Walgreen’s Acquisition of Amerisource Bergen is based on the need for integration to survive

The news of Walgreen’s potential acquisition of Amerisource Bergen is one of a string of recent announcements that signify efforts by channel players in the massive life sciences market to set up barriers to competition against behemoths by the likes of Amazon, (in my opinion).  This is similar to the recent acquisition of Aetna by CVS, which involved a merger between another big pharmacy and a health care insurance payor.

What are these companies seeing that everyone else isn’t?  Many acquisitions occur when there is a lucrative company that can bolster profits, but no one is saying that Amerisource is especially profitable, over and above what other distributors like Cardinal Health and McKesson are making.  Those days of hefty prices using “Next Best Alternative are gone – and pharmaceutical distribution is a cut-throat business with very tight margins.  In the old model, forward buying distribution services assisted pharmaceutical companies to manage the complexities of unpredictable demand, lumpy capacity, and served as a key transition element for distributing pharmaceutical products to a wide array of fragmented hospitals and pharmacies.  This model was effective for many years, and provided a valuable service to the pharmaceutical companies, who did not possess a core competency in distribution strategy and technology.  However, in 2005-2007 wholesalers’ position in the channel was challenged due to increasing pressure for pricing controls, lower inflation, ASP regulation, and other external variables.  As a result, pharmaceutical distribution companies had to adopt a different model, one identifying a Fee For Service model.  This model has by and large been adopted by the industry, and represents an industry standard approach

Rather, I think there are three major forces at work here that are driving this activity.  This is based on a book I wrote about five years ago which developed a set of future predictions on what will unfold in the biologics and pharmaceutical supply chain, (based on hundreds of interviews with executives).

The three primary forces are:

1. Compensation Forces: Increased use of inventory management agreements, fee for service models, pay for performance, and pricing pressure applied by government agencies and third parties.  These forces will shape the way that products are sold, delivered, and administered in the future.  In the case of Walgreen’s and CVS, both pharmacies are facing increasing pressure to reduce costs, and payors such as insurance companies are a big part of those forces (in addition to government agencies).  By controlling the payment and reimbursement function, CVS/Caremark can streamline the efficiencies, but also start to set policies very expensive drugs, such as Orphan Drugs.
2. Channel Forces: The increasing threat of direct sales models by pharmaceutical manufacturers and the threatened entrance of third party logistics providers (3PLs) and other competing entities in the channel.  This may be the underlying reason for the Walgreens/Amerisource relationship.  For years, big pharma was in a state of delusion thinking they could distribute to pharmacies, and by-pass the Big Three (Cardinal, Amerisource, and McKesson).  Wrong!  Compensation is earned by wholesalers through performance of wholesaling services for manufacturers, rather relying on speculation about future price increases.  Examples of services wholesalers provide to manufacturers:

• Sophisticated ordering technology
• Daily consolidated deliveries to health care providers
• Emergency shipments to providers 24/7/365
• Consolidated accounts receivable management
• Contract and Chargeback administration
• Returns processing
• Customer service support
• Inventory management
• Licensed, environmentally controlled, PDMA compliant[1], secure facilities

To receive these services, manufacturers (who are now playing the role of a “supplier” to the wholesalers, in that they move product downstream through the supply chain) are required to pay a quarterly distribution service fee (DSP) equal to a “DSP Fee Percentage” times the WAC (wholesale acquisition cost) sales times product sales.   By moving towards a merger with Amerisource, Walgreens may be able to get these same services at a more efficient DSP than what they would pay otherwise.  And even a small percentage reduction here would amount to a huge savings.

3. Product Forces: Increasing levels of product diversity requiring specialized handling and delivery coupled with increasing concerns about the pedigree – legitimacy – of goods being distributed in the pharmaceutical supply chain. The rise of personalized medicine will also impact how drugs are shipped to individuals.  The key to this will be having the right DATA  – and this may be the biggest opportunity that all of these providers are seeking – is the ability to drive analytics, and handle these challenges.

Examples of the types of specialized services required in this new environment are shown in the following table.  Improving performance in these markets will require greater use of integrated analytics, which is difficult when there is an array of information exchanges going on.  Integration creates the opportunity to make this a reality.  At least that’s the vision ….let’s see if Walgreen’s can convert the vision into that reality.

[1] Regulatory compliance with the PDMA is discussed at: http://www.bio-itworld.com/archive/011204/strategic_pdma.html.