Bill Roth, IntegriChain

If you have spent any time thinking about or interacting with the channels in pharmaceuticals recently, you’ve probably thought to yourself, “I think something has changed.” We have retail pharmacies turning away branded prescriptions. We have wholesale distributors charging fee-for-service rates of 300% to 500% of what they had charged just five or six years ago. We have group purchasing organizations (GPOs) thinking about selling to private equity. We have new retailers, GPOs, and distributors getting into the business, while legacy players complain about declining margins. We have pharmacy benefit managers (PBMs) under significant fire exposing their desire for high wholesale acquisition costs (WACs) and average wholesale prices (AWPs). And according to the American Society of Health System Pharmacists, we hit a record of generic drug shortages in the first quarter of this year, while we have report after report of generic manufacturers selling or discontinuing portions of their product lines or simply shutting down their businesses and walking away. What’s happening?

We’ve spent the last year or so staring at these behaviors and have come to a central conclusion. The impact of the 2016 branded patent cliff—in association with the implementation of the 2017 CPI-U penalty for generics—have sent shock waves through the business models that have relied on them for decades. The business areas described above all took significant hits to their financial performances, resulting in changes in leadership and management teams. And we’re seeing these new teams attempting to reinvent themselves while holding their models together.

As noted in a position paper by Bates White Economic Consulting from Sept. 12, 2017,

 the CPI-U penalty on brands resulted from the enactment of the Omnibus Budget Reconciliation Act of 1990 (OBRA 90), when the US government imposed certain regulations on the prices of sole-source (patent-protected) medicines' additional rebates to Medicaid based on the rate of price change over time relative to the overall rate of inflation as measured by the consumer price index for urban consumers (CPI-U). Essentially, if a product’s price has risen faster than the CPI-U, the company selling that product is required to rebate an additional amount to Medicaid that is equal to the amount by which the price of product has exceeded the rate of inflation. As part of the Bipartisan Budget Agreement of 2015 (BBA), Congress extended the CPI rebate provisions to multisource generic drugs.

It may not be an obvious aspect of the pharma industry that so many business models work on a bundled pricing schema that has become highly dependent on economics for generics. In a bundled pricing model, some portion of the products sold are sold well below their cost (usually brands), while the other portion is sold at some higher margin (usually generics). For this bundled pricing arrangement to work for the seller and buyer, the product mix must be predictable and balanced. For the last six years, this has been slowly eroding business models now trying to reinvent themselves.

In this issue's column, I’ll cover five of the bundle-types affected by the trendline on the demise of new item generics, along with the impact of the inability for generic manufacturers to raise price.

For those familiar with generics, historically, larger generic manufacturers have sold about a third of their product at a loss while making enough profit on the remainder of the line to clear an aggregate profit. The loss-leading third works as a hook to secure the relationship with the buyer, and the remainder is where the profit has typically been realized. From the mid 1990s to the mid 2010s, new item generics 

launched at a fever pitch pace, with 2012 being the pinnacle year for generics. New item generics are important to the industry as the generic typically launched at a price between 50% to 90% of the reference product depending upon market competition and reimbursement levels. Then, as more competition entered the generic drug class and reimbursement declined, the price would eventually bottom out at around 5% to 10% of the reference product, the competition would exit the market, and the two to three products left would raise price back up to a balanced level. After 2016, there were no more notable retail generics coming, and on Jan. 1, 2017, the CPI-U penalty was added to generics, creating the inability to raise price as this serves as a penalty due payable to Centers for Medicare & Medicaid Service (CMS) on Medicaid volume.

Given the pressure that the loss of this model placed on channels such as retail pharmacy and wholesale distribution, the purchasing alliances such as Red Oak, WBAD, or ClarusOne, and large hospital GPOs, such as Premier, Vizient, and HealthTrust, have been pressing down on the full portfolio. However, these actions have a long-term effect of decreasing the overall size of the generics market, and brands are simply not as profitable as generics to the channels.


Ask any PBM leader from the late 1980s to current day, and they will proudly describe the role they played in converting sales of branded pharmaceuticals to generics pharmaceuticals. This was their main value proposition to plan sponsors and the reason that retailers used to love PBMs. (Yes, that’s changed quite a bit over the years.) The PBMs would set incentives for a retail pharmacy to maintain a ratio of generics to brands, and if the retail pharmacy sold enough generics, they could receive higher reimbursement margins on all their products. Retailers gladly complied, as dollar for dollar, the retailer could make four to five times the dollars on new item generics. The success of this model is evidenced by 90% of the prescriptions that flow out of a retail pharmacy are generics.

How fast could a retailer convert a branded pharmaceutical prescription? The typical conversion rate since the mid-to-late 1990s has been 90% within the first month; if a brand had a list price of $100, the retail pharmacy might make 5% to 7% percent on it, or $5 to $7. When a generic would launch at, for example, 70% of the brand reference product at $70, the retail pharmacy would make somewhere between $20 to $30 on that same prescription. This was accomplished by the combination of better reimbursement rates and more opportunities for the retail pharmacy to source product. Then, as the price of the product declined and reimbursement went with it—usually driven by the maximum allowable cost (MAC)—the profit would decline to something less than the original $5 to $7 the pharmacy made on the brand. The retail pharmacy would then need to look out to the next new generic for their next opportunity. That is the importance of the 2016 patent cliff and 2017 CPI-U penalty. But payers have held retail pharmacies to that bundled mix of generics to brand and have optimized the reimbursement incentives to continue to favor the generic by both improved dollar economics on the generic and extremely low reimbursement on brands, which are currently at 3%.

This low reimbursement threshold combined with the pharmacy’s cost to service the prescription due to step edits and prior authorizations on some brands has retail pharmacies not accepting some prescriptions for brands—especially new products.

A common question people ask in the industry is how does the wholesale distributor sell branded prescriptions to retail pharmacies at cost less 4% to 5% and to hospital and institutional pharmacies at cost less 5% to 10%? The answer: their generic-to-brand bundle and how they receive their discounts and fees on WAC, and not the contract cost of the product. Just like the payer’s incentive for the pharmacy to sell generics, wholesale distributors create an incentive to buy generics. For years, the wholesale distributors have been able to maintain 85% of their revenues as brands and 15% as generics.

The impact of the patent cliff and CPI-U penalty to them was that brands keep marginally increasing price and new brands keep coming to market, and without new item generics, the dollar portion of generics dropped. Prior to the patent cliff, wholesalers made gross margins of roughly 4.5% on brands and 20% on generics. This mix of product and profit worked as retail pharmacy made enough reimbursement dollars to pay a premium for the generics for the benefit of buying brands that they would otherwise have to buy at cost less 2% for their cost less 4% to 5%.

With generics as a shrinking portion of the mix, the wholesalers have had to extract more dollars out of manufacturers significantly reliant on their model—specifically, emerging manufacturers (those with one to three products and just starting out), biosimilars, and generics—either smaller companies or the two-thirds of the bundle mentioned in the generic manufacturer bundle. This is creating significant problems for these types of manufacturers and is a direct impact to several of these product types failing to gain the sales and net revenues that had originally been forecasted when they decided to bring these products to market.

Once the distributor bundle is understood, it’s relatively straight forward to understand the GPO bundle. While safe harbor takes effect here, it’s customary for a brand to pay administration fees of 0.5% to 2%, and generics to pay 3% to 5%. This model, too, relies on generics to be priced high enough to generate more dollars. Add to this issue the growing trend of short supply in generics, and the problem compounds itself both for the GPO and its downstream members.

The immediate risk is to emerging pharma, biosimilars, and generics, while the longer-term risk is to branded manufacturers. As a result, we all need to think about the channel through which they sell product to resellers and to patients. As PBMs, retailers, GPOs, and distributors have worked a certain way for more than 20 years, we all have taken their models for granted: we believe they will always be there and will always operate the same way.

While not obvious, the rates of abandonment of some brands have reached 40% to 50%, and even 60%, and adherence to prescribed regimens still hover at the same 75% rate they have over that time. That means that roughly 50% to 60% of legitimate branded prescription volume is lost because the channels have relegated brands to loss-leader positions, and the reimbursement margin is not enough to cover the pharmacy’s cost to service that prescription.

It’s a wakeup call to all of us. The profit left in these businesses is in generics, but even there, there is a movement to shift the sale away from insurance sponsored to cash. That is the trendline that Mark Cuban’s Cost Plus Drug Company, Amazon Pharmacy, GoodRx, and others are assuming/hoping will happen. The industry hangs on this thread and branded manufacturers have to think in new ways.

If we do not act as an industry, the likely outcome is the lack of commercial uptake, product discontinuations, divestitures, bankruptcies, or as we’re starting to see, manufacturers removing their portfolios from Medicaid and, consequently, 340B. This means rethinking PBM contracting and whether cash is a better way to sell products at retail pharmacy. This means rethinking retail pharmacy. This means rethinking the role that GPOs can or need to play. And, of course, this means rethinking modes of distribution.

I will focus on the movement to cash pay. As the generic space appears to be another bubble set to pop in general, it seems only fitting. Layered in this is likely to be the rise of the eCommerce pharmacies focusing on this trendline. I’ll also dive into the "Fight for the Dollar" more at the Access Insights Conference in November.

Bill Roth is the SVP of IntegriChain’s consulting business, which includes Blue Fin Group, a strategic consulting company he started in 2001, and the existing IntegriChain operational consulting business.

1. Manning, R.; Selck, F. Penalizing Generic Drugs with the CPI Rebate will Reduce Competition and Increase the Likelihood of Drug Shortages. Bates White Economic Consulting. September 12, 2017. 

https://www.accessiblemeds.org/sites/default/files/2017-09/Bates-White-White-Paper-Report-CPI-Penalty-09-12-2017.pdf

Articles

How the ‘fight-for-the-dollar’ is coming and likely will impact the bundled pricing of industry stakeholders.

Breaking the Pharma Industry’s Bundled Pricing Arrangements

Back in the mid-2000s, my management team made the rounds with industry leaders of healthcare payers, pharmacies, and distributors to alert them to a trend we saw. The response, however, was denial. We were attempting to alert them to a major seismic shift in the pharmaceutical market: new products coming to market were very different than the primary care brands and generics that our industry had nurtured for the past century, and we all needed to get ready for change.

The extreme examples driving the change were precision medicines, such as cell and gene therapies and orphan and rare drugs—with patient counts of less than 100 to less than 10,000, and price tags in the hundreds of thousands if not millions of dollars. We recognized these products didn’t fit into the large decaying legacy payer, pharmacy, and distribution models that formed in the 1980s and '90s.

In part, we were curious to know how these channels would evolve to embrace the new science but also to provide a heads up so the channels could begin to think about what might need to evolve and how they would accomplish their evolution. The lack of foresight—and inability to openly admit—that the industry was changing was disheartening because it meant that our manufacturer clients would have to design new models to accommodate the new realities of uber-low patient counts, exorbitant prices, payer hurdles like we’d never seen before, and complexities of therapy management.

We even had one executive tell us, “You’re going to have to pry our [historical] business model out my cold dead hands.” Within 10 years, that executive was no longer with the industry, let alone the multi-billion-dollar company he used to lead.

The point in this history lesson is that 20 years ago, Blue Fin Group saw a phenomenon developing that changed how products were commercialized depending on their “product archetype.” Fast forward to today, we track and analyze 10 archetypes—traditional brand, generic, vaccine, specialty lite, specialty generic, biosimilar, specialty (self-administration and healthcare provider administration), orphan and rare, cell and gene, and digital. When developing commercialization strategies, we separate and segment these archetypes because the payers, providers, pharmacies, patients, and physical flows are significantly different for each one.

A shelf life to the ‘copy-and-paste’ model

Having now worked with more than 450 pharmaceutical manufacturers, most struggle to visualize these segmentations and instead apply a “copy-and-paste” model to their contemporary commercial strategies based on the old models that gave success once upon a time. If we go back to a more simplistic time prior to the '80s, the pharmacy world was primary brand and primarily a cash-pay market. Pharmacy benefit managers (PBMs) did not exist. Generics had not really penetrated the market yet because there wasn’t a significant need. The concept of specialty was mainly around blood products, fertility, and HIV.

As PBMs came to power and the generics improved their quality and availability, the '90s and '00s were filled with rising brand prices combined with more generics that brought significant savings to plan sponsors and enhanced margins to payers, pharmacies, and distributors. But like most good ideas, there was a shelf life. The money to be made in generics was primarily in the first six to 18 months of introduction, and as long as new-item generics kept coming to market, all was well.

2012 marked the pinnacle of the “primary care LOE wave,” and 2016 marked the end of the party. The stocks of PBMs, retail pharmacies, and distributors took massive hits. Executive teams fully changed over. Business models were destroyed, not because of mismanagement or competition, but simply because one archetype took over from another. And this has been the trendline.

Here in 2023, we are facing the next wave of archetype transition, known as the “specialty LOE wave.” It features the expansion and explosion of proteomic and genomic medicines, and is hitting at a time of massive payer and regulatory reform. With more than $228 billion worth of specialty products set to lose exclusivity on their patents from 2023 to 2028, there is significant consideration for what this might mean. Many channels are counting on the success of specialty generics and biosimilar products. But traditional brand or reference products aren’t necessarily sitting back and converting markets like they did for primary care. The successful companies that are either defending their market or penetrating are realizing that even specialty generics and biosimilars need many elements of a traditional brand commercial strategy. These products still face prior authorizations, step edits, patient out-of-pocket hurdles, and other headwinds. For example, does interchangeability matter on a biosimilar if the product is not covered by the payer? That is what several adalimumab manufacturers are learning as they get to launch their generic products against the juggernaut Humira.

The market is experiencing similar trends now with so-called "specialty lite" products priced between $5,000 and $25,000 annually; there is no pharmacy that will support these products. They are too complex for retail pharmacy, which is 92% generic, and they are not priced high enough to be considered by specialty pharmacy. It’s simple: the economics don’t work for pharmacy, or at least not the current pharmacy models. Mind you, this is where e-commerce and digital pharmacies are supposedly coming to the rescue, but they have their own set of challenges with payer access, coordinated care, and the splintering of the patient journey by exacerbating the growing issue with polypharmacy.

So, what are the implications to industry? In a word: complexity. It means that each product, and, therefore, every commercial strategy, is essentially a snowflake of a business model—meaning that no two products or commercial strategies can be the same. If your team, advisors, or consultants are approaching you with “trust me I’ve done this for X number of years,” run, don’t walk away. With highly varied therapeutic areas, benefit designs, payer mixes, patient counts, payer headwinds, prescribing requirements, and regulatory headwinds, all the pieces of a commercial strategy need to align. The simple implication to pharmaceutical manufacturers is that copy-and-paste or ChatGPT-generated strategies aren’t going to get the manufacturer too far.

The ability to see even one to three years into the future has become a challenging task with huge downside risks. And the customers of pharma manufacturers—the payers, PBMs, pharmacies, and distributors—aren’t going to provide direction or insight as they themselves are figuring out how to survive this new world.

A practical first step is to consider the current and future portfolio. What therapeutic areas, archetypes, and benefit structures are likely in the development or M&A plans? A line we have been saying around the office recently is, “If the manufacturer is lucky enough not to be handed a complete response letter (CRL), what are the chances of a positive gross-to-net?” Enter the golden age of the CFO.

For the last two to three decades, pharma manufacturers have operated in commercial silos with marketing, field sales, payer and market access, channel and distribution, and patient support services operating as separate business units making decisions that have profound implications to net revenues and government prices. We see this mindset coming to an end and more fiscal planning and projections being the future.

But this is met at a time when payer, pharmacy, group purchasing organization (GPO), and distribution channels are fighting quarter by quarter to hold on to their own business and margin. That’s why we are coining the phrase that “fight for the dollar” is the new “flow of the dollar.” Models that show product simply moving from a third-party logistics provider (3PL) to a wholesaler, to a pharmacy, and to a patient with payer coverage and happy providers are only true for a small and shrinking portion of the market.

Look to the future and ensure you and your commercial teams are as educated as possible on industry and commercialization trends, along with new concepts of distribution and patient access, and, importantly, stay nimble. Stay tuned for my next column where we’ll dive deeper into the flight for the dollar and what you can do to prepare yourself for commercialization success.

New PC column explores commercialization trends and how pharma can adjust to the new squeeze of market, regulatory, pricing, and gross-to-net pressures.