Wednesday, January 7, 2015

The Pharmaceutical Drug Supply Chain 101



After the drugs are approved for market, they must be manufactured.

Drugs can be branded (patented), generic  (off patent) and biosimilars.  Generics can be a “brand name generic.”  

Pharmaceutical wholesalers buy and trade in the manufactured pharmaceuticals

They are distributed by the buyer/retailers – pharmacies, hospitals and third party payers (TPPs)

The Big Three
Pharmaceutical wholesalers act as middlemen for retail drugstores. They stock brand-name drugs, generics, over-the-counter drugs and sundry items to sell to retail, hospital and clinical pharmacies. Primary pharmaceutical wholesalers can buy directly from the manufacturer.  They can also buy from secondary wholesalers. The three biggest pharmaceutical wholesalers are Cardinal Health, Inc. (NYSE: CAH), McKesson Corporation (NYSE:MCK) and AmeriSourceBergen.Corporation (NYSE:ABC).  They  generate about 85% of all revenues from drug distribution in the United States. 
In addition to these three companies, there are a number of smaller nationwide wholesalers such as Morris & Dickson, H.D. Smith, Smith Drug, Curascript Specialty Distribution, NC Mutual Wholesale Drug, Rochester Drug Cooperative and Anda Distribution.  Regional and specialty wholesalers include Burlington Drug, Dakota Drug, FFF Enterprises, Florida Infusion, Harvard Drug Group, King Drug, Metro Medical, Seacoast and Value Drug.  There are thousands of much smaller companies that are licensed as wholesalers.  The Big Three often buy out smaller wholesalers.

Additional regional and specialty wholesalers include: Burlington Drug, Dakota Drug, FFF Enterprises, Florida Infusion, Harvard Drug Group, King Drug, Metro Medical, Miami-Luken, Seacoast, and Value Drug. There are also thousands of very small companies that are licensed as wholesalers. Over the past 10 years, the Big Three companies have acquired many regional and specialty wholesalers.

Full-line wholesalers purchase inventory and often sell a manufacturer’s complete pharmaceutical product line.  They sell mostly to pharmacies.  (Keep in mind that most pharmaceutical pills cost very little to make and the markup is very high.  That is why the pharmaceutical business is so lucrative.)  Specialty distributors sell specialty pharmaceuticals mostly to physician-owned and operated clinics. Hospitals and hospital owned outpatient clinics.  These are often intravenous  drugs that must be administered.

The top five dispensing retail pharmacies are CVS Caremark, Walgreens, Express Scripts, Rite Aid and Walmart.   They account for nearly 2/3 of U.S. prescription dispensing revenues.

Pricing Basics
The price at which brand manufacturers sell to wholesalers and chain warehouses is generally the Wholesale Acquisition Cost (WAC).  This is generally a published list price minus a small discount for prompt payment and other incentives. In turn, wholesalers sell branded small molecules to retail and mail order pharmacies a few percent above their WAC, and at a 15-20% or larger discount off what is known as the Average Wholesale Price (AWP).

Providers include retail and mail order pharmacies, various wholesalers, hospitals, and physician offices that administer medicines (typically by intravenous, infusion or injection). In comparison, payers include health care plans, pharmaceutical benefit managers (PBMs), most group purchasing organizations (GPOs) and employers which do not handle drugs directly.  These reimburse providers for purchases of their beneficiaries.

Types of Drugs
Brand manufacturers (the pharmaceutical company) of  patented, small molecule drugs (branded drugs) sell primarily to wholesalers and chain warehouses.  In theory, they have relatively limited direct sales to hospitals, retail, mail order pharmacies and physician offices.  However, as we learned in my last post, Big pharma does use indirect means to encourage sales to hospitals and physicians under the guise of educational seminars and meetings, through the media and literature and various other sales incentives.

Generics and “branded” generics.  A prescription generic must contain the same active ingredients as the original patented formulation.  They may not be identical to the original drug, however. A branded generic is simply a drug that is bioequivalent to the original product, but is now marketed under another company's brand name

Biosimilars
These are distinct from the small molecule drugs.  They are larger and more complex molecules and are more costly and challenging to manufacture.  Their surfaces may fold in different ways and not block receptor sites as uniformly as synthesized small molecules. Prior to 2010 there was no procedure for generic entry of biologics.  The Patient Protection and Affordable Care Act established a license procedure for biosimilars.  Original biologics are granted 12 years of market exclusivity.

Wholesalers face different markets for branded and generic drugs. They can purchase branded drugs only from a single manufacturer, whereas they can purchase most generic drugs from many manufacturers. As a result, they can create price competition among the various generic manufacturers of a particular small molecule – that is, the expired patented drugs.

Large retail chains also buy directly from generic manufacturers and shop for the best prices.  Gross profit margins for both wholesalers and large retail chains are larger for generic than branded, patented small molecule drugs.

Many biologics are administered via injection or infusion by health care providers (i.e., physicians and nurses), rather than being patient self-administered oral tablets or capsules purchased from retail or mail order pharmacies. As a result, manufacturers of branded biologics sometimes sell directly to hospitals and physician offices rather than to the wholesalers to which the branded small molecule manufacturers usually sell.

Firms known as “specialty pharmaceuticals,” however, often provide wholesaler-type intermediary services between biologic manufacturers and providers. Biologic manufacturers generally sell products to the specialty pharmaceutical firms at a slightly discounted WAC, and often at slightly higher prices to the providers who are buying directly.

Intermediary Services
Over the years a variety of intermediary services for all drugs have increasingly been provided by pharmaceutical benefit managers (“PBMs”). Services provided by PBMs include contracting with manufacturers for third party payers (insurers, employers, governments aka TPPs).  They underwrite benefit plans, process claims, regulate formularies, operate mail order pharmacies, negotiate for rebates with manufacturers and so forth.  Obviously the PBMs are a big business and they are the administrative middleman for most consumer’s drugs.

Pharmacies can contract with TPPs.  Both TPPs and GPOs can negotiate a TPP/GPO price with wholesalers.  The chargeback is the difference between the manufacturer’s price charged to the wholesaler and the manufacturer’s contract price with the TPP/GPO.  Manufacturers under contract with TPPs provide financial incentives (rebates) for them to meet certain sales targets.  We already know that there is big money in pushing pills and it seems that everyone but the patient is handsomely rewarded along this drug chain.

Patients pay more than ever for health insurance, managed by third party payers, group purchasing organizations and pharmaceutical benefit managers.  Insurers may pay a copay or coinsurance rate – a fixed dollar amount or fixed percentage of the total cost for drugs that are purchased.  Formularies have been established.  These are lists of drugs covered by the third party payer.  Formularies can be open or closed.  Open formularies cover all drugs approved by the FDA.  Closed formularies cover a subset of FDA approved drugs and the insured must pay full pharmacy price for the drugs that are not covered.


The Red Book was one of several directory or catalog publications that provided guidelines for wholesale and retail prices of drugs.  Pharmacists used these as a reference.  The books listed a “manufacturer’s suggested retail price”.  “Trade list prices” were what the retail druggist paid for the drugs.  The pharmacy could calculate their profits based on this information.

Next, a competitive price catalog publication called the American Druggist Blue Book  began publishing a similar informational guide.  However, rather than calling them “trade list prices”, they were now called “average wholesale price” (AWP) or Direct Net Price.  They also added a “suggested wholesale price.”  The terms were misleading since the public was not receiving a wholesale price at all.

First DataBank (FDB) - the unit of Hearst Corporation publishing the Blue Book - decided to increase the AWP to WAC markup from 1.20 to 1.25 for over 400 hundred drugs in a secret agreement with drug wholesaler McKesson. Third party payers and groups representing the uninsured sued FDB and McKesson.   McKesson and First Databank were accused of engaging in a racketeering enterprise to fraudulently increase the published AWP of over four hundred branded drugs during 2001 – 2005.  According to the settlement provisions, the price of the drugs was lowered 4%.   However, small pharmacies were hurt by the loss of this profit margin.

The Prescription Drug Insurance Market
In the U.S. prescription drug insurance benefit services are typically purchased from a pharmacy benefits manager (PBM). The employer may offer medical insurance plans from multiple health insurers but require all of them to use one PBM. The PBM acts as the middleman between the employer and the health insurers and of course, will want to pay what is most economical to their bottom line.

The American PBM industry has become increasingly concentrated.  At the beginning of 2010 it was dominated by three large firms (Caremark/CVS; ExpressScripts; Medco) who had a combined market share of just under 50 percent. The three large PBMs have substantial bargaining power with manufacturers.  Obviously, they too, want to buy low and “sell” high.

WalMart Pharmacy
In September 2006 mass merchandiser giant retailer Wal-Mart announced it was offering a number of 30-day generic drugs for a price of $4 per prescription. About a year later Wal-Mart expanded the list of available generic drugs and simultaneously added a new 90-day prescription for a price of $9 per prescription, implying a dime per day cost of that prescription. A Wal-Mart spokesperson called this the “commoditization” of generic drugs, made possible in part by its buying directly from generic manufacturers and bypassing wholesalers.   

By doing this, they not only beat their competition but they increase customer traffic in their one-stop-shopping environment.  Within months, a number of other mass merchandisers and food stores, such as Target, Kroger, Safeway and Giant Food, followed Wal-Mart and began offering very low priced generics, aimed particularly at cash customers.

Other retail pharmacies responded and set up their own prescription savings clubs. In 2008, Wal-Mart entered into an agreement with the Illinois based Caterpillar.  WM would charge a zero copay for Caterpillar’s 70,000 beneficiaries on 2,500 generic drugs.  Caterpillar’s PBM agreed to reimburse Wal-Mart based on Wal-Mart’s actual invoice prices on drugs.  Caterpillar added Walgreens to its network in 2010.  Other pharmacies still have generic copayments where customers pay cash, then fill out forms for reimbursement.  Walmart streamlined the process, benefiting both the patient and their business.

Vulnerability of the Drug Supply Chain
American consumers have purchased counterfeit Adderall, Vicodin, Viagra, Xanax, flu medication and even cancer drugs that have made their way into the established pharmaceutical supply chain.  Online pharmacies that peddle drugs without a doctor’s visit are not included in these statistics – that is an entirely different subject.
Public outcry, brought together a large group of drug supply line stakeholders to try and find solutions to the problems of fake and adulterated drugs and theft of drug shipments along the supply chain.  The technology existed to effectively operate a federal electronic traceability system, but the FDA lacked the authority to implement the federal standards. The Drug Supply Chain Security Act (2013-2014 Congress) passed and is now in effect. 

Now the drug supply chain can implement nationwide standards. Numerous companies have sprung up to provide this “security.”  Tracking and tracing programs have been created and put into operation but are they unified?  How can they be when the state laws regarding interstate commerce vary so greatly? 

One state requires all medication to have a serial number and electronic records detailing every instance where the product changed hands.  Only half of the states have similar track and trace laws and their implementation and enforcement vary widely. Some states use paper – other computers.  Some start tracing and tracking with the primary distributor and others, the secondary wholesaler.  Compliance with the new systems will cost billions of dollars overall and be passed on to all those along the drug supply chain including the consumer.

The idea and the new law sound good on paper but for the unethical, laws are meant to be broken.  This is the bare bones framework of the drug supply chain.  I plan to add more pieces of the structure in future posts.

Reference and Further Reading



Contract Pharma for pharmaceutical and biopharmaceutical contract services and outsourcing

Dangerous Doses Paper Trail.  Katerine Eban.  








Pricing and reimbursement in U.S. pharmaceuticalmarkets.  Faculty research working paper series.  Ernst R. Berndt. Joseph P. Newhouse. Working Paper 16297 MIT Sloan School of Management and NBER and Harvard School of Public Health. 




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