Amazon Might Be Able To Fix The Prescription-Drug-Market Mess
Amazon Could Make Tens Of Billions By Distributing Prescription Drugs And Those Drugs Would Also Be Cheaper
By David Grace (www.DavidGraceAuthor.com)
AUTHOR’S NOTE: I wrote this column in December, 2016 and asked a friend familiar with the drug industry to review it. I was advised that Amazon could not effectively replace PBMs and that the basic premise of the column was flawed. Based on that feedback, I decided not to publish it.
On June 28, 2018 Amazon purchased PillPack, an on-line pharmacy that had all the licenses required to sell prescription drugs directly to members of the public in 49 states (Hawaii is still pending).
The thrust of this column was that Amazon should become the intermediary between drug manufacturers and drug retailers, displacing wholesalers and PBMs.
With its purchase of PillPack, Amazon may instead plan to itself become the drug retailer, ordering drugs directly from manufacturers and re-selling them directly to consumers through its PillPack subsidiary.
It will be interesting to see what role Amazon eventually assumes in the drug-distribution system.
In any event, I think that Amazon’s recent purchase of PillPack and its obvious intention to assume some role in the prescription drug business makes the publication of this column worthwhile, even if my idea that Amazon could replace PBMs is wrong .
I would very much appreciate feedback from people familiar with the prescription drug distribution ecosystem with constructive ideas on what Amazon might be able to do to lower the price consumers pay for prescription drugs.
— David Grace
There Are Five Players In The Prescription Drug Distribution System
Most people think that drug companies sell their drugs to wholesalers who sell them to drug stores where people buy them. That’s not really the case at all. The real players are:
- The drug manufacturers
- The drug wholesalers
- The drug retailers
- The insurance companies
- The Pharmacy Benefit Managers (PBMs)
Wait. The Pharmacy Benefit Managers?
What Is A PBM?
The PBM is the middle-man who sits between the first four players like a spider in the center of a web, and it takes a piece of every transaction. There are three major PBMs which comprise 78% of the U.S. market and their clients insure 180 million people.
Express Scripts is the largest PBM in the U.S. In 2013 it’s gross revenue was $104.6 Billion dollars. Industry-wide, PBMs are taking in at least $200B each year.
That means that they are adding at least $200B to the cost of prescription drugs and/or prescription-drug insurance each year.
In 2015 domestic U.S. retail sales of prescription drugs were approximately $425 billion dollars. The fees paid to PBMs were equal to almost half of the entire amount of money sick people spent on prescription drugs.
That’s a big deal.
The Drug Manufacturers
The drug manufacturers just want to make and ship big quantities of drugs. They don’t want to deal with small orders or with tens of thousands of drug stores. They don’t want to deal with insurance company paperwork. They sure as hell don’t want to deal with patients. So, they contract with third parties to do all that stuff — the PBMs.
The Drug Wholesalers
The drug wholesalers don’t want to get involved with marketing schemes, discounts, coupons or any of that kind of stuff. And they absolutely don’t want to deal with insurance companies and claims forms and collecting insurance payments. They do want to be paid promptly for the drugs they sell. So, they contract with third parties to do all that stuff — the PBMs.
The Drug Retailers
The drug retailers don’t want to deal with insurance companies and claim forms. They just want to be paid fast. And many of them don’t have the power to negotiate discounts and rebates from the drug companies. So, they contract with third parties to do all that stuff — the PBMs.
The Insurance Companies
The insurance companies don’t want to negotiate directly with dozens or hundreds of drug companies and they don’t want to deal with hundreds or thousands rebate plans or process all the rebate or coupon paperwork from thousands of individual pharmacies. So, they contract with third parties to do all that stuff — the PBMs.
How The Drug Market Really Works
The PBM contracts with:
- Pharmacies to advance insurance-covered drug payments to the pharmacies who sell drugs to the insurance companies’ insureds. For this service the pharmacies pay the PBM a fee
- Pharmacies to process all the insurance claim paperwork from the individual drug stores for sales to the insurance companies’ insureds. For this service the pharmacies pay the PBM a fee.
- Insurance companies to get rebates from drug manufacturers for drugs sold to the carriers’ insureds. For this service the insurance companies pay the PBM a fee.
- Pharmaceutical companies to increase their sales in exchange for negotiated rebates from the manufacturer for drug sales to the patients of the insurance companies that are the PBM’s clients.
Essentially, a PBM will contract with an insurer, e.g. Blue Cross, to provide drug savings to Blue Cross’ insureds and to process payments to pharmacies for Blue Cross’ insured’s drug purchases and to process rebates from manufacturers in connection with Blue Cross’ insureds’ drug purchases.
The PBM will also contract with pharmaceutical manufacturers, e.g. Pfizer, to provide increased sales for their products, e.g. Lipitor, in exchange for a rebate for purchases of Lipitor by people insured by the PBM’s client, Blue Cross.
Lastly, the PBM will contract with a pharmacy, e.g. Walgreens, to provide quick payments to Walgreens’ for sales of Pfizer drugs to persons who are insured by the PBM’s client, Blue Cross.
The PBM tells Pfizer that it is under contract to provide drug benefits to X million people, namely, Blue Cross insureds. It promises that it will help Pfizer increase the sales of Lipitor to Blue Cross’ insureds if Pfizer will give the PBM an $XX dollar rebate/payment for every a 30-day supply of Lipitor that is purchased by someone insured by the PBM’s client, Blue Cross.
Pfizer agrees.
The PBM agrees to pay Blue Cross’ obligation to Walgreens quickly for a Blue Cross insured’s Lipitor purchase and, in return, Blue Cross agrees to pay the PBM a processing fee for each Lipitor prescription that the PBM processes with Walgrfeens for one of Blue Cross’ insureds.
The PBM tells Blue Cross that it has negotiated a $50 Lipitor rebate from Pfizer for Blue Cross’ insureds under a special deal that the PBM has obtained from Pfizer.
The PBM agrees to pay Walgreens directly for Blue Cross’ insurance obligation for its insured’s Lipitor purchases and the PBM agrees that it will be responsible for collecting the insurance payment from Blue Cross so that Walgreens will not have to be involved in the insurance payment claims or collection process.
An Example
When John Smith, a Blue Cross insured, buys Lipitor from Walgreens, the PBM directly pays Blue Cross’ insurance obligation to Walgreens for that prescription.
The PBM notifies Pfizer of that sale and Pfizer sends a $50 rebate check to the PBM for that Lipitor sale to John Smith, a Blue Cross insured.
The PBM keeps $5 of the rebate and credits the remaining $45 of that rebate to Blue Cross against the amount Blue Cross owes it for the money the PBM advanced to Walgreens as Blue Cross’ share of the payment for the Lipitor that Walgreens sold to John Smith.
Blue Cross eventually repays the the PBM for: (1) the insurance-covered portion of the cost for John Smith’s Lipitor prescription and (2) the service fee for processing the paperwork for that Lipitor sale by Walgreens to John Smith, minus the $45 Pfizer rebate that the PBM has credited against Blue Cross’ payment obligation to the PBM for the insurance money the PBM advanced to Walgreens.
Since the rebate only applies to insured purchasers, all uninsured patients pay the full list price for Lipitor.
In the end, the PBM takes a share of the rebate payment form Pfizer, a fee from Blue Cross for processing the claims, and a fee from Walgreens in connection with John Smith’s purchase of Lipitor from Walgreens.
Why The PBM System Continues To Exist
Because the PBM’s paperwork processing service fee from Blue Cross is less than the rebate the PBM obtains from Pfizer for the benefit of Blue Cross’ insureds, on balance Blue Cross saves an amount of money equal to the difference between the Pfizer rebate that the PBM obtained and credited to Blue Cross and the service fee that the PBM collected from Blue Cross.
Pfizer pays the amount of the rebate as a marketing expense in exchange for increased sales.
Walgreens doesn’t care because the PBM pays them promptly and the PBM has to deal with the insurance company claims process instead of them.
The insured doesn’t care because all of this is invisible to him and the only charge he sees is his co-pay which doesn’t change.
The PBMs make hundreds of billions of dollars by being the intermediary between the insurance companies, the drug companies and the pharmacies.
The Cost To Insured Consumers From The PBM System
The net result of this byzantine system is that the cost of prescription drugs to insured patients is increased by the total of the portion of the rebate kept by the PBM plus the service fees paid to the PBM by the insurance carriers and the drug retailers.
This extra cost is reflected in increased insurance premiums.
The PBM’s share of the retail cost of this Lipitor prescription is in the range of 25% to 30% of Pfizer’s wholesale list price for the drug.
Essentially, the PBM increases the cost of the prescription to Blue Cross’ insureds by 25% to 30% of the wholesale price over and above the wholesaler’s additional 10% to 15% markup or a total price increase of 35% to 45% over what the cost would be if Pfizer sold the drug directly to Walgreens at the list price reduced by the rebate amount it was willing to give, and Walgreens directly filed its insurance claims with Blue Cross.
The Big Losers Are Uninsured Consumers
The biggest losers in this system are the patients who do not have prescription drug insurance. They pay the full, list price, including the overhead costs to the wholesaler without receiving any of the rebates or discounts negotiated by the PBM.
An Inefficient System Ripe For Disruption
This is a distribution system that is ripe for disruption by Amazon to Amazon’s great profit and to the great benefit of both medical insurance companies and, ultimately, to both their insureds and to those who are uninsured.
The Prescription Drug Market
In 2015 domestic U.S. retail sales of prescription drugs were approximately $425 billion dollars. The gross sales of prescription drugs purchased by retailers were in excess of $325 billion dollars.
How Amazon Could Disrupt The PBM System
Pharmaceutical companies are terrible at logistics, so except for sales to a few huge customers such as state or federal agencies, pharmaceutical companies leave the distribution of their products to independent wholesalers.
Amazon excels at logistics. While secure inventorying of prescription drugs and verifying the bonafides of licensed purchasers would present some challenges to Amazon’s existing distribution system, none of them would be prohibitively expensive or difficult.
If Amazon were able to garner only one-third of that $325 billion wholesale market it’s gross revenue from that activity would exceed $100 billion dollars/year. If it’s markup was only 15% that would translate to a $15 Billion dollar annual gross profit from selling prescription drugs.
Amazon Could Eliminate Quantity Discounts
Big Pharma is focused on the idea of quantity discounts. They’re willing to drastically reduce the price per dose of a drug if the quantity sold is large enough. That’s the system that keeps the PBMs profitable — they offer huge customer pools in exchange for substantial rebates and they take a cut of every rebate.
Big Pharma wants to make as few sales of as high a volume as possible and it is willing to grant rebates/discounts to get those sales.
If Amazon distributed prescription drugs, as far as the manufacturer was concerned Amazon would represent one massive buyer. Because of Amazon’s huge volume the manufacturer could give Amazon the same low prices it’s willing to give the insurance companies that are the PBMs’ clients.
Here’s the key: once the Amazon volume price was set big pharma wouldn’t care what price Amazon charged its individual drug-store customers.
From Amazon’s point of view, it doesn’t need to pursue a plan of volume discounts for its customers. Amazon has its automated warehouses and shipping services fine tuned. It profitably sells millions of small, individual orders every day. It can afford to sell drugs at the same price per dose to every purchaser irrespective of the quantity ordered by that purchaser.
That means that Jim’s Drug Store in Fargo, North Dakoka could buy 300 doses of Lipitor from Amazon at the same price per dose that CVS would pay Amazon for 3,000,000 doses.
That pricing would be invisible to Pfizer because it’s already giving Amazon the low, low 5,000,000 dose price and it doesn’t care how Amazon breaks out the individual sales.
In short, Amazon can pass the volume-purchase savings on to every consumer irrespective of whether they were insured or not.
Why Pharma Companies Would Deal With Amazon
The lower the per-dose price Amazon is willing to charge its customers the more doses will be sold to both insured and uninsured end-users, and that’s good for Pfizer for three reasons:
- It increases Lipitor’s customer base which is likely to stick with the product for life, and
- It saves Pfizer from having to make dozens of different rebate deals, and
- It saves Pfizer the cost of all those rebates which it can now skip in favor of one high-volume discount for sales on Amazon.
All Pfizer has to do is give Amazon a very low price per dose because it knows that Amazon will be selling millions of doses per month and let Amazon worry about all the logistics of filling small-dose orders.
Essentially, today Big Pharma tells the PBMs, “We’ll write you a check if you increase our sales without us having to be involved in all the inconvenient processing details.”
There is no reason why the pharma companies wouldn’t be equally willing to have Amazon handle all the messy paperwork and the logistics details instead of leaving them to the existing wholesalers and the PBMs, especially if Amazon can expand the patient pool for the product beyond that offered by any one particular PBM — which Amazon easily can because it can directly sell a discounted drug to every drug store in the country and, indirectly, to every patient in the country, insured or uninsured, at the same price per dose.
The PBM can only facilitate sales to patients who are insured by the PBM’s client insurance companies, a far smaller market pool.
Having Amazon take over the wholesaler’s and the PBM’s jobs makes life easier for the manufacturer because instead of having to deal with several wholesalers and several PBMs they can centralize both functions with just one company, Amazon.
Amazon can list Lipitor like any other product on Amazon.com (except that the purchasers are limited to licensed pharmacies) but with a transparent price schedule that takes into account all discounts and rebates.
For this service Amazon would take a percentage of the drug’s gross sales. Existing drug wholesalers take a 10% to 15% markup. Amazon could do that while eliminating the entire rebate scheme and all its related costs.
Why Insurance Companies Might Abandon The PBM Model
Under the current system the PBM adds 25% — 30% to the wholesale cost of the drugs. Eliminating that cost goes directly to the insurance companies’ bottom line.
Blue Cross doesn’t care why or how its insureds get a lower price on drug purchases. It only cares that the drugs are sold to their insureds at a discounted price.
If Amazon can deliver a lower price without the insurance company having to pay a fee to a PBM then the insurance company will be happy to see that fee go away.
Note that an important element here is that the uninsured patient would pay the same amount per dose as the insured patient, thus eliminating the inequity in the current system where the people who can afford to pay the least are required to pay the most.
Why Pharmacies Would Abandon The PBM Model
The pharmacies want to avoid the paperwork and delays of trying to get paid by the insurance companies.
The PBM fronts the money to thousands of individual pharmacies then provides a unified monthly bill and accounting to the insurance company.
There is no reason why Amazon can’t do the same thing much more easily.
Amazon’s systems will know how many doses of Lipitor were sold by Amazon to Walgreens at any given point in time. Instead of Walgreens reporting a Lipitor sale to John Smith to the PBM, it can report that sale to Amazon. Amazon will credit Walgreens’ account with the amount of the insurance payment that would be due to Walgreens for that Lipitor sale as a bookkeeping entry.
Amazon’s systems would automatically total Blue Cross’ entire monthly payment obligation to Walgreens and, on a weekly or monthly basis, Amazon would bill Blue Cross for the payments it owes to Walgreens in the same manner that the PBMs bill the carriers now. But the bookkeeping would be baked-in to Amazon’s systems and thus cheaper and easier for them to do.
Essentially, Amazon would step into the PBM’s position, cutting them out of the system and taking a substantially smaller fee from the insurance companies for the service.
Amazon could charge the pharmacy a fee equal to X% of the payment as compensation for paying the money quickly and handling the paperwork with the insurance company, and/or Amazon could charge the insurance company a fee equal to X% of the payment as compensation for aggregating all the pharmacy claims and directly making the individual pharmacy payments on the carrier’s behalf.
Pharmacies want to sell more drugs. Getting rid of PBMs would lower prices to uninsured patients which in turn will spur increased sales to uninsured customers.
Between the fees for selling the drugs (replacing the wholesaler) and fees for acting as a payment intermediary between the pharmacies and the manufacturers, Amazon stands to make billions of dollars while at the same time cutting the cost of prescription drugs to both insured and uninsured end users.
Can Amazon Replace The PBMs?
There is no part of the present wholesaler/PBM system that Amazon cannot do better, more efficiently and cheaper. The existing wholesalers and PBMs are as vulnerable to Amazon as the 1950s American elms were to Dutch elm disease.
It would take a huge amount of work by Amazon for it to own the prescription drug distribution market. If it did enter that market Amazon would add hundreds of billions of dollars to its annual gross sales volume and tens of billions of dollars to its annual bottom line and it would lower the price of drugs to every patient, both insured and uninsured.
I encourage readers with drug industry and insurance industry experience to comment on what Amazon might or should do in this regard.
–David Grace (www.DavidGraceAuthor.com)
