shutterstock_381184204.jpgBill Coyle and Paul Darling co-authored this blog post with Pratap Khedkar.

The healthcare world had barely thought through the potential effects of the CVS/Aetna merger when news broke of another deal aiming to blur healthcare’s established business models: Four provider networks announced a nonprofit collaboration to manufacture generic drugs to keep prices down and lessen shortages. Skeptics have already pointed to considerable regulatory and manufacturing hurdles, so let’s focus on strategy and not implementation. If this DIY drug supply does start flowing, will it have its intended impact?

The collaboration aims to introduce “much-needed competition” into the generics market, not to create a “competitive advantage” for the providers. It’s absolutely true that some bad actors such as Valeant Pharmaceuticals and Martin Shkreli have taken generics (those without competitors) and hiked up their prices by 500 to 5,000%, and creating more competition would benefit society by combatting such practices. But to have that effect, this effort should focus on exactly those low-volume, non-competitive product situations because the common, high-volume generics already have about eight to 10 manufacturers competing for thin commodity margins (~10%) where prices are being held at 85% below the branded price. If the providers focus on competitiveness only where it’s needed, and not on the broader, high-volume game, then it will become a niche, high-cost business—a scenario that isn’t easy to maintain.

Penetrating one part of the supply chain inevitably involves tangling with another. Supply chain stakeholders like PBMs and pharmacies make a much higher percentage of the profits and markup on generics than they do on branded drugs because of generics’ low price-per-unit base and high negotiating leverage: They have full switching power without the doctor’s permission. This is the main reason why 89% of prescriptions dispensed in the U.S. are already generic. If the providers supply these drugs to themselves and others directly (or through a GPO channel), and have a large impact with no markup, they’ll surely get a reaction from the distributors that they squeeze.

To create savings, the doctors and the dispensing party will have to choose—and prefer—this particular source, so there will need to be some extreme controls in place to limit choice. They’ll also need to determine whether the parameters apply to these four systems or across all systems that want to buy. The hospitals can gain more control of the supply chain—beyond prescribing power—through technology and stocking choices. The providers know how to control the cost of medical devices and supplies, and they’ll bring the same know-how to ensuring that this latest endeavor is successful.

While this collaboration is making headlines, and there’s evidence that it may lower provider costs, what effects could it have on the drug market in general? Is this a shot across the bow? In what way could it affect the branded drug business over the long term? Here are three considerations:

  • Transparency: Will the health systems take their own medicine and publish detailed manufacturing costs (as they’ve been asking pharma to do), and perhaps pressure others to do the same? So far, most providers have resisted being transparent about their own costs and markups on medical procedures. Will this be different?
  • Expansion: Could this idea, once established, spread to include biosimilars? There’s no shortage of companies that are interested in manufacturing biosimilars, but the rate of price erosion has been slower than expected, partly because the doctors’ practices have no strong incentive to switch. Here, the doctor’s employer would be the manufacturer, and the ASP-based approach to reimbursement would help create good provider profits.
  • Integration: Looking at the big picture, this is one more step in the ongoing vertical integration of healthcare players. We’ve seen PBMs buying payers (with some success), providers getting into risk bearing (and many getting burned), payers buying providers (with much better success), branded pharma buying generics (with some dilution), and now providers becoming manufacturers.

As the lines drawn between healthcare’s traditional business models continue to blur, healthcare stakeholders are trying to predict—and brace for—what will come next. What’s your organization doing to prepare?


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Topics: generics, healthcare provider networks, Bill Coyle, Pratap Khedkar, Paul Darling, pharma companies, collaboration, drug distribution, CVS/Aetna, drug manufacturing, branded drugs