Rob Besse, Senior Vice President, Principal, Archbow Consulting

Fair Market Value (FMV) is a legal concept in the pharmaceutical industry that defines the appropriate amount to pay for services. It's a critical component of compensation arrangements and a regulatory compliance issue. FMV reports help determine the value of bona fide service fees rendered during government price reporting and provide financial guardrails during wholesaler distribution service agreement negotiations. They are often referenced to justify certain fees the manufacturer cannot exceed. While no single formula is defined by law to guide the development of FMV calculations, should an entity be investigated for violating the False Claims Act or Anti-Kickback Statute, its FMV calculations will be highly scrutinized. Therefore, FMV calculations are typically created using analyses and feedback from internal compliance, outside legal counsel, and consultant firms and must be carefully documented with regular internal and external reviews.

Given the rigor and expense of developing FMV calculations and the sensitivity of pricing negotiations, they are treated as highly confidential information. Their existence is often shared with wholesalers in service fee negotiations to justify arguments for lower price points. Wholesalers frequently push back against FMV arguments during negotiations, insisting that these fees do not account for the full range of services they provide. They are keenly aware of their own costs thus are motivated to maximize fees during manufacturer negotiations to achieve margins consistent with “like” brands.

Before these negotiations commence, each party must assess its Current Market Leverage (CML), which we are redefining from a financial debt risk metric to the degree of leverage each party 

 they can exert. This can be a valuable strategic effort by pharma to help align financial and operational expectations within the organization.

Distribution Services Agreements (DSAs) between wholesalers and pharmaceutical manufacturers were designed to create financial and operational service terms for which a wholesaler would be compensated and create more predictable inventory management and performance expectations for both parties. Wholesalers analyzes each deal to determine if the DSA will produce a positive net profit consistent with their anticipated gross margins.

Wholesalers' buy-side economics are extracted through distribution fees and prompt pay discounts, which depend entirely on the drug's Wholesale Acquisition Cost (WAC). Wholesalers are highly motivated to understand the WAC, patient population and target customers for every new drug they distribute. Managing inventory levels is crucial since significant wholesaler capital can be tied up in product and price increases 

Wholesalers’ sell-side economics are heavily influenced by a customer’s overall revenue potential, prescription purchase share commitments (ideally >90%), product mix (generic, biosimilar, specialty, and brand—in that order of profitability), and contract utilization. The ideal wholesaler account purchases high percentages of generics and biosimilars, utilizes 340B or government contract pricing, and agrees to short customer invoice terms. The resulting financial proposal will include discount tiers differentiated by invoice terms and contract type that will be regularly “graded” and re-evaluated.

When does Pharma have a higher degree of Current Market Leverage?

We recommend that pharmaceutical manufacturers consider the following questions when determining their CML:

This is a hot topic in the industry. As mentioned earlier, wholesalers primarily make money as a percentage of WAC applied to distribution fees and prompt pay discounts. These fees and discounts consume most operating costs. Low WAC prices, low units/orders overall demand, and the aforementioned sell-side economics can indicate that wholesalers may lose money on every sale. This creates more pressure to increase fees, which can counter FMV assessments. It has also created significant concern when manufacturers significantly lower their WAC pricing long after the fees were negotiated.

Patient access to therapy is the ultimate goal. Denying legitimate access to a patient in need is a lose/lose scenario. It is essential to meet the patient where they will be treated and not force alternate models that can cause undue pressure on the patient, their caregiver, or health care professional. If a new drug is an oral preparation dispensed at a retail pharmacy, ensuring access at chains, independents, and/or mail-order pharmacies via their preferred vendor wholesaler may be critical. If a new drug is a cold chain biologic that will be infused at an oncology clinic, ensuring access through their preferred Specialty Distributor may be critical. The financial agreement between each customer and their wholesaler will unlikely change to fulfill a manufacturer’s desire to pay less. This does not mean the wholesaler holds all CML, and there are other access factors to consider.

Does my therapy have any significant brand or generic alternatives that would create less urgency for the wholesaler to make it available at launch?

. They can auto-substitute (per customer approval) or make therapeutic suggestions for AB-rated generics via their ordering systems. They can use their GPO entities or paid marketing efforts to make specific therapies more visible, but their main goal is always to have the drug available. The more unique the therapy, the more pressure on the wholesaler to stock the product immediately at launch. But the opposite can also be true. If alternatives are readily available, the sense of urgency by the wholesaler may lessen, putting more pressure on the pharma company to compromise during negotiations to achieve launch access. But this leads to the next question.

 distributing through each wholesaler, and what is my fee structure by existing brand?

Given their buying power and higher overall customer demand, larger pharma companies have more CML over smaller ones. They expect to pay less and generally do. Wholesalers are motivated to keep existing fee structures static or raise fees if CML allows. Emerging manufacturers with unknown demand should expect to pay more—and generally do. Wholesalers will argue that emerging manufacturers gain instant entry to the same highly efficient distribution systems that much larger manufacturers already access.

Is my product temperature-sensitive, or do we have any regulatory concerns

Drugs that require cold chain storage and shipping cost more to handle. Controlled substances have more DEA and state regulatory risks and costs. These risks are especially true in light of the national opioid settlements.

These are just a few of the questions pharma should ask before wholesaler negotiations. Unless alternate distribution models can be made more viable, the vast majority of drugs will continue to be distributed by McKesson, Cencora, and Cardinal. These entities have invested significant infrastructure capital in enhancing efficiency and cost-effectiveness and are unlikely to adjust their negotiation approach or manufacturer-calculated FMV rates.

Aligning realistic financial and operational expectations using the scenarios above and a strategic plan may result in a win/win scenario for both parties, thus preserving precious patient access to effective therapies. Contact Archbow Consulting today if our expertise in this space can help your team.

Rob Besse is a Senior Vice President, Principal, and Subject Matter Expert in Distribution at Archbow Consulting

Articles

How pharmaceutical manufacturers should consider their Fair Market Value cost assessment compared to their negotiation leverage when contracting for distribution services
