How will new supply chain dynamics affect you?

May 2, 2005

Will pharmacies see more drug shortages and price increases as a result of a new way of doing business for wholesalers? That's what some experts have warned.

Will pharmacies see more drug shortages and price increases as a result of a new way of doing business for wholesalers? That's what some experts have warned.

Adam Fein, president of Pembroke Consulting, cautioned earlier this year that inventory management agreements (IMAs) and fee-for-service (FFS) arrangements that wholesalers are adopting may contribute to drug shortages and price increases. The problem, he said, is that IMAs have worked as expected, decreasing the amount of inventory in the supply chain by about $4.6 billion since 2002. But less inventory in the supply chain also means less inventory to fill unexpected demand from pharmacy customers. According to Fein, lower inventory levels may translate into increased risk of drug shortages that could affect patient care, product access, and pharmaceutical prices.

Wholesalers insist they continue to fill the same 98% to 99% of pharmacy orders they filled in past years. Inventory levels have declined sharply and many drugmakers now pay product distribution fees to wholesalers, but supply chain efficiencies have not changed, according to the Healthcare Distribution Management Association (HDMA).

About one-third of U.S. hospitals are currently losing money, Scheckelhoff continued. Another third are in marginal financial condition, and the rest show modest returns most years.

"Incurring new costs is something most hospitals would not be able to absorb," Scheckelhoff added. "No one yet knows if distribution fees will eventually be passed through to hospitals." For now, he added, there is no indication that inventory management agreements have contributed to product shortages.

IMAs entered the marketplace in 2002, Scheckelhoff explained. But ASHP tracking data compiled by the University of Utah indicate that the number of pharmaceutical product shortages peaked in 2000, then began a steady decline that continues into 2005.

A decline in the absolute number of drug shortages is the good news, he said. The bad news is that the severity and duration of shortages have increased. The question is how, or if, shortages could be related to changes in wholesale distribution.

"When there is a shortage now, it sticks around for some time," Scheckelhoff said. "There are dozens of possible reasons for drug shortages, and every shortage has multiple causes. With IMAs, there is less product in the supply chain, but I'm not sure there is a direct cause-and-effect relationship in terms of product shortages."

Cause and effect is equally fuzzy from the retail side. Susan Winckler, VP of policy and advocacy for the American Pharmacists Association, said the group has not heard members link IMAs with drug shortages or price increases. "IMAs are a hypothetical problem, not a real one," she said. "At least so far." HDMA is staying out of the debate.

"When it comes to IMAs and fee-for-service agreements, we have stayed out of the discussion," said HDMA president and CEO John Gray. "It will be months before anybody sees what kind of agreements are actually signed and their true impact."

The supply chain debate began in the early 2000s. Bristol-Myers Squibb spent nearly $500 million to settle shareholder suits and regulatory actions by the Securities & Exchange Commission for alleged accounting fraud. BMS, like many drugmakers, encouraged wholesalers to buy unneeded inventory at the end of a quarter or fiscal year in order to inflate sales figures. Artificially inflating sales, called channel-stuffing, is a violation of SEC rules and generally accepted accounting practices.

Once the inflated orders were in, drugmakers boosted prices. Wholesalers bought at the old, lower price, sold at the new, higher price and pocketed the difference. Investment buying, or forward buying, as the practice was sometimes called, accounted for up to 20% of wholesaler profits.

Cushioned by forward buying on the wholesale side, manufacturers got distribution services for free. And buoyed by reliable investment buying profits, wholesalers competed for customers by providing a growing array of inventory management and other supply chain services for free.