a very intriguing blog called Investor Relations Musings. It’s written by John Palizza, a fomer Walgreens insider who was the principal investor relations contact for 15 of his 23 years working at the company. Mr. Palizza states that he left Walgreens in 1999 due to a disagreement with Mr. Rein.

In a post last week, Mr. Palizza openly asked and answered the question that many of us are thinking: Why Not Just Tell Us Why You Fired Him?

The whole post is worth reading, but here is Mr. Palizza’s bottom line on the strategic tension inside Walgreens:

“There seems to be two competing long-term strategies at Walgreens over the past nine months – one that was committed to growth at any price, and one that recognized the limits to growth and sought slower growth with higher returns. When the original acquisition talks with Longs did not pan out earlier this year, it would appear that the Board of Directors endorsed a view towards slower growth.

Then, within sixty days of announcing this new strategy, something changed – my guess is that Walgreens’ CEO bought into some new arguments by investment bankers that they could get the Longs deal done – and they decided to publicly pursue Longs. While technically, the acquisition bid is not at odds with the slowing of “organic” growth previously announced, investors were confused.

Finally, when Walgreens’ CEO couldn’t get the deal done, the Board axed him for both zigging when they had publicly said they were going to zag and failing to be a strong enough leader to get the job done.”

I’ve been similarly confused by Walgreens actions over the past few months. Last Thursday’s Drug Channels post Will the economy hurt drug stores? (answer: probably not) was inspired in part by Mr. Rein’s comments on Walgreens’ September 30 earning call. He said:

"We are facing a continuation of the slowest-growing prescription drug market in 47 years, according to IMS Health. We believe the biggest impact has been the very tough economy." Source

Leave a comment below and tell me what you think happened at Walgreens. Or if you prefer, just tell me who will win the World Series.

Will the economy hurt drug stores?

The economic outlook for 2009 looks grim. The Wall Street Journal’s October survey of economic forecasts puts the odds of recession at 89% and forecast negative GDP growth through the first part of 2009. U.S. retail sales dropped sharply in September, leading to another down day on the stock market.

So what, if anything, does this mean for overall sales at drug stores in 2009?

Based on the historical evidence … not much.

I looked at year-over-year changes in quarterly retail sales at Pharmacies and Drug Stores (NAICS 44611) as collected by the Bureau of the Census. These government-collected data provide the most complete picture of revenues at all drug stores, not just the big public companies. Note that these data exclude non-pharmacy dependent retail formats, such as supermarkets or mass merchants, and also combine prescription and front-end sales.

I compared these data to U.S. Gross Domestic Product (GDP) and Total U.S. Retail Sales data. The chart below tells the story – there was no clear relationship between changes in GDP and drug store sales during the past 8 years. (Click to enlarge the chart.) There was also no clear relationship in the 1990s (not shown).

Changes in sales at pharmacies and drug stores were not strongly correlated with changes in either GDP (-40%) or total retail sales (-41%; not shown). In fact, the correlation was actually negative, i.e., drug store sales tend to go up when GDP goes down. In case you’re wondering, changes in total retail sales had a +90% correlation with changes in GDP over the same time period.

The chart above also illuminates the sharp slowdown in year-over-year growth at drug stores that began in early 2007, which was well before the recession started. I think this trend reflects more fundamental industry forces at work, such as a lack of new blockbusters and rising generic utilization rates (which reduces revenue but boosts profits). The nature of health care products also implies limited sensitivity to a downturn.

A further piece of evidence comes from same-store sales at major retailers. (See Consolidated Summary of Sept Retail Sales Results.) Twenty-eight of 36 major retailers had negative same-store sales growth in September. Who was up?

• Discounters: Wal-Mart (WMT), Costco (COST), BJ's Wholesale (BJ)
• Drug Stores: Walgreens (WAG), Rite-Aid (RAD), Fred's (FRED)
  

Do these facts “prove” that drug store revenues will hold up in 2009? No, of course not. The future could look quite different than the past.

But as Mark Twain said: “History does not repeat itself. But it rhymes.”

Great Series from the Columbus Dispatch

Over the weekend, the Columbus Dispatch published a six-part expose/overview about the diversion and sale of controlled substances. Mike Pramik, the reporter who wrote all six parts, has pulled together a must-read series, especially since the Dispatch is also Cardinal Health’s (CAH) hometown paper.

Here are links to the six parts along with my commentary on each article.

Online Overdose – The main article provides a succinct summary of the biggest problem with the pharmaceutical supply chain today. Guess what? It’s really easy to get controlled substances via rogue Internet pharmacies sites, which “flourished in a virtually unchecked pharmaceutical supply chain that allowed anyone to answer a few questions and easily receive addictive medications, the same controlled substances that are in high demand on the street.” Lots of good facts and quotes, including one from yours truly. For more background, see my post The DEA's Anti-Diversion Strategy.

Cardinal pays up for drug slip-ups – A behind-the-scenes look at the problems that led to the license suspensions at Cardinal Health (CAH). Mike even quotes Richard Molitor, whom I interviewed back in February 2008. There are some eyebrow-raising statements in this article about what happened between the DEA and Cardinal, including some very negative statements from Cardinal’s former director of compliance. Hard to tell what is true and what is spin. Regardless, Mike did some nice reporting to pull together this story.

Small-town pharmacist caught up in scheme – The strange tale of how independent pharmacist Steve Holtel of Stoltz Drugs got mixed up with a national scheme to fill false prescriptions faxed from other states. All pharmacists should read this cautionary tale, although Mr. Holtel is a complex character with a troubled legal past.

Ex-employee, Cardinal both profited in buying discounted medicine – Summary of previous allegations about secondary market trading by Cardinal employees. You can read more in Dangerous Doses or Cardinal’s agreement with then-New York attorney general Eliot Spitzer.

Pending law will regulate online prescription-drug sales – Summary of the Ryan Haight Online Pharmacy Consumer Protection Act, which will be signed by President Bush any day.

Demand for addictive drugs testing security – Drug addicts are quite persistent.

----

Today’s photo has nothing whatsoever to do with this post. It’s just a friendly reminder of another great series from this blogger's hometown (despite last night's game)!

Cardinal: The Once and Future Wholesaler

Last week, Cardinal Health (CAH) formally announced plans to spin off its Clinical and Medical Products business. The post-spin business will be a return to Cardinal’s wholesale distribution roots, although getting back is only the beginning. Here are a few high-level thoughts on the pharmaceutical distribution business.

First, congratulations to management for (finally) resolving the DEA issues that have been plaguing the company since last November. (See Cardinal Health Resolves Controlled Substance License Suspensions.) I’ve written critically on Drug Channels about Cardinal’s handling of the situation and the impact on its market position with independent pharmacies and small chains. Cardinal even publicly apologized for its actions in June.

I’ve been a fan of George Barrett’s straight talk about Cardinal’s problems, especially when he publicly confirmed what I was saying on Drug Channels about market share losses among independent pharmacies. The company’s FY2008 10-K quantifies the damage:

• Overall revenue growth for the pharmaceutical distribution segment was 3.5%, which is below the company’s estimated rate of drug price inflation of 7.7% during the same time period. In other words, Cardinal’s revenues declined in real (inflation –adjusted) dollars.
• Revenue declined by $1.9 billion due to a “loss of customers.” The net effect was smaller because of price inflation, general volume growth, and the gain of new customers.
• Cardinal’s revenues from its smaller (non-bulk) customers declined by 1.6% ($680 million), while revenues from its bulk customers – such as CVS Caremark (CVS) and Walgreens (WAG) – grew by 10% ($3.4 billion).

Speaking of bulk customers, the CVS Caremark brand supply contract with Cardinal expires in mid-2009 – right around the time of the spin-off. In my opinion, this coincidence implies that management expects to continue servicing CVS Caremark’s retail business, which I have always viewed as the most likely outcome. See Wholesaler Impact of a Longs Drug Deal for background on the CVS Caremark/Cardinal/McKesson relationship.

Cardinal still faces many company-specific issues, as I noted inelegantly in an August Wall Street Journal article: “There are certainly some things that are out of Cardinal's control, such as the consolidation of retail customers; however, there are some specific issues that Cardinal has had to deal with...that are very Cardinal-specific.” Sounds like my training at the Department of Redundancy Department paid off!

BTW, anyone else catch the following comment by Mr. Barrett from last week’s conference call: “[W]e will be exploring opportunities to expand both into new adjacent spaces and perhaps new geographies. Having said this, our immediate focus is here at home and on our core businesses.” Cardinal Goes to China, perhaps?