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Don't blame Obama for the malaise of healthcare…

Over the last eight years, I’ve had the opportunity to meet with many different participants in the healthcare supply chain: drug manufacturers, Group Purchasing Organizations, retail pharmacies, hospital pharmacies, physicians, consultants, academics, clinical researchers, third party logistics providers, pharmacy benefits managers, and others. Over this period, the level of anxiety has been mounting considerably, culminating with the angry response to President Obama’s healthcare act in 2010, and the ensuing set of debates and judicial proceedings that is taking place as we speak in the Fall of 2011.

Although I’m not going to argue that there aren’t flaws with the Obama healthcare legislation of 2010, I believe that “Obamacare”, as many critics have named it, is really nothing more than a manifestation of what is happening globally in the healthcare ecosystem. The primary element is that current business models for the life sciences are no longer sustainable, and will surely result in collapse unless something radical changes. This view is not just an opinion – a multi-agent simulation model shows it to be the case.

The proposal that current models are not sustainable has been validated by NCSU faculty simulation findings, using multi-agent based simulation. Using current models of biopharmaceutical development, the research suggests that the evolution of the current operating model, when carried out, results in complete collapse. (Jetly, Guarav, Rosetti, Christian, and Handfield, Robert, “A Multi-Agent Simulation of the Pharmaceutical Supply Chain (PSC)”, Proceedings of the POMS 20th Annual Conference, Orlando, FL, May1-4, 2009.)

A multi agent system involves interplay between multiple interacting agents. Although individual agents may follow a simple strategy, it may result in complex evolution of the system. Therefore, multi agent system (MAS) methodology is used to analyze systems which are too complex to be solved using alternative methods (traditional mathematical or statistical). Application of MAS is ideal for problems whose solution is dynamic, uncertain and of distributed nature.

Our research indicates that in the end, bigger pharma is NOT better. According to our model, when manufacturers consolidate, they can’t cover the cost of supporting their large asset base – plants, equipment, research laboratories, administration etc… Although their research productivity increases as they grow, as measured by the number of drugs released by individual manufacturers, the productivity of the supply chain diminishes. In addition, since drug sales represent a fixed pie, as only blockbusters will support the cash drain from larger assets. Because blockbusters are increasingly less likely to occur, it doesn’t take a genius to determine where this ends up.

In the simulation merger activity is based on the acquirer’s determination that the acquisition will perform above itself as well as industry average. As appears to be the case in reality, the agents assume that past performance in drug development is a good predictor of future performance. The acquirer examines each manufacturer based on the number of drugs it has released in the past two years. Unfortunately, by this time the drug is approaching its maximum sales. Although the larger manufacturer has a greater chance at creating a drug over many games. Results show that over the course of a sample of 177 games, the manufacturer is not assured that this increase in probability is greater than that of two large manufacturers.

Policy makers may be tempted to regulate manufacturer prices in order to decrease their share of supply chain profits and pass savings onto consumers. Our findings show that this form of regulation may have a limited impact. Currently, manufacturers are spending in excess of 20% of their revenues on sales and marketing activities. This activity is deemed necessary to fulfill a requirement for blockbuster drugs. Our results indicate that blockbusters are more necessary than the number of drugs released. If prices are limited, manufacturers will more likely cut back on research and development activities and focus more energy on marketing.
In addition, the results found that distributors have a limited impact on supply chain profitability. Manufacturers and suppliers through drugs released and consolidation impact profitability greatly. Consolidation at the manufacturer level tends to decrease profitability, generally because of reduced research productivity. Consolidation at the supplier level increases supply chain profitability because rents from increased bargaining power are passed on to the consumers.

As this simulation shows, not only is the old operational model broken; but the rules of the game are changing as well. The very nature of the healthcare industry is undergoing a rapid series of changes, primarily in the way that patient-centric reimbursement will occur. The movement towards personalized medicine, pay for performance, and targeted therapies will radically change this space forever.