Nick Basta

While the drug wholesaling industry appears reasonably healthy right now, the ongoing generic drug price war among retail pharmacies will create the risk of reduced wholesaler profitability. Understanding this dynamic is crucial for predicting the future of wholesaler relationships with manufacturers and pharmacy customers.

Total revenues from the drug distribution divisions of the three largest wholesalers were $255.8 billion in calendar year 2008, up 5.8% versus calendar year 2007. Although profit margins have come down in recent years, operating cash flows are up sharply since wholesalers began reducing inventory levels in 2003. Wholesalers have used the extra cash flow to buy back about $15 billion of shares, repay debt, and fund acquisitions. Return on Assets (ROA) has increased in part because the ROA denominator (inventory assets) has dropped sharply. 

Drug wholesaler revenues are linked most closely to sales of brand drugs at retail pharmacies. Revenue growth from these products will slow during the next five years as an estimated $70 billion of current branded product revenues is converted to generic revenues during the next four years. 

Despite the revenue impact of brand sales, more than 60% of drug wholesalers’ gross profits come from generic drugs. The coming wave of generics should provide an initial boost to wholesaler profitability because generic drugs offer higher gross profit margins to wholesalers. Wholesalers also have the opportunity to earn higher returns on invested capital because generic inventory costs reduces balance sheet inventory assets compared to an equivalent amount of branded drugs. 

	However, there will be countervailing pressure on wholesaler’s profit margins from generics as the pharmacy industry changes. The ongoing consolidation of the pharmacy industry pressures wholesaler profit margins from generic drug distribution. The top six dispensing pharmacies — CVS Caremark, Walgreens, Medco Health Solutions, Rite-Aid, Wal-Mart, and Express Scripts – now account for more than half of all dispensed prescriptions. 

The biggest chains act as their own wholesaler because they have developed self-warehousing capabilities for distributing drugs to individual stores from the retailer’s own warehouses. They typically bypass wholesalers to buy generic drugs directly from manufacturers, although most chains still use drug wholesalers for the warehouse logistics of brand drugs. 

Right now, pharmacies are fighting a retail price war over certain generic drugs. Wal-Mart launched its $4 generic drug program in September 2006. Non-pharmacy retail chains — supermarkets and other mass merchants – quickly followed Wal-Mart’s move. These retailers have been able to absorb lower generic margins because pharmacy represents a minority of their sales and gross profits. In 2008, the three large pharmacy chains were forced to respond and launch their own low-cost generic programs. 

Discount generic programs have two primary effects on wholesalers. One, we believe that retail market share is shifting away from wholesaler-supplied dispensing channels, especially independents, small chains, and other non-self-warehousing retailers. Independent pharmacies, which rely on drug wholesalers for 98 percent of their drug purchases, are an ever-smaller part of drug dispensing. Two, pharmacy customers require more aggressive pricing from wholesalers in order to remain competitive with the larger chains that are buying directly from manufacturers. 

Pressure on generic pharmacy profits will also increase as payers learn more about channel economics. 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 almost 70% and rising, which means that pharmacy channel costs and margins for generic drugs will be increasingly seen as a mechanism to control drug spending. The large volume of upcoming generics will focus even more payer attention on hidden economics of the channel, such as the profits on generic drugs earned by wholesalers and others.

Adam J. Fein, Ph.D., is president of Pembroke Consulting, a management advisory and business research firm. He writes the popular industry blog www.DrugChannels.net. This article is adapted from Dr. Fein’s 2009 Economic Report on Pharmaceutical Wholesalers. 

Articles

Drug Wholesalers and the Generic Price War

Every three months or so, UPS Healthcare Logistics, a dedicated unit of Big Brown for pharma, med devices and other healthcare products, announces the opening of a new distribution center or transportation hub; now it is growing by acquisition as well. The company announced the purchase of Pieffe Group, a mid-size distributor in Italy (with blue-chip clients like Pfizer, GSK, Novartis, Lilly and others), and two locations (Formello and Liscate). UPS has two other facilities in Italy, near Milan and Rome. 

Meanwhile, at presstime the New York Post reported that UPS had been looking to acquire World Courier, a Stamford, CT-based express delivery company that handles a considerable amount of clinical trial logistics, but that the reported $500-million deal broke off for unknown reasons. The Post cited sources speculating that a private-equity company would buy the firm, and quoted a UPS spokesperson saying that “We make no secret about healthcare being a strategic segment for growth.” 

About the Pieffe transaction, Bill Hook, president of UPS Healthcare Logistics, says that the company’s longterm strategy is to build or acquire resources globally commensurate with the global scale of its life sciences customers. “The Pieffe acquisition fits with our plans to expand in Europe, but more importantly, Pieffe brings the same cultural values of quality, service and regulatory compliance that we strive to maintain.” Pieffe’s existing services, beyond basic distribution, include labeling, controlled substances distribution, and temperature-sensitive handling. 

UPS has opened new facilities in Venlo, the Netherlands, this year, which Hook says will be the hub for European distribution. In addition, new facilities have been opened in Brazil; Singapore; Louisville, KY; and Canada. “Going forward, we’re looking at China, Central America and Eastern Europe,” says Hook. 

Purchase of Pieffe Group, combined with new facility launches, brings UPS capacity nearly to 5 million sq.ft. worldwide; more expected in 2012

UPS Healthcare Logistics adds to network with an Italian acquisition

Gartner’s 2011 Healthcare Supply Chain Top 25 shows considerable movement from last year’s, with Cardinal Health replacing Owens & Minor as the top billing. “Cardinal made significant gains in the opinion component of the poll, a reflection of the credibility it has established with healthcare providers, manufacturers and the analyst community. Cardinal has the closest thing to a “one-stop shop” in serving providers and gets credit for having a unique ability to support its trading partners,” according to the Stamford, CT, market research firm. 

The top pharma manufacturer on the list (see below) is Becton Dickinson; J&J, Abbott and Novartis also were in the Top 10. 

Gartner’s annual analysis is more properly a value chain analysis, emphasizing how the companies add value by means of the services they provide. By taking a focus on the “patient-based moment of truth” when services roll up to healthcare delivered to the patient, it says it can draw relative comparisons among manufacturers, distributors and healthcare systems. Mercy, a hospital network in Janesville, WI, is the top-rated healthcare system. 

“In analyzing our list this year, we see a ranking that demonstrates the importance of maintaining focus on both internal and external collaboration as the vehicle to drive industrywide change,” says Barry Blake, Gartner research analyst. “Leaders here are persistent in applying smart and thoughtful pressure to persuade their organizations to adopt processes and metrics that ultimately will lead to cost and quality enhancements for the patient.” 

Analysis combines financial and operational performance, and industry reputation, among manufacturers, distributors and healthcare systems

Gartner 2011 Healthcare Supply Chain Top 25 puts Cardinal Health at No. 1

The National Home Infusion Association (nhia.org; Alexandria, VA) represents the hundreds of businesses across the country that provide nursing and pharmacy services to homebound patients requiring pharmaceutical therapy that is typically infused. As such the organization sits at the crossroads of the booming specialty pharma distribution business 

, as well as the ongoing movement toward individualized outpatient services. For the first time, NHIA has undertaken a survey of its membership; while no one knows for sure just how many home-infusion service companies there are, NHIA believes that its 730 members represent the vast majority of service providers.

 “It’s hard to measure overall infusion services, because many of them are provided by hospitals, who may manage patients both within the facility and as outpatients; in fact, 20% of our membership is hospitals,” says Russell Bodoff, president of NHIA. “But this study is the first phase of a program that we hope will help analyze the overall industry.” 

Home infusion is further complicated by the range of services offered, notes Nancy Kramer, VP of clinical affairs for the group. She explains that services can be short-term or chronic, and can combine a variety of infused therapies, such as anti-infectives along with chemotherapy or parenteral nutrition. The common element is that the infusion is typically managed by a nurse. “A professional nurse is key,” says Bodoff. “They assess the patient condition, deliver the therapy, and make decisions about the course of treatment. The goal is to provide the highest level of independent living possible for the patient, which can be very patient-specific.” 

NHIA analyzed its member data according to three types of members: single-site, multi-site and national. Single-site and multi-site refer to the number of locations that a business operates; multi-site organizations tend to be regionally focused. Single sites are also more common in rural areas; multi-site or national in more urban areas. The “site” is where drug therapies are compounded; they often need to be tailored to individual patient needs. All these sites (including within hospitals) operate according to USP 797 standards, which require clean rooms and ultrasanitary conditions for compounding the dosages. 

Fig. 1 shows the variations in types of services, by type of provider. Providers are often chosen by insurers; some prefer to work with a national provider. Specialty-pharmacy and anti-infective therapies tend to administered most by national organizations, while enteral nutrition and pain management tend to be delivered by single-site providers. Drugs that have limited or controlled distribution strategies (i.e., most specialty drugs) tend to favor the national providers, NHIA conjectures. 

The single-largest revenue source for home infusion providers is specialty pharmacy drugs paid for by commercial health plans, which represents nearly $1.4 billion in annual revenue nationally. Self-paying patients represent the smallest revenue stream (no surprise there) at $59 million. 

Home-infusion providers use a variety of methods to get drugs deliverd to patients; beyond the obvious method of the nurse administering the drug bringing it themselves, it often works best to have the drug delivered by a courier or parcel-post company, especially in cases where patients are self-admnistering while under a nurse’s supervision. Fig. 2 shows the breakdown of how deliveries are transported. 

Bodoff says that the survey will become a first milepost for subsequent surveys that will track the evolution of home infusion business, specifically growth rates. For now, he says, member business is growing well, and, as evidenced by a markedly high level of interest among private-equity firms who are looking at the business opportunities in home infusion, a bigger part of the drug-delivery landscape. 

2010 NHIA Provider Survey Comprehensive Analysis Report

Home infusion association gathers member data, measuring variations in business practices