Recently I had the pleasure of addressing a dinner gathering of esteemed institutional investors in NYC who follow the health care space, and more specifically, the PBM realm.  At WBC ( we love the opportunity to share our insight on how PBMs operate. There was plenty of discussion regarding mergers, market practices and views on the current selling season.

As is usually the case, much of the conversation focused on the Big 3, and how they continue to dominate the PBM landscape. As part of that dialogue, the subject of scale was introduced, particularly in light of the Catalyst RxIts not what you Buy, but what you Bill acquisition of Walgreens PBM.  Now that Catalyst has the perceived necessary volume to compete with the Bigs, how do other worthy, yet significantly smaller players, get a shot to step up to the plate?   Firms such as Envision Rx, Partners Rx, ProCare Rx and HealthTrans to name a few. 

When discussing the merits and business practices of both the traditional spread pricing model (favored by the Big 3)and the pass-through model (more to the liking of the newer PBMs) the question of scale keeps emerging.  During our dinner conversation several of the institutional investors could not reconcile the apparent disconnect between the Bigs ability to buy prescription drugs compared to any of their smaller competitors.  There are a couple of answers to this quandary. First, there really isn’t much of a difference between what the PBMs pay a pharmacy for drugs.  Maybe a 1/2 point here or there, maybe even a point on some occasions, but for most NDCs and most pharmacies, the PBMs are part of a commodity distribution chain.  This of course, is both counter-intuitive and counter Big 3 spin on why clients should do business with them. 

The second, and more relevant answer to the above-mentioned question is a wbcbaltimore axiom: It’s not what you buy, but what you bill!  This means that even if a super-big PBM could buy at significantly better pricing than its smaller rivals, none of that matters unless the plan sponsor is reaping that benefit in the form of reduced drug cost that appears on their monthly invoice or bill.  When a PBM uses traditional spread pricing, they create spreads by paying the pharmacy one price and billing the plan sponsor a higher amount.  Improved purchasing power would mean that stockholders are happy when the PBM continues to meet or exceed earnings forecasts. It does not mean that any pricing differential makes its way to the plan sponsor in the form of reduced drug spend.

Lets look at a simple example: A PBM using traditional spread pricing buys a drug from a pharmacy for a list price (“AWP”)  of $100.  Because of their humongous purchasing power, they pay the pharmacy $10 (AWP-90%). When they invoice the plan sponsor, they request $30 (AWP-70%) and the PBM keeps the “spread” for their efforts.  A competing, much smaller PBM, who uses a pass-through business model, buys the same $100 drug from the pharmacy.  Lets just say that they don’t get the same pricing concessions from the pharmacy chain so they have to pay $20 for the Rx (AWP-80%). They turn around and invoice the plan sponsor their cost, in this case $20 plus an administrative fee of say $3.00, for a grand total of $23 (AWP-77%).  So you see, it’s not what you buy, but what you bill that makes the difference to the plan sponsor.

That being said, readers may believe that I’m advocating pass-through pricing as the only way to go. Not at all. I believe spread- pricing may be a good option for many plan sponsors, they just have to know what they are purchasing. If the spreads are warranted by a demonstrated clinical improvement in health outcomes and reduced overall net cost of health care for the plan sponsor, than there is value in continuing traditional pricing.  If not, than maybe pass-through is the way to go.  What we do know, however, is that there are more than 3 or 4 viable PBM outlets for consideration.