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The wheel turns on the PBMs



PBM transparency
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Everybody likes to pick on the PBMs (pharmacy benefit managers) these days. It's a sector of healthcare whose business model is maddeningly opaque, mechanically complicated, and whose value is constantly being called into question. But I'm not here to pile on. 


This a complicated topic, and I won't go through the complex economics of PBMs and their role in the healthcare value chain. But in a nutshell: PBMs manage drug benefits for employers and payers through a series of purchase agreements and rebates that separate drug benefits from other healthcare benefits (the economics are quite different after all), and (ostensibly) secure lower prices for end purchasers. The evidence that they actually lower costs is…debatable (no, I'm not getting into it here). But they do manage benefits over a byzantine part of the ecosystem so that HR managers don't have to. 


In today's Slide of the Week, we show some of the disruptors seeking to capitalize on industry discontent with PBMs and offer lower-cost options through simpler drug-benefit contracting, and an ability and willingness to pay for drugs at a lower price, along with the somewhat similar plans and programs that incumbents have been rolling out in response. But will these new models really shake up this part of the industry, to the point where drug expenditures come meaningfully down? While I see some opportunities to simplify and streamline administrative costs, on balance, I’m skeptical. Contain your shock. Two main reasons:

 

  • "Cost-plus" models do not inherently drive down overall spending. In a cost-plus model, drugs are sold to pharmacies or employers/payers at acquisition cost plus a small markup, rather than through the traditional and convoluted rebate-based model. In theory, with enough competition, such models could reduce prices and drastically simplify administrative costs. But although cost-plus strategies can reduce costs with ample competition (a key factor), they also provide an incentive to deliver higher cost drugs, because that's the only way to increase overall profit. Think how the 15% cap on non-patient-care costs in the Affordable Care Act actually provided an incentive to prop up premium and provider rates. This point has gotten a lot of attention already. 

 

  • But I think the second reason is the most important, which that PBMs just aren't all that profitable. We're talking mid-single-digits of operating margin in many cases. And so legacy PBMs may not be as ripe for disruption as many would like to think. Yes, PBMs generate a tremendous amount of revenue for their parent companies. And they are more profitable than they once were, having added larger and more fees in recent years to achieve those goals. Are PBM administrative costs in total too high? Maybe. Are there real opportunities to excise unnecessary spending? Almost certainly. The newest disruptors are out there making that case, and have already created incentives for the legacy players make that happen.

 

But at the end of the day, when your margin is, say, 6%, you need an absolutely massive market share to make a sustainable profit. And that is why the PBM market is so concentrated. (And I hate to bring this up, but this is the precise argument that some other sectors in healthcare make when they want to consolidate. You know who you are. Ahem.) 

 

To ‘disrupt’ the legacy PBM sector, new entrants would need to be able to cut out a substantial excess cost from status quo PBM operations—enough to offer purchasers meaningfully lower prices while also sustaining their own operations. This probably translates to even smaller margins for disruptors, making it all the more urgent to get to scale as fast as possible. But today’s legacy PBMs have the market share—and while today’s disruptors are winning headlines for taking even one major customer at a time away from the incumbents, they have a very long way to go to tip overall market share in their favor. To my mind, the most interesting aspect of cost-plus models is their ability to shed more daylight on how drugs are actually priced (leading to a good deal of unwanted attention, I would imagine.)

 

So to all the newest drug-benefit disruptors out there: go forth and prosper!  Bring on the reforms that could actually bring down costs (somewhat). But let's keep in mind that in this part of the business, scale is king. A streamlined administrative cost structure will likely be good for everyone, but to win long-term, scale is almost the only thing that matters, and it will be very hard to be low-cost enough, for long enough, to take that crown from the incumbents.


We'll be talking about this issue a lot more in our upcoming State of Healthcare, out in the next few weeks. And it'll be a big part of our Board Briefing update on health plans; register to attend that one here (it's open to the public). Our members can access our full bootcamp on the life sciences sector (including PBMs), and view the recording here. If you'd like to learn more about becoming a member, you can do so here.





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