Breaking the Pharma Industry’s Bundled Pricing Arrangements

Pharmaceutical CommercePharmaceutical Commerce - August 2023
Volume 18
Issue 4

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

Bill Roth

Bill Roth

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, 2017,1 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.

Generic manufacturer bundle

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.

PBM bundle

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.

Pharmacy bundle

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.

Distributor bundle

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.

GPO bundle

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 risks

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.

What this means to industry

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.

What to do about it?

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.

In the next column in my "Fight for the Dollar"series, 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.

About the Author

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.

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