botched pbm merger highlights health

Botched PBM merger highlights health care industry challenges

The changes in the health care industry have led to botched mergers

with PBMs in the past.

It's worth explaining the challenges facing drug companies, the

emergence of PBMs and their impact on drugstores like CVS. The upshot?

Companies are trying to cut the cost of health care for their

employees to improve their profits. Up until the 1970s, there was a

simple health care model: drug companies would invest hundreds of

millions in research to developed patented products; their sales

forces would offer doctors in private practice lots of goodies like

all expense paid trips to Bermuda; if the drugs worked, the doctors

would prescribe them regularly; and insurance companies would

reimburse the companies who bought the drugs for their employees,

regardless of price.

But with the emergence in the 1980s of Health Maintenance

Organizations (HMOs) and PBMs, this profitable club began to collapse.

HMOs, whose drug formularies saved money for their corporate clients

by encouraging their doctors to prescribe the lowest cost drugs

available to treat a disease, took market share from private physician

practices. For example, between 1986 and 1992, HMOs share of drug

sales rose from 7% to 22% while private physician practices' share

declined from 60% to 43%.

In 1946, the Veterans Administration (VA) began to offer drugs to

veterans on a mail order basis. Instead of paying a co-payment for a

30 day supply and picking up the drugs in a pharmacy, veterans got a

90-day supply through the mail. In 1983 Marty Wygod, an investment

banker, started Medco with the idea of spreading this mail order

concept to companies and HMOs. This did not sit well with the CVSs of

the world because PBMs could buy drugs at a discount from the drug

companies and ship them directly to the patient -- bypassing the

wholesalers and drug stores altogether -- and passing the savings on

to the companies, HMOs and patients. Medco also worked with companies

and HMOs to find the cheapest drug that worked for a particular

disease.

Merck's 2,200 person sales force with their trips to Bermuda was of no

avail when it came to persuading HMOs to stock Merck's drugs. For

example, in 1992 Medco negotiated a deal with Bristol Myers Squibb

Co.'s (NYSE: BMY) to distribute its cholesterol drug Pravachol which

slammed sales of Merck's cholesterol reducing drugs. In the next year,

Merck's cholesterol drug sales rose a mere 2% while Bristol's spiked

205%.

Merck had heard rumors that Bristol was planning to buy Medco --

extending its power over Merck -- so Merck jumped at Medco.

Unfortunately, Merck did not add value to Medco -- leaving it to

operate independently and never merging the information flows that

would have given Merck the ability to develop better and cheaper

drugs. Merck also angered its retail pharmacy customers by buying one

of their competitors -- causing them to substitute $400 million worth

of Merck drugs for a competitors'. And Merck got into regulatory

trouble when Medco failed to disclose its Merck connection when

setting up drug formularies in 17 states -- leading to a $1.9 million