Human Capital & Careers

Will Caterpillar’s Walgreens Deal Shrink Drug Costs?

The tractor maker's pharmacy-benefit arrangement seeks to cut out the middleman to gain transparent pricing.
David KatzSeptember 4, 2009

Hal Rosenbluth, who, as president of Walgreens’s health and wellness unit, may have an interest in buttering up finance chiefs, observes that CFOs have an “innate” ability to find out the true cost of goods or services their companies are spending money on.

Rosenbluth, whose company launched a direct pharmacy-benefit purchasing arrangement with Caterpillar last week, suggests that the current national focus on cutting health-care costs and the structural shift in workplace-based drug buying that the Caterpillar model features will push CFOs to start asking tough questions about waste in the current pharmaceutical supply chain.

The drugstore executive was alluding to the current arrangement whereby employers contract with pharmacy-benefit managers to handle their drug-purchasing arrangements. Typically, employers negotiate price discounts with PBMs, and the PBMs earn a “spread,” or profit margin, between what they pay a drugstore for the employee’s drug and what they charge the employer. In many of the deals, the PBM agrees that the employer will get rebates that pharmaceutical makers pay out when their brand-name drugs appear in an employer’s list of preferred drugs on their benefit plans.

The complicated pricing system has drawn the ire of many employers, who complain that it’s foggier than a rainy day in London. But it’s also widely acknowledged that the intermediaries do negotiate cheaper drug prices than employers might otherwise get, and that there are powerful incentives that keep the system going despite its potential for waste. In some cases, Rosenbluth alleges, “these rebate dollars are being used to offset the cost of a particular department within the company so it looked like it was a profit center.”

Spurred by current cost concerns, he suggests, a sharp-eyed CFO might detect a cozy relationship between his company’s employee-benefits manager and a PBM in which the benefits department is credited with a nice rebate check — even though the company is paying a higher price than it would have in a direct arrangement with drugstore chain like Walgreens. For instance, a company might get a 15% rebate for a drug priced at $1 that the drugstore is actually selling for 70 cents.

Rosenbluth acknowledges that he knows of such situations only from conversations he’s had with employers and consultants. But there’s no question that a yen for rebates is built into the system. “I can’t argue with the idea that any company would get used to the income of a rebate check, a reliable source of revenue for a quarter,” says Sean Brandle, prescription-drug consulting practice leader of The Segal Co. in New York. Although he hasn’t encountered the exact situation the Walgreens executive describes, Brandle adds that when he advises employers on PBM selection, “the rebates are part of the equation…part of the decision-making process.”

In the arrangement it launched last week with Caterpillar, however, the drugstore company claims to be setting up a leaner and clearer system. Walgreens contends that it has established “a direct relationship for the purchase of prescription drugs using a transparent pricing model,” according to a release issued by the company, which has nearly 7,000 drugstores nationwide. Under the program, Caterpillar will be given a “Walgreens Proprietary Price List,” which it contends is based on the cost Walgreens pays the drug manufacturers.

An Open Marriage
The arrangement is also nonexclusive, meaning that neither Caterpillar nor Walgreens is locked into it with that particular company. That will enable Caterpillar to continue a similar arrangement it began last year as a pilot program with pharmacies at Wal-Mart Stores. Todd Bisping, Caterpillar’s PBM, also notes in an interview that the company will continue to work with the PBM it has used for the past 10 years, West Bend, Wisconsin-based Restat. But while the PBM will still administer all of Caterpillar’s drug-benefits claims, it will not be involved in the company’s price negotiations with Walgreens.

As part of an effort to make its drug-benefit plan more cost-efficient, Caterpillar found that there was a great deal of waste inherent in a system that uses PBMs as middlemen, according to Bisping. “They would negotiate a price with drug manufacturers, on one hand, and then employers would pay a higher price. [The PBMs] would keep the spread,” he says. “And they would keep all or a portion of rebates.”

Another problem, says Bisping, is that PBM-generated pricing arrangements with employers are based on discounts off a drug-industry benchmark called average wholesale price. But drugstores typically buy drugs and negotiate payment from PBMs using a different benchmark, wholesale acquisition cost. Usually, AWP amounts to a 20% markup of WAC. To Bisping, AWP pricing is laughable. “We sometimes joke that it’s a random number,” he says. “It’s a price that we don’t feel is based on the actual cost of the drug.”

After it entered into its pilot program with Wal-Mart, Caterpillar began to work with Walgreens, a much bigger pharmacy chain, according to Bisping. Under the arrangements with the two chains, “the cost that we pay for drugs is not based off of AWP in any way. It is only based on what Walgreens paid a manufacturer for that drug,” he says. “It’s a real price, like most things that are procured in this world.”

For its part, Walgreens is willing to give up a bit of its profit margin to gain the market share that a big employer like Caterpillar can deliver. The pharmacy chain will base its discounts on the market share it stands to gain from its relationship with the company in the regions both operate in, according to Rosenbluth. Caterpillar will be motivated to steer more of its employees to Walgreens via incentives because the more drugs the employees buy at the stores, the cheaper the drugs will be for both the employer and the employee, he notes.

The price Caterpillar and its employees will pay, Bisping notes, is based on a “cost-plus pricing methodology.” Asked what the “plus” consists of, Rosenbluth says it includes distribution cost (the cost of getting the drug from the manufacturer to Walgreens’s 12 distribution centers and then finally to its drugstores), cost to fill prescriptions at the pharmacy or via mail order, and a profit. The pharmacy executive says he doesn’t want to go into all of the factors “because I don’t want to give our formula away for everybody to copy.”

For other reasons, Bisping does not want to reveal what specific incentives Caterpillar will offer its employees to buy their prescription drugs at Walgreens, although Walgreens has said the program will include decreases in drug copayments. The program will go into effect on January 1, 2010, which coincides with the start of Caterpillar’s benefit-plan year. “We’re in the process of trying to communicate with members. We can’t [publicly] share the incentive we’re offering because I don’t want them to read it in a newspaper before we can share it with them personally,” he says.

Will the model mark a sea change in how employers provide drug benefits to their employees? While the arrangement is Walgreens’s first, it’s in “active discussions” with 20 client companies and 25 noncustomers about such direct-buying deals, according to Rosenbluth, who notes that most are Fortune 100 companies and the rest are in the Fortune 1,000-size range.

Such arrangements “will be disruptive” to the current PBM business model, contends Bisping. “Now that we’ve developed a way for companies to be able to influence the price they pay for prescription drugs, that takes away the need of PBMs to do that.”

No one, however, will say that the middleman is completely on the way out. “I think [direct-purchasing] deals, in essence, are supplementing a PBM base,” says Michael Taggert, a senior vice president in Aon Consulting’s health and benefits practice. He notes that employees at plants in places where Walgreens doesn’t have stores must get their medications from local stores or regionally managed chains, which are unlikely to have the resources to strike direct-purchasing arrangements with employers. “There’s a place for PBMs,” he adds.

Not unexpectedly, Mark Merritt, president of the Pharmaceutical Care Management Assn., which represents PBMs, goes further, contending that such an arrangement is useful to an employer like Caterpillar that operates in largely rural settings, but not to many others. At companies with locations in big cities and other well-populated areas with many competing pharmacy chains, employees would resist driving 10 miles to find a Walgreens when there’s a Duane Reade or a CVS around the corner.

The Walgreens-Caterpillar deal, he adds, “is one of many niche plays and experiments. It’s not one that would be applicable for the vast majority of employers.”