Supply Chain Frontiers issue #14. Read all articles in this issue.
Cost pressures are fracturing the pharmaceutical supply chain in the United States, but what the reshaped chain will look like is open to debate. One outcome seems certain: the role of drug wholesalers will not be the same. The competitive rules are changing, and wholesalers will either adapt and prosper or face the prospect of being marginalized.
“The changes that are taking place are driven mainly by cost concerns not service levels,” said Mahender Singh, Research Associate at the MIT Center for Transportation & Logistics. He has carried out extensive research on the changing structure of the drug supply chain, and new CTL research in the area was published this month.
In the drugs industry there are a number of routes to market. For example, large pharmacy chains such as CVS and Rite-Aid mostly distribute product to retail outlets from their own warehouses. On the other hand, independent pharmacies, clinics, and hospitals rely largely on deliveries from wholesalers’ distribution centers.
Moving drugs from manufacturers to buyers is big business, particularly for the three dominant US pharmaceutical wholesalers: AmerisourceBergen, Cardinal, and McKesson. According to the study entitled Preparing for the Future Retail Pharmacy Supply Chain by Philadelphia-based consulting firm Pembroke Consulting, these majors collectively generate $53 billion in revenues by acting as transactional intermediaries or as redistributors of bulk product from the manufacturer to the warehouses of large pharmacies.
Established revenue streams like these are now under threat. As Singh explained, traditionally, wholesalers used a “buy and hold” model to generate extraordinary rates of return on their investments. For a long time, intermediaries engaged in large-scale speculative buying, stored the products, and sold when prices increased. “Under the new Inventory Management Agreements in some cases manufacturers do not allow these intermediaries to hold more than 21 days worth of demand in inventory, so this margin has gone,” he said.
Another major change is that the market’s arcane fee structures have become more transparent to manufacturers. New pricing mechanisms are being introduced that bring more standardization and reveal the true cost of distribution. “As a result, manufacturers have a clearer picture of their distribution costs and are seeking alternative ways to economize,” Singh said. Manufacturers are now looking at third-party logistics services providers as a viable option for delivering product. Not surprisingly, logistics companies such as UPS welcome the opportunity and have invested in their pharmaceutical businesses.
Delivering direct to retailers is another option manufacturers have for streamlining distribution. The Pembroke Consulting study concludes that: “A shift to direct purchasing by large retail chains will effectively eliminate wholesalers’ role in warehouse deliveries, which are now more than 30% of top-line revenues for McKesson and Cardinal.” The impact on individual wholesalers will vary with the relative importance of this business, the study adds.
Does this mean that pharmaceutical wholesaling faces a bleak future? Not necessarily. As Singh pointed out, drug distribution requires specialized infrastructure and replicating existing distribution channels is not easy. A 2004 white paper written by consulting firm Booz Allen Hamilton for the Healthcare Distribution Management Association estimates that replacing distributors’ daily direct distribution services without lowering service levels “would add at least $10.5 billion per year to industry costs.”
In addition, wholesale distributors are fighting back. According to Singh, they are widening the scope of their offerings to include activities such as contract manufacturing and packaging. And they are extending their supply chains into their customers’ domains by taking over the management of inventory systems for health care facilities. These players are even moving closer to patients. They are investing heavily in bedside care initiatives to provide support systems that will reduce error rates when caregivers administer medicines, along with other functions that will improve the quality of overall service delivery in health care facilities.
“These changes are now playing out,” said Singh. “Nobody knows for sure who will be the ultimate winners and losers, but we can be certain that five years from now the drug supply chain will look very different.”
Two 2006 theses by CTL Master of Engineering in Logistics program graduates were presented at MIT this month. For more information on the CTL’s research into the pharmaceutical supply chain, contact Mahender Sing.