GLG News by Adam Fein, PhD

Implications: CVS Caremark (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). 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. It seems inevitable that this war will suck a lot of margin from the pharmacy and PBM industry over the next few years. I’m also puzzled by the fit between the new generic program and the legacy Caremark mail order business.

Analysis: Walgreens (WAG) caved into Wal-Mart (WMT) last June when it reversed course and started promoting the Walgreens Prescription Savings Club. See my post Walgreens’ $4.33 Surrender to Wal-Mart. (Council site)

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,

Tom Ryan said the following on an 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.

However, 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.

Implications: 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). 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.

Analysis: 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.

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 (See Wal-Mart + Caterpillar: The Future of PBM & Pharmacy? -- Council Site) 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 New Twists for the AWP/First Databank Settlement (council site) 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.

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.

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.

Implications: Walgreens (WAG) announced the acquisition of McKesson’s (MCK) specialty pharmacy business in a win-win transaction for both companies. 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 its now-abandoned plan to buy Longs Drug Stores (LDG).

Analysis: GOOD FOR WALGREENS

Walgreens made a good strategic move when it acquired Option Care in July 2007. 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. 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 Wal-Mart + Caterpillar: The Future of PBM & Pharmacy? -- Council Site)

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. McKesson is better off building scale against AmerisourceBergen's Specialty Group (ABC), the current market leader in specialty distribution. 

Implications: The New York Times ran a story on the impact of the economy on prescriptions. The article provided many compelling personal stories to illustrate data from IMS Health showing a decline in the total number of prescriptions dispensed in the United States. 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. 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.

Analysis: 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. The company is also setting up innovative agreements that will increase their share. (See Wal-Mart + Caterpillar: The Future of PBM & Pharmacy? -- Council Site).

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’m not suggesting that the prescription market is booming, but 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. 

Implications: 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. Since the Dispatch is also Cardinal Health’s (CAH) hometown paper, there are some good insights into the ways that Cardinal has dealt with the challenges of selling to potential rogue Internet pharmacies.

Analysis: The main article ("Online Overdose") 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.

The second article ("Cardinal pays for drug slip-ups") A behind-the-scenes look at the problems that led to the recently resolved license suspensions at Cardinal Health (CAH). (See Cardinal Health Finally Resolves DEA Issue -- Council site).  There are some eyebrow-raising statements in this article about what happened between the Drug Enforcement Administration (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, but it's a well-reported story.

The other four article are also good and highlight the problems of drug diversion and illegal online pharmacies.

Implications: Last week, Cardinal Health (CAH) announced agreements with the Drug Enforcement Adminstration (DEA) regarding its license suspensions for controlled substances. These suspensions had a negative impact on the company's sales and market position. The company even publicly apologized for its actions during the suspensions. (See Cardinal Health Apologizes to Customers - Council Site). With the formal agreement, it can now get back to business and focus on the core problems with its pharmaceutical distribution business.

Analysis: Congratulations to management for (finally) resolving the DEA issues that have been plaguing the company since last November. This issue has reduced the company’s market position with independent pharmacies and small chains, as indicated in part by the company’s FY2008 10-K:

•    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).

Implications: Cardinal Health (CAH) is rapidly growing its Chinese drug distribution business, while expanding manufacturing in India (but not China). This strategy is especially interesting given Cardinal’s planned separation of its supply chain division from clinical & medical products. The era of global wholesalers is coming, with or without a U.S. importation law.

Analysis: China is one of the fastest growing markets for (legitimate) pharmaceuticals and is projected to be the fifth largest market within a few years. Thus, it may represent a growth opportunity for U.S. drug wholesalers in China.

Just consider what’s been going on in China, where the number of drug distributors in China has been dropping rapidly since the Chinese government began opening up the market in 2003. A few notable foreign investors:

* Swiss-based Zuellig Pharma has long been a major player in Asia and established a Chinese presence before distribution industry was open to direct foreign investment.

* Global wholesaler Alliance Boots entered in January 2007 by buying a 50 percent stake in Guangzhou Pharmaceuticals Corp., the third-largest pharmaceutical wholesaler in China.

* US-based BMP Sunstone (BJGP) has been actively acquiring Chinese drug wholesalers. (BMP is also linked to Alliance Boots via the Guangzhou investment.)

Implications: Wal-Mart Stores (WMT) announced an innovative new program with Caterpillar (CAT) that provides $0 co-pays on 2,500 generic drugs for 70,000 beneficiaries (employees, retirees, spouses, dependents). As I see it, the deal does not represent a direct frontal assault on PBMs such as Express Scripts (ESRX) or Medco Health Solutions (MHS). Instead, Wal-Mart is subtly undermining the PBM’s economic model, which is overly dependent on margins from generic drugs by mail. Wal-Mart’s program highlights these “excess” margins by offering an alternative channel choice. I’m also intrigued by the competitive comparison with CVS Caremark (CVS). Many of CVS Caremark's new benefit options try to create channel neutral choices (my terminology) within a restricted retail network. For example, Maintenance Choice is their drug benefit option that lets patients choose a 90-day supply from mail order or a local CVS retail outlet at the same cost or co-pay.

Analysis: Note that Wal-Mart is not giving these drugs away, despite the Reuter’s statement that Wal-Mart “will fill certain generic drugs for free.” Only the co-pay for beneficiaries is $0. Caterpillar’s health plan still pays for the drugs, but now negotiates directly with Wal-Mart rather than using a PBM intermediary.

This plan is offers a “restricted network” trade-off:
•    Give your beneficiaries freedom of pharmacy choice and pay $X for drugs.
•    Restrict choice to a more efficient channel, e.g., Wal-Mart pharmacies, and pay less than $X.

Restricting the network to Wal-Mart pharmacies won’t work in many geographies, limiting the impact on urban/suburban chain pharmacies such as Walgreens (WAG) or Rite-Aid (RAD). However, there are 12 Wal-Mart stores near the Peoria, IL, headquarters of Caterpillar, making it a more realistic option. View a map of WMT stores in Peoria.

See Walgreens’ $4.33 Surrender to Wal-Mart (Council site) for more on the retail pharmacy impact of Wal-Mart. 

Implications: Walgreens (NYSE:WAG) and CVS Caremark (NYSE:CVS) are now in a bidding war for Longs Drug Stores (NYSE:LDG). No matter which company wins, the long-term outcome will probably be negative for AmerisourceBergen (NYSE:ABC), which is Longs’ primary wholesale supplier.  The sale of Longs Drug Stores will be one more step in the ongoing consolidation of the pharmacy supply chain.

Analysis: Right now, Longs buys more than 90 % of its pharmaceuticals from AmerisourceBergen (ABC) under a long-term contract, which includes a minimum purchase requirement over the contract term. (Source: Long’s most recent 10-K filing.)

Based on the public data, I estimate that Long’s represents less than 3% of ABC’s total drug distribution revenues.

The eventual buyer will presumably want to consolidate purchasing volumes for brand drugs with its primary wholesaler while shifting generic purchases to direct relationships with manufacturers.

Here’s a quick rundown on current wholesaler relationships for brand supply at CVS and WAG:

* CVS Caremark is now the single largest customer of both McKesson (NYSE:MCK) (primarily Caremark/Pharmacare mail) and Cardinal Health (NYSE:CAH) (primarily CVS retail). CVS Caremark will decide its brand purchasing strategy no later than mid-2009.

* Walgreens is the second largest customer of Cardinal Health. The companies signed a three year contract renewal in January 2008 that will shift an estimated $2 billion in business from ABC to CAH.

Implications: Both Barack Obama and John McCain have made negative statements about the pharmaceutical industry. Both also favor drug importation into the U.S. from countries with price controls. The emergence of global wholesalers makes it more likely for an importation law to pass, despite the dangers to supply chain security.

Analysis: The current importation bill before the Senate is S.242. Senators Kennedy (D-MA) and Grassley (R-IA) just introduced S.3409 The Drug and Device Accountability Act. Section 122 of the new bill touches on drug importation safety "standards" and could be seen as foundational legislation.

Of course, importation won’t actually save very much money for consumers because most of the price differential will be absorbed by the channel. For example, wholesalers, importers and exporters are the big winners from importation because they absorb 80% or more of the price differences between European countries. (See my op-ed from last year Importation Illusions.)

That’s why I’m keeping my eye on cross-border wholesaler transactions. European wholesaler-retailer Alliance Boots entered the Brazilian market in July. Alliance Boots already has a strategic alliance with Cardinal Health (CAH) and entered the Chinese market last year. Meanwhile, both McKesson (MCK) and AmerisourceBergen (ABC) have significant market positions in Canada.

The Healthcare Distribution Management Association, which represents the drug wholesalers, has an official position against importation, stating: “HDMA is opposed to permitting the importation of pharmaceuticals. Importation, whether restricted to just Canada or not, significantly increases the likelihood of counterfeit or adulterated drugs entering the U.S. market and reaching our medicine cabinets.”
I happen to agree with HDMA on the dangers, but I wonder if their position will change if (when?) importation is legalized under a new administration.

Implications: A new OIG report highlights supposed “excess” payments by Medicare’s cost-plus drug reimbursement model, giving us a peek at the time path of generic margins in the Part B program. However, OIG overstates their case by ignoring the powerful incentives for rapid generic substitution that are created by higher profits early in the generic life cycle. Pay attention to this report because it illustrates the generic drug profit dynamics that exist elsewhere in healthcare – retail pharmacies, providers, wholesalers, and PBM mail order. And as generic utilization rates will move toward 75 percent over the next few years, I expect that pharmacy channel margins on generic drugs will be increasingly seen as a mechanism by which payors can manage their drug trend.

Analysis: The OIG looked at prices and reimbursement for Pfizer’s Camptosar (irinotecan hydrochloride) after the launch of nine competing generics on February 20, 2008. In the first month after generic launch (March 2008), the generics were priced at about one-third of the brand price and captured about 86 percent of sales.

Since Medicare pays for irinotecan through the Part B program, provider reimbursement is calculated using the Average Sales Price (ASP) plus five percent. I refer to the Part B approach as “cost plus” reimbursement in contrast to the “list minus” reimbursement models typically used for retail pharmacy. In a cost-plus model, the total margin dollars available to the drug channel are capped at a percentage of the manufacturer’s actual sales price.

The OIG report highlights the profit opportunity for providers and wholesalers created by the two-quarter time lag between the calculation of the cost-plus reimbursement benchmark and the actual acquisition cost. The Medicare Part B payment amount does not include the generic versions in price calculations until the third quarter of 2008 (beginning July 1, 2008). Since the generic came out in the middle of Q1:2008, the full price impact does not get reflected until Q4:2008.

Cost-plus reimbursement models, such as the ASP-based approach used in Medicare Part B, use market prices to dictate the pace of decline. In contrast, retail pharmacy margins can get compressed earlier in the cycle through maximum allowable cost (MAC) limits set by payors.

As I see it, the superior profitability of generic drugs for the drug channel has dramatically accelerated generic substitution rates during the past ten years. While brand manufacturers may not like this trend, private payors recognize that rapid generic substitution is crucially important for lowering their drug trend. Pharmacies, providers, PBMs, and wholesalers are all racing the clock against the expected reimbursement decline for generics.

Alas, OIG seems to miss this essential point. If Medicare completely eliminated the profit opportunity from generics (under Part B or otherwise), costs would likely increase because generic substitution would slow down. On the other hand, the big profits during the adjustment period raise eyebrows.

Thus, the real question that OIG and Medicare should ask is more complex: At what level of drug channel profits could payors still encourage rapid generic substitution while not “overpaying” for generics? Understanding how payors will answer this question will help predict the future profit streams of pharmacies, wholesalers, and PBMs.

Implications: Representatives Steve Buyer (R-IN), Gene Green (D-TX), Jim Matheson (D-UT), and Mike Rogers (R-MI) co-sponsored H.R. 5839 Safeguarding America’s Pharmaceuticals Act of 2008. H.R. 5839 was going to be incorporated into other related FDA legislation, but intense behind-the scenes lobbying by the pharmacy industry against the bill has now stopped that option. However, I believe that it would be best for the FDA to implement national serialized e-pedigree in sync with a new California timeline. Although the FDA has not decided on its next step, I presume that nothing will happen until after the Presidential election and a possible new FDA commissioner.

Analysis: As I point out CA E-Pedigree Delayed to 2015 (Council Site), the California serialized e-pedigree law will likely be delayed until 2015. Unfortunately, the federal situation will not provide a quick solution, leaving us with the prospect of managing our crazy patchwork of inconsistent state laws regarding drug distribution for the next few years.

Paul Kelly, NACDS vice president of government affairs, is quoted as saying: “We remain very pleased that Chairman Dingell has decided not to include an electronic pedigree requirement, and more importantly the track-and-trace requirement, in that bill.”

The Food and Drug Administration Amendments Act of 2007 requires the FDA to establish technology standards for the pharmaceutical supply chain by 2010. The FDA requested comments and information earlier this year. 

However, the FDA remains stymied in its attempts to implement the pedigree regulations of the Prescription Drug Marketing Act (PDMA) following a December 2006 injunction. The U.S. District Court for the Eastern District of New York recently “affirmed” the preliminary injunction against the FDA in the case of RxUSA Wholesale, Inc. v. Department of Health and Human Services (HHS). See the FDA’s Backgrounder re: RxUSA Wholesalers, Inc. v. HHS for more details.

Implications: Implementation of California’s e-pedigree law has (probably) been pushed back to 2015. The widespread industry support for the bill makes me believe that the 2015 date might actually stick. The more realistic timeline should encourage pharmaceutical manufacturers to get serious about mass serialization for their products – a necessary first step for California’s vision of serialized e-pedigree. I expect that “mass serialization” will become increasingly important for supply chain security efforts at multinational drug makers, especially given the new serialization requirements in countries such as Belgium, Italy, and Turkey. The new California legislation also clears the way for a Federal approach to serialized e-pedigree by setting strong federal pre-emption language.

Analysis: The new CA timeline comes from SB1307, a bill sponsored by CA state Senator Mark Ridley-Thomas and passed by the state assembly on August 19 by a vote of 58-1. Technically, the bill still needs to be signed by Governor Schwarzenegger to become law in California.

Here are the new deadlines for compliance:
-- Manufacturers: 50% of product lines serialized by January 1, 2015; 100% by January 1, 2016
-- Wholesalers: January 1, 2016
-- Pharmacies: January 1, 2017

There was extensive lobbying from all sides throughout the summer as everyone raced to meet the end-of-session deadline. Senator Ridley-Thomas described the process in a press release (State Assembly Aproves Ridley-Thomas Measure to Protect Public from Bad Medicine), saying:

“All vested parties, including consumer protection advocates and pharmaceutical manufacturers and distributors have reached resolution and have identified a reasonable and workable solution that will allow additional time and flexibility to comply with current requirements.”

I suggest that you read the official Senate Floor analysis for a good summary of the bill’s evolution. When you get to the bottom, you will be rewarded with a list of the 13 associations and 22 companies that formally supported SB1307. Curiously, only two of the big wholesalers – Cardinal Health (CAH) and McKesson (MCK) – are listed as public supporters.

Implications: State Senator Mark Ridley-Thomas’ editorial argues California needs its own pharmaceutical supply chain security laws because the Federal government has failed to implement the Prescription Drug Marketing Act (PDMA). However, it does not necessarily follow that every individual state pharmacy board should establish unique documentation requirements for manufacturers, wholesalers and pharmacies operating within each state. This approach has already created a disparate patchwork of inconsistent regulations for tracking pharmaceuticals in the U.S. supply chain. In the absence of federal standards, ambitious local politicians around the country are establishing their own incompatible systems, raising costs, reducing product availability, and lowering patient safety. 

Analysis:

Senator Ridley Thomas is the sponsor of SB1307, a bill that proposes a new phased-in timeline for California’s e-pedigree requirement. See CA Sets More Realistic Pedigree Deadline, but Timeline Still Uncertain (Council Site) for details, although the bill has changed slightly since my last write-up.

Senator Ridley-Thomas’ editorial also represents a response to the Schwarzenegger’s Administration new legislative proposal for California pedigree regarding an “accredited distribution chain,” which is similar to the “Normal Channel of Distribution” rules implemented in many states. California’s current legislative session ends in August, so any action on SB1307 will happen over the summer. Read the first draft proposal here.

California’s current legislative session ends in August, so any action on SB1307 will happen over the summer.

Note that there is currently a bill before Congress regarding national standards.  See National Supply Chain Security Standards Will Benefit Everyone (Council Site).

Implications: A new report from Accenture attempts to assess the financial costs of implementing a serialized track-and-trace system for the U.S. pharmacy supply chain. But even if we assume that Accenture did a credible and impartial job building their pharmacy cost models, the estimates in this report reflect an extreme situation that no one is seriously advocating. In other words, Accenture’s calculations may not be technically wrong, but its conclusions are highly misleading given actual proposals and practices regarding supply chain security. Thus, you should think of this report as the inflated, upper bound, "worst case" costs of a track-and-trace thought experiment.

Analysis:

I commend NACDS and NCPA for correctly highlighting an important barrier to authentication of serialized products at the point of dispensing. A truly closed-loop, interoperable track-and-trace security solution based on serialization requires a massive infrastructure upgrade at the 150,000+ points of pharmacy dispensing in the U.S. The report correctly highlights the fact that counterfeit drugs are still extremely rare in the United States and summarizes some of the business changes that have occurred to make the supply more secure. The full report is available online: Current Status of Safety of the U.S. Prescription Drug Distribution System

COST ESTIMATES

However, I do not believe that the cost estimates in this report make an accurate contribution to the debate over supply chain security.

Accenture created detailed pharmacy cost models for a 100% compliant “complete track and trace system” that is federally mandated to be implemented at the unique unit-level for all products everywhere at the same time.

I can’t evaluate the assumptions hidden in the pharmacy costs models because Appendix F, a detailed Excel spreadsheet with all of the calculations, was not made publicly available. But my calculations show that Accenture estimates first-year implementation costs to be about 3 percent of revenues for a pharmacy chain such as CVS Caremark (CVS) or Walgreens (WAG).

These figures are much higher than Accenture's previous cost estimates made in November 2007. I think that some of the newly-discovered costs come from additional pharmacy labor for scanning serialized products in the newer estimates as well as the assumption of complete year one implementation. But given the surprisingly large inflationary bump, I also surmise that NACDS and NCPA got their money's worth from Accenture.

A SIMPLIFIED MODEL

Careful readers will note that Accenture’s “complete track and trace system” is much more comprehensive than anything being seriously proposed or considered right now. In my opinion, Accenture has defined a “track and trace” model in an unrealistic manner and then proceeded to explain that such a model is cost prohibitive.

I’ll mention just four important ways that the actual implementation of “track and trace” will likely differ from the models estimated in Accenture’s report:

• A risk-based approach to serialization for high-risk products with the greatest likelihood of counterfeiting or diversion, which is included in H.R. 5839 Safeguarding America’s Pharmaceuticals Act of 2008. See National Supply Chain Security Standards Will Benefit Everyone (Council Site).
• “Normal Channel of Distribution” rules that exempt certain transactions in many states. Even California may incorporate this exemption, judging by the Schwarzenegger’s Administration new legislative proposal for California pedigree regarding an “accredited distribution chain.”
• Central-fill operations and mail order pharmacies that aggregate prescription fulfillment would dramatically lower the per pharmacy costs. (Neither is contemplated in the study.)
• The willingness of wholesaler’s and other third-parties to provide data center services as a fee-based service.

To be fair, Accenture's language is fairly neutral regarding the implications of the study, whereas the NACDS/NCPA press release mistakenly links the "results" to a specific legislative proposal. Hence my view that this report represents unrealistic, upper bound costs of a track-and-trace thought experiment.

Implications: Perpetual also-ran Rite-Aid (RAD) reported another quarter of weak results. When Rite-Aid Brooks/Eckerd came together in August 2006, the deal seemed to make sense given the marketplace dynamics although none of the companies were as well run as CVS or Walgreens. However, the company’s ongoing struggles support the folk wisdom saying: “If you tie two rocks together, they still won’t float.”  The widespread $4 generics strategy will hurt the company even more.

Analysis:

Last February, Rite-Aid’s stock had the dubious honor of being named the Worst 10-Year Performer when the stock was still a comparatively lofty $2.79 per share. Industry analyst Larry Abrams calculated at the time that Rite-Aid was worth more closed than as an ongoing concern. (See Rite Aid: Worth More Closed Than Open.)

Rite-Aid’s stock closed at $1.35 after its earnings release. A Goldman Sachs analyst is quoted in the Wall Street Journal article as saying “it is hard to find compelling long-term value even at the $2 level.” That must be very demoralizing for the pharmacists there.

FYI, McKesson (MCK), Rite-Aid’s primary wholesaler, generated about 15% of its U.S. distribution revenues from Rite-Aid. Their contract runs until April 2010. I presume that McKesson is keeping a tight hand on accounts receivable here.

Implications: Walgreens (WAG) has begun touting its Walgreens Prescription Savings Club, which offers a 3-month supply of over 400 generics for $12.99 (plus an annual membership fee). Walgreens latest move suggests that the low-priced generic wave is having a bigger effect that many people (including me) expected. It also means that competition in the private sector is now removing generic margin from the channel much faster than an Average Manufacturer Price (AMP)-based FUL ever could have.

Analysis:

WAL-MART SETS THE RULES

When Wal-Mart (WMT) launched its $4 generic drug program in September 2006, I viewed the move as a massive change in the U.S. pharmaceutical distribution system because it threatens our current system of cross-subsidization.”  Non-pharmacy chains followed Wal-Mart’s move – Target, Kroger, Safeway, Giant Food, et al. These retailers have been able to absorb lower generic margins because pharmacy represents a minority of their sales and gross profits.

Non-pharmacy chains are taking advantage of the high generic margins embedded within in the traditional pharmacy business model, especially for cash-pay customers. Read my most recent analysis of Wal-Mart’s generic drug strategy in Analysis of Wal-Mart's Generics Plan  (Council Site).

WALGREENS REACTS

Like many people, I’ve believed for some time that chains such as CVS Corp (CVS) or Walgreens (WAG) were not especially vulnerable to Wal-Mart’s (WMT) $4 generic program because customers with third-party insurance do not save much versus standard co-pays. Walgreens was so confident in its own business model that it issued this Statement On Wal-Mart’s Promotional Drug Pricing in October 2006:

“Walgreens will not match Wal-Mart’s promotion. Once consumers learn the fine print of Wal-Mart's program, they'll realize Walgreens offers the best value for pharmacy patients with its convenient locations, close-in parking and unique pharmacy services.”

But on the most recent earnings call, Walgreen President Gregory Wasson recanted, stating: “Discount retailers and grocery chains are picking up their pace of promotional pricing, especially in the pharmacy, which they’re using to build traffic.” Hence the emphasis on the new savings card, albeit with the requisite positive spin about convenience, service, brand, yada yada yada.

Overall, Walgreens still looks like a very strong company. The convenience factor is surely higher than Wal-Mart for most consumers. But I wonder whether Walgreens is throwing in the towel too soon simply because we are in a generic drug lull. I also note that Walgreens is aggressively (and sensibly) diversifying away from its core retail pharmacy roots.  Unfortunately, it’s very difficult to assess the true impact of $4 generics because Walgreens provides almost no public disclosure about its generic volume and margins.

COMPETITION IS EVEN WORSE THAN AMP

Most pharmacists have been fretting about reduced generic margins for Medicaid scripts if the Average Manufacturer Price (AMP) rule ever gets implemented (and cheering every legislative victory.) But Walgreens' move signals that competition among pharmacies is now removing generic margin dollars from drug channels much faster than AMP. I suspect that Pharmacy Benefit Managers (PBMs) will be worried by Walgreens decision, too.

I have been trying to warn pharmacists for the past year that AMP is NOT the single biggest threat to the survival of independent pharmacies or to generic script margins. The pharmacy shakeout is coming, but don’t put all the blame on CMS.

Implications: Average Wholesale Price (AWP) data for pharmaceuticals is still being published, but will continue to lose appeal as a reimbursement benchmark for pharmacies and Pharmacy benefit managers (PBMs).  The latest amended (and still unapproved) settlement does not require First Databank to stop publishing AWP or roll back AWP on all drugs. Nonetheless, First Databank has announced that it will unilaterally roll back the AWP for all drugs to 1.20 and discontinue publishing the Blue Book AWP data independent of the litigation. So the outcome would be the same (no more published AWP) although the currently proposed settlement does not technically require the demise of AWP.

Analysis:

Alternative list price benchmarks, such as WAC, are likely to become more common. Example: the Department of Defense’s TRICARE contract that I discuss in Will TRICARE Boost WAC for PBM Pricing? (Council Site)  Where possible, pharmacy benefit managers (PBMs) will be structuring reimbursement relationships to maintain dollar-based economic arrangements regardless of the benchmark.

Computed (non-list price) benchmarks such as Average Manufacturer Price (AMP) could one day become the norm for retail pharmacy, but the legal and publication status of AMP makes the timing very uncertain. See The AMP Pharmacy Reimbursement Saga Drags On (Council Site).

Since AWP is still widely used as a drug reimbursement benchmark for pharmacies and PBMs, the original June 2007 proposed settlement was rejected in January 2008. In particular, pharmacy associations objected to the proposed class settlement, including the Pharmaceutical Care Management Association (PCMA), the National Community Pharmacists Association (NCPA), the National Association of Chain Drug Stores (NACDS) and the Food Marketing Institute (FMI).

This latest amended settlement was filed in June 2008 and would require First Databank to roll back the AWP-to-WAC markup only for the subset of about 1,400 drugs identified in the original complaint, among other actions (such as paying $1 million).  See the June 2 letter on FDB's website.

Implications: Cardinal Health (CAH) has recently started publicizing An Open Letter to Our Customers from Chairman and CEO Kerry Clark.  Cardinal is still struggling to balance their enforcement responsibilities with the legitimate needs of pharmacies and patients. While Cardinal desperately needs to resolve its DEA issues, I think that the company still has an opportunity to recover from its missteps and regain some lost market share.

Analysis:

The company's apology was published on the inside cover of Drug Topics magazine, among other places and was recently posted on their web site.

The letter acknowledges an “unintentional” lack of due process that I described most recently in More Trouble for Cardinal Health (Council Site).

Here’s a key passage:

“In our zeal to do the right thing in addressing the diversion issue, we unintentionally put an undue burden on some of our legitimate and long-standing customers. This is disappointing to all of us, and we apologize to those customers who have been affected.”

George Barrett described the challenges facing Cardinal in refreshingly candid statements last month, which was an important first step.  (See Straight Talk From Cardinal Health’s George Barrett – Council Site). Mr. Clark’s letter is another step on the road to recovery.

The NCPA, which represents independent pharmacies, is also concerned about the DEA’s efforts to make wholesalers responsible for stopping diversion by pharmacies. So, the group is “gathering information that Congress can use to exercise its oversight authority and get involved” according to this item on the NCPA web site.

NCPA is encouraging pharmacies that have had difficulties ordering C-IIs and C-IIIs through a wholesaler to e-mail the NCPA government affairs department. If you are skeptical, just keep in mind that the NCPA has demonstrated an impressive ability to gather affidavits from independent pharmacies, such as the 22 statements compiled for the First DataBank case. Stay tuned for more on this issue and whether it will impact Cardinal Health.

Implications: California State Senator Ridley-Thomas has proposed further extensions of the deadline for serialization for pharmaceutical manufacturers.  I’m encouraged that California will be incorporating more realistic timelines for serialization, especially given the unknown prospects for national standards. However, it's harder than ever to predict the precise future deadlines that manufacturers, wholesalers, and pharmacies will face.

Analysis:

The CA Board of Pharmacy extended the e-pedigree implementation deadline to January 1, 2011.  See California Delays Drug Tracking Law to 2011 (Council Site).

But SB1307, which was introduced by CA State Senator Ridley-Thomas in February and passed by the State Senate last week, now proposes the following new e-pedigree implementation timelines:

* Wholesalers: January 1, 2011

* Pharmacies: January 1, 2012

* Manufacturers: January 1, 2011 to January 1, 2013

The manufacturers have a phased in serialization schedule under SB1307 because “the process of implementing serialized electronic pedigree for all prescription drugs in the entire chain of distribution is a complicated technological and logistical undertaking for manufacturers, wholesalers, pharmacies, and other supply chain participants. The Legislature seeks to ensure continued availability of prescription drugs in California while drug manufacturers implement these requirements.” (according to page 10 of the bill’s text.)

Here is the proposed schedule by which a manufacturer must (1) designate the particular drugs that will be serialized, and (2) actually comply with the serialized electronic pedigree requirements:

* Designated by January 1, 2010; Compliance by January 1, 2011: 20 percent of drugs

* Designated by January 1, 2011; Compliance by January 1, 2012: 30 percent of drugs (Total = 50 percent)

* Designated by January 1, 2012; Compliance by January 1, 2013: 50 percent of drugs (Total = 100 percent)

It is unclear how manufacturers and wholesalers will manage the legislative risk associated with this potential CA state bill compared to the national bill (H.R. 5839 Safeguarding America’s Pharmaceuticals Act of 2008), which proposes Federal preemption of the multiple state-level mandates.  See National Supply Chain Security Standards Will Benefit Everyone (Council Site).