Drugmakers aren’t the only ones getting hammered by scrutiny of rising pharmaceutical prices.
McKesson Corp., a drug wholesaler, blamed fewer price increases, and lower rates of price increases on branded pharmaceuticals for earnings that missed expectations. McKesson’s only reporting the second-quarter of its fiscal year, but said the whole year will be worse as a result.
Its shares plunged more than 20% Friday morning. Rivals Cardinal Health and AmerisourceBergen were also slammed.
In the pharmaceutical industry supply chain, wholesalers are in charge of stocking a whole bunch of drugs from a number of different drug companies and dispensing them to pharmacies. They take a slice of each drug’s sale price for this, so they benefit if prices are higher.
But price increases are slowing, in part because of media and political scrutiny over the issue. Drug company CEO’s have been hauled before congress to explain how prices of old drugs can increase as by as much as triple-digit amounts.
Here’s McKesson CEO John Hammergren’s explanation
“As for branded inflation, I suspect many of you have tracked the evolving conversation in the U.S. Last month, James highlighted concerns we had around some manufacturers appearing to delay some price increases we would have otherwise anticipated, based on their historical and our historical experience.
What we have seen this year to-date, [are] fewer products with price increases, and those price increases are at lower rates than both prior year results and our expectations for the current fiscal year. Given our second quarter performance specific to branded price inflation, we now expect full-year branded pharmaceutical pricing trends to be meaningfully below those experienced in Fiscal 2016.”
Hammergren went on to explain the relationship between wholesalers and branded pharmaceutical drugs (emphasis ours).
“Let me spend a minute and talk about how we are compensated for branded pharmaceutical product distribution services. Today, all of our contracts with branded pharmaceutical manufacturers are individually negotiated, but generally, are constructed around charging for the service we provide. In almost all cases, the charge is derived as a per cent of revenue managed and delivered by McKesson for that specific manufacturer. These charges vary not only by manufacturer, but also by the service requirement at the product level.
Clearly, revenue-based fees are all affected at some level by inflation. However, in some cases the benefit from inflation is greater, given the specifics and the characteristics of individual contracts, and a specific behaviour of the manufacturers that are our party to these agreements. So although a large majority of our compensation is relatively easy to forecast, inflation-based income derived from these relationships can impact our results on a more variable basis. Through these agreements, speculative buying or buying large quantities of product in front of anticipated price increases no longer exist.
Essentially, all of McKesson’s pharmaceutical purchases are done in partnership with the manufacturer, unlike the industry standard practice years ago, before any contracts presided over the relationships between wholesalers and their manufacturer partners. These changes that happened years ago have translated into more stable inventory levels that are appropriate to meet the customer demands and service levels.
So the takeaway here is that branded inflation still plays a meaningful role, and in some cases, it can be an important part of our overall compensation with specific manufacturers, and we can be impacted by their decisions, relative to price increases. Although some contracts with manufacturers may not have specific compensation elements tied to product price changes, our internal branded price inflation assumptions often appear to be directionally aligned with externally published data.
But the mix matters. So even relatively small changes in behaviour could have a more or less impact on our results, depending on the characteristics of that individual manufacturer contract. We’d like to think we do a superior job of exceeding the expectations of these partners, so there should be even some variability in our industry related to results driven by brand and generic inflations.
So what does all of this mean moving forward? It means we expect to receive less compensation from branded price increases than we originally anticipated in fiscal 2017. It means we will continue to monitor pricing activities throughout the year, especially in our fiscal fourth quarter, which is typically an important quarter for price increases.
And it means we are engaging with our manufacturer partners to ensure we receive appropriate compensation, relative to the services and value we deliver, amidst a softer pricing environment.”
McKesson, combined with Cardinal Health and AmerisourceBergen control about 85% of the wholesale market. The two competitors were also hit hard after McKesson reported.
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