True Value Chain Pharma Disruption is (Finally) Here to Stay


In light of breaking news, the pharma value chain is definitely ripe for disruption. Here's how health plans, employers, and drug companies can adjust to the new normal.

Terry Stone and Julia Goldner

12 min read

Editor's Note: This piece was published prior to news of Walgreens Boots Alliance's potential acquisition of drug wholesale company AmerisourceBergen. This is perhaps yet another sign the pharma market is ready for transformation.

Did 2017 mark the start of true value chain disruption in pharma? We think the answer is yes – and it’s about time.

There have been plenty of acquisitions and alliances in the pharma industry over the past 10 years, but they have mostly focused on traditional consolidation to increase scale and buying power. Market activity has left only three or four major players in the pharmacy benefit manager (PBM), retail pharmacy, and wholesale distributor sectors.

The more recent formation of generics purchasing organizations like Red Oak and Walgreens Boots Alliance Development (WBAD) has also effectively consolidated the market, leading to accelerated generics commoditization. While these market movements have pressured pharmaceutical companies on price and negotiating leverage, the value chain has maintained the same fundamental structure for decades.

Pharma has largely been insulated from the massive value chain disruption that has shaken other players in healthcare for several reasons:

  • Drug spending, though accelerating, has remained a relatively small portion of the total $3.3 trillion spent on healthcare in America. Retail drug spending represents only 10 percent of total expenditures, according to a 2016 National Health Expenditure (NHE) report from The Centers for Medicare & Medicaid Services (CMS). That number totals closer to 14 percent when non-retail spending is included. When tackling the rising cost of healthcare, most efforts have addressed bigger buckets of spend. Many new programs focus on limiting insurer profits and better managing hospital and physician care, which accounts for greater than 50 percent of total expenditures.
  • Pharmaceutical companies were largely unaffected by the Affordable Care Act (ACA). Provisions in the ACA required health insurers to manage newly restricted margins through the introduction of Medical Loss Ratio (MLR) floors, guaranteed issue mandates, and minimum essential benefit requirements. Since the launch of the individual exchanges, many payers have reported losses on those populations; the Commonwealth Fund estimated a nearly 50 percent reduction in underwriting gain across all US insurers in 2014 alone – the first year of the exchanges. Conversely, the ACA did not hold pharmaceutical companies to as many far-reaching or structurally challenging new regulations. It is true pharma was subject to new taxes and additional rebates on drugs for Medicaid, but increased drug spending by newly insured individuals would cover the loss. More specifically, GlobalData estimated that though the ‘Branded Prescription Drug Fee’ would cost pharmaceutical companies nearly $30 billion dollars in tax over 10 years and additional Medicaid rebates would cost nearly $20 billion over 10 years, those hits would be offset by a potential $115 billion in new drug spending by the formerly uninsured population – equating to $10 - $35 billion in incremental profits. The relative impact of the ACA was far less challenging for pharmaceutical companies than for payers.
  • Pharma has enjoyed consistent legislation around patents and market exclusivity for years. In 2015, the Biologics Price Competition and Innovation Act even sweetened patent protections for innovating pharmaceutical companies – offering a 12 year exclusivity period of data protection for biologic innovators.

This protection from market forces could not last forever; the pharma value chain is ripe for disruptionIn fact, it is almost surprising disruption has not happened sooner.

  • Despite the national healthcare cost crisis, pharmaceutical companies have maintained upwards of 15 to 20 percent margins. Though these higher margins are justified by the high Research and Development (R&D) costs, significant risk, and long development lead-times inherent to drug development, the industry struggles with the disparity between pharmaceuticals and all others. Payers, providers, and drug distributors hover in the two percent to four percent margin range. PBM margins are closer to five percent, but PBMs are often criticized for a lack of transparency around their profitability.
  • Healthcare costs continue to rise, with retail pharma spend growth eclipsing the nearly five percent annual total cost growth in recent years: 12.4 percent growth in 2014, and 8.9 percent growth in 2015. In response to public demand for pharma cost controls, some companies (such as Allergan, Sanofi, Novo Nordisk, and AbbVie) announced they would not raise prices by more than 10 percent in 2017. General infighting and finger-pointing among pharma stakeholders – pharmaceutical companies, PBMs, and retailers – to assign blame for rising drug costs has persisted throughout the year. The Anthem/Express Scripts Inc. lawsuit, public statements by PhRMA, and the National Community Pharmacists Association condemning PBMs are a few highlights. Though growth in retail pharmaceutical spending was a much lower 1.3 percent in 2016 – largely due to fewer new drug approvals and slowing of spending on Hepatitis C drugs – spending is still expected to grow in coming years as the market portfolio of drugs leans toward biologic and specialty therapies.
  • Specialty drugs have demanded steeper and steeper pricing. It is not uncommon to see a new oncology therapy costing over $100,000 for a year of treatment – Celgene’s Revlimid, Shire’s Oncaspar, and Novartis’ Kymriah are just a few.
  • And the media has shined a light on some of the more unsavory pharma price hikes in the last few years – Shkreli’s decision to increase Daraprim’s price by 5,000 percent overnight, and Mylan’s decision to increase EpiPen’s price by 500 percent over the last 10 years are a couple often-cited examples, though many drugs have seen less egregious price increases.

During the back half of 2017, we started to see different, bigger, more seismic shifts in the pharma industry. New alliances & nontraditional acquisitions are disrupting the structure of the industry. The game of how to create and sustain control in the value chain is changing, and several patterns are emerging:

  • Value chain convergence to manage total healthcare cost. Several major announcements came in October and November of last year – ESI to acquire eviCore for $3.6 billion, Anthem to launch its own in-house PBM called IngenioRx with CVS’ back-office help, and CVS to acquire Aetna for $69 billion. While different stakeholders are involved, all of these deals create entities vying for breadth across healthcare in an attempt to get a better handle on total cost and own more of the consumer experience.
  • Broadening scope of the PBM as a value chain stakeholder. The CVS/Aetna and Anthem/IngenioRx announcements also have significant impact on the PBM industry as a whole. In the span of a quarter, one of three major PBMs has aligned to a national insurer (CVS) and a fourth potentially major PBM has entered the market (IngenioRx). A now-majority of the largest PBMs is linked to health insurance. ESI and other smaller independents remain – for the moment. Diplomat recently snapped up two smaller PBMs (Leehar Distributors, LLC, and National Pharmaceutical Services) to expand its effectiveness as a specialty pharmacy. PBMs are broadening their reach and capability set to bring more value to their clients.

Intensifying threat of new entrants. Just last week, a consortium of health systems – including Intermountain Healthcare and Ascension – announced plans to establish a provider-backed drug manufacturer to combat generics price increases and sporadic shortages of common medications. The providers that depend on access to critical generics to serve patients are fed up with ceding price and supply controls to a handful of drug manufacturers. Rumors of Amazon’s entry into drug distribution also emerged in late 2017. While Amazon’s wholesale distribution licenses appear to be limited to medical devices for now, it is not far-fetched to assume Amazon might enter healthcare in a bigger way. Amazon is already selling over-the-counter drugs and other pharmacy products through its marketplace, and analysts speculate of a play in the cash-pay space to come. The threat of new entrants like Amazon is intensifying, and based on market reactions to Amazon rumors, the Street believes it is real.

These ongoing shifts in the pharma value chain mean different things for different players in healthcare – opportunity and risk alike. How can the market adjust to the new normal?

  • For health plans: Unless you are Anthem, Aetna, or UnitedHealthcare, you do not have your own PBM in-house. And one of your major PBM partner options, CVS, just teamed up with a likely competitor of yours. How do you manage this change? What can be done to rethink your PBM contracting strategy, or your overall drug management strategy? Should you consider working with a smaller, independent PBM, or with a nontraditional drug manufacturer?
  • For large employers: Similar to health plans, your drug management options have narrowed. If you have carved drug away from medical, is that still the right approach – or would an integrated PBM/Insurer offer better trend? If you continue to contract for drug separately, do major PBM options still offer what you want? Should you also consider working with a smaller, independent PBM to customize your experience and offer greater transparency?
  • For pharmaceutical companies / drug manufacturers: Consolidation has been a consistent trend, but now cross value-chain integration is accelerating around (and without) you. Other stakeholders have more bargaining power and leverage than ever before. Formulary exclusion is becoming more accepted and value-based contracting is slowly becoming more common. What can you do to effectively align with science, and/or richen your portfolio? Can you maintain your strategic control by demonstrating and standing behind the impact of your drugs? 

What does 2018 hold? Our team just released our 2018 predictions, and as this post might suggest, groundbreaking change in pharma is one of them. But only time will tell if this momentum and accelerated change continues.

  • Terry Stone and
  • Julia Goldner