Call To House Republicans On Pharmaceutical Supply Chain Middleman Investigation. Put On The Gas.

In February, the House Republicans launched investigation of the role of pharmaceutical middlemen in the cost of healthcare. My advice? Put both feet on the gas, look deep, and don’t glance back. Side-step the lobby efforts. Take no hostages. Please help save the healthcare value chain from the current dysfunction.

pharmacyxx_016_ls.JPG Richard Burge, owner of Baneth’s Pharmacy. *Richard Burge, owner of Baneth’s … [+] Pharmacy, is waging a one man battle against the way pharmacies are paid. The targets of his ire are pharmaceutical benefit managers, which are essentally middlemen that promise to use their mass buying power to secure discount for employers and health plans. Burge’s battle is taking the form of the pharmacy dropping its contract with the Health Plan of San Mateo on April 1. That contract accounts for about a third of his business and includes the country’s Medi-Cal and Medicare patients. Burge says the health plan signed such a lousy contract with its middleman that he can’t survive. This is a pretty unusual, drastic move for a pharmacy to take. Photo taken on 3/27/06 in Menlo Park, CA. Photo by Lea Suzuki/ The San Francisco ChronicleRan on: 04-05-2006 Pharmacy owner Richard Burge says he can no longer afford to fill prescriptions for Medicare and Medi-Cal patients. (Photo By Lea Suzuki/The San Francisco Chronicle via Getty Images)

San Francisco Chronicle via Getty Images

Ironically, the most profitable value chains—pharmaceutical and medical device— have the lowest level of supply chain expertise. The practices are unequal to those in other value chains.

Richard Burge, owner of Baneth’s Pharmacy, is waging a war on pharmaceutical benefit companies. A pharmaceutical benefit company charges a healthcare service provider to negotiate prices while pocketing rebates. The result is lower profits for the independent pharmacy, like Richards’s, while distorting the demand signal for manufacturers increasing overall value chain waste. Over the last decade, the number of middlemen in healthcare grew, each with a self-serving agenda.

A Call For Leadership

Leadership to solve healthcare costs, and improve the value chain from branded manufacturers, is a vacuum. While leaders in other value chains collaborate to improve value chain initiatives, no leader is emerging in the pharmaceutical or medical device supply chain to improve transparency, decrease waste and improve outcomes. I witness behavior that is just the opposite.

For example, Wegman’s, P&G, Coca-Cola
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and Smucker’s worked together to pilot the use of barcode scanning in the 1980’s. The use of the barcode increased transparency and increased data velocity. You can thank these leaders each time you go to the grocery store and effectively scan. This type of collaboration does not exist in healthcare.

Instead of leadership to simplify and streamline these important value chains, over the last decade nodes were added and new middlemen evolved— distributors, Group Purchasing Organizations (GPO), and Pharmacy Benefit Management Companies — reducing price transparency due to escalation of multi-party payments and increasing the bullwhip effect. (The bullwhip effect is the distortion of the demand signal as it moves through multiple parties.) Rebates, kick-backs, and advertising escalates the issues.

Why Change Is Needed

Why does it matter? For the United States consumer, the cost of prescription drugs is 2.56 times the cost experienced by consumers in 32 other nations. The United States accounts for 58% of sales, but just 24% of the volume of branded pharmaceuticals. The healthcare value chain is shrouded in bi-furcated trade agreements—rebates, pricing schemes, and multi-party payments— making it difficult to understand actual pricing, but more importantly it is a barrier to the translation of actual demand to reduce waste and better serve patients. Rebates are the most complex in the United States and only four countries allow television advertising.

Bi-furcated trade is the highest in pharmaceuticals and medical device value chains: large companies making 20-22% margin shroud pricing through multi-party trade agreements. It is ironic that the most profitable value chain is the most convoluted in managing price.

Spending on healthcare in the United States represents 20% of the Gross Domestic product. The average pharmaceutical company averages 22% operating margin, while a hospital struggles to return a profit of 2-8%. The healthcare value chain remains focused on efficient sickness side-stepping the opportunity to shift to wellness.

The pharmaceutical supply chain needs to be responsive—the ability to quickly adapt to demand—but the historic practices of bi-furcated trade and outdated design with a dependency on healthcare distributors and the growth of GPOs (Group Purchasing Organizations) increases the bullwhip effect making it more difficult to understand actual demand patterns. The answer is not more inventory. Branded pharmaceutical companies increased days of inventory by 36 days over the last decade while medical device company inventories increased by 44 days, yet cost and response time is worse not better.

Observation.

Recently, I spoke at a National Healthcare conference on supply chain visibility. I asked the simple question of, “How can a value chain this important to welfare be hijacked by the increasing the number of nodes while shrouding price transparency? Where is the leadership of brand owners to drive outcomes?”

What followed was a series of presentations highlighting innovation to solve the issue. My takeaway was three issues:

1. Design. The issues with the increasing bi-furcated trade distorts demand and increases supply chain waste. In addition, the growth in the number of nodes also distorts demand and increases waste. Each party is self-serving pocketing rebates and adding to waste through localized, but not holistic, optimization.
2. Innovation. While the group of industry leaders touted innovation, the presentation content seriously lagged the understanding of the supply chain in other industries. The healthcare industry operates at a lower level of supply chain understanding than other value chains.
3. Leadership. The supply chain is managed as a cost mitigation activity by pharmaceutical and medical device companies. Innovation in supply chain process development is conspicuously absent and not well-understood by branded manufacturers.

My hope is for the investigation to call for a pharmaceutical and medical device redesign. The industry needs to evaluate the role of distributors and other nodes, and the lack of readily available consumption data to guide supply chain decisions.

Role of Government

In the presentation, a representative from the FDA raised his hand, and asked, How the government could help?” At the end of his question, I smiled. If only the government better understood the supply chain. I am not a fan of big government, and wish that the brand owners would step forward to act, but here is my answer:

1. Make Government Data More Available. The government has a lot of data to share and help drive market insights. Work aggressively to help companies use outside-in data. Drive innovation dollars with academics to use new forms of modeling to drive a redefinition in supply chain planning.
2. Stop Television Advertising and Rebates. The investment in advertising and rebates by branded manufacturers is an opportunity cost to understand baseline demand and minimize waste in the value chain. The investment in demand shaping without aligning the supply chain shifts demand increasing waste and latency. No branded company is good at the measurement of baseline demand with minimal latency.
3. Drive Authoritative Identifier Adoption. Define authoritative identifiers using ISO-8000 standards for company, manufacturing locations and distribution characteristics. Drive adoption to improve traceability and safety requirements.
4. Train Government Officials on Supply Chain

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   Fundamentals. The focus on the efficient supply chain is the wrong discussion. The healthcare supply chain needs to be designed for a proactive response. A low cost supply chain will never serve hospitals well.

My Advice

So as the Republicans begin their investigation, I encourage all to think differently. We need to reduce the number of nodes of the supply chain, eliminate advertising and bi-furcated trade, and encourage the branded manufacturing leaders to step forward and drive value chain innovation. I join Burge and other independent drugstore owners trying to drive change, but I want it to be more holistic and encompass the entire value chain.

Source: Comparative data on pharmaceutical drug prices sourced from the Rand study sponsored by the Office of the Assistant Secretary for Planning and Evaluation in the U.S. Department of Health and Human Services.

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