CVS, Cigna, and Others Spearhead a Revolution in the Pharmaceutical Supply Chain Targeting Inefficiency and Lack of Transparency

The planned acquisition of Express Scripts by U.S. health insurer Cigna has been drawing significant attention within the industry.

Recently, this matter took another critical step toward success, as the U.S. Department of Justice is “close to approving” the merger deal between the two parties.

Cigna Group is one of the world’s largest insurance, healthcare, and financial services companies, while Express Scripts is one of North America’s largest pharmacy benefit management companies.

The merger of the two will undoubtedly have a significant impact on the entire healthcare industry ecosystem.

In fact, the complex pharmaceutical market has been continuously evolving, ranging from large enterprises playing multiple roles in the drug supply chain (such as CVS’s impending acquisition of Aetna) to startups leveraging technology to facilitate drug distribution.

Wherever there are pain points, business opportunities often arise. Now, some companies are once again setting their sights on the entire pharmaceutical supply chain.

The continuous rise in U.S. drug prices has raised questions about the pharmaceutical supply chain. Healthcare providers, patients, and politicians have all pointed out inefficiencies in the current system. This strong dissatisfaction seems well-founded: according to a 2017 report from the University of Southern California, for every $100 spent on prescription drugs, $41 goes to intermediaries in the supply chain.

For every $100 spent at retail pharmacies, intermediaries generate total revenue comparable to that of manufacturers, who typically spend a decade developing drugs and are responsible for marketing.

Furthermore, the net profit margin of Pharmacy Benefit Managers (PBMs) is misleading, as they classify drug costs as an expense—even though they never actually handle the medications.

It is projected that the U.S. pharmaceutical market will reach $500 billion by 2020. An increasing number of pharmaceutical companies are seeking solutions to make the pharmaceutical supply chain more cost-effective, efficient, and transparent.

VCBeat (WeChat: vcbeat) has translated a report by CB Insights that delves into the workings of the U.S. pharmaceutical supply chain, the key stakeholders involved, and the startups and technologies aimed at streamlining its processes. Drawing on external insights to refine local practices, we hope this will provide inspiration for entrepreneurs in China.

The U.S. pharmaceutical supply chain involves numerous stakeholders, ranging from manufacturers that produce drugs, to pharmacies that distribute them, and pharmacy benefit managers (PBMs) that oversee this process.

•Manufacturer: Research, development, and production of pharmaceuticals. Examples include Johnson & Johnson, Pfizer, and AbbVie.

• Payer: Entities that pay medical expenses other than patients (usually insurance companies). The “Big Five” insurance companies include UnitedHealth Group, Anthem, Aetna, Cigna, and Humana.

•Pharmacy Benefit Manager(Pharmacy Benefits Manager): Negotiates drug prices with manufacturers on behalf of payers.

• Wholesaler: Purchase large quantities of pharmaceuticals from drug manufacturers and then resell them to pharmacies. The “Big Three” wholesalers include AmerisourceBergen, Cardinal Health, and McKesson. Together, they account for 85% of the market share.

• Pharmacy: Accept pharmaceuticals from wholesalers and sell them to patients. Market leaders include CVS, Walgreens, and Walmart. / Specialty pharmacies: Manage the sale of expensive, uncommon, or fragile medications. Prominent specialty pharmacies include CVS Specialty, Accredo/Freedom Fertility, Alliance Rx, and BriovaRx.

• Patient: The last person to accept and take the medication.

Pharmaceutical manufacturers produce drugs and sell them in bulk to wholesalers, who then resell them to pharmacies. Throughout this process, wholesalers employ sophisticated logistics and packaging methods to ensure the timely receipt and delivery of medications in intact condition. Subsequently, patients can collect their prescribed medications from pharmacies.

Service Process

Pharmacy benefit managers (PBMs) represent payers and leverage large-scale purchasing volumes to secure drug discounts.

Pharmacy benefit managers, manufacturers, and insurers jointly develop the list of drugs covered by insurance plans, known as a formulary. Pharmacy benefit managers may grant preferred status to certain drugs in exchange for discounts and other benefits.

Insurers provide prescription drug coverage to patients, passing on a portion of the savings negotiated by pharmacy benefit managers.

Fund Flow

Capital flows in the pharmaceutical supply chain are typically complex and inefficient.

• Patient: Pays health insurance premiums to the payer (typically an insurance company). When purchasing medications, pays a copayment to the Pharmacy Benefit Manager (PBM). (Note: When the patient pays the copayment at the pharmacy, the pharmacy does not retain these funds; instead, they are remitted directly to the PBM.) When purchasing certain medications, the patient may receive a copayment assistance subsidy from the manufacturer.

• Pharmacy: Pays wholesalers when purchasing medications; receives negotiated fees from pharmacy benefit managers (PBMs) when dispensing medications.

• Wholesalers: Pay manufacturers when purchasing pharmaceuticals in bulk. Charge fees when selling pharmaceuticals to pharmacies.

• Pharmacy Benefit Manager (PBM): Pays the agreed-upon fee to pharmacies when patients purchase medications. There are three sources of funding: payers (who pay for the PBM’s negotiated services), patients (in the form of copayments), and manufacturers (who provide discounts and other benefits to PBMs in exchange for preferred placement of their drugs).

• Manufacturer: May provide payments to patients (in the form of copayment assistance) to encourage them to purchase the drug. Charges fees to wholesalers that purchase its pharmaceutical products.

It is evident that the entire system is complex and inefficient. Funds may be transferred from one party to another, but ultimately return to the original party (for instance, pharmacies pay copayments to pharmacy benefit managers, but these funds eventually flow back to the pharmacies).

Patients never pay drug manufacturers or pharmacies directly. Insurance coverage is ultimately determined by the benefits that manufacturers provide to pharmacy benefit managers (PBMs), rather than by patients’ medication preferences or even the drug’s efficacy.

Given the intricate nature of the pharmaceutical supply chain, some companies have opted for vertical integration strategies. Payers, in particular, have recognized the benefits of merging diverse business lines and controlling distribution.

If the acquisition of Aetna proceeds smoothly, CVS will assume all roles in the supply chain except that of a wholesaler.

Similarly, Cigna is set to acquire Express Scripts, which will provide it with pharmacy benefit management and specialty pharmacy services to complement its existing business. Meanwhile, UnitedHealthcare’s subsidiaries include Optum (pharmacy benefit management) and BriovaRx (specialty pharmacy).

The complexity of the pharmaceutical supply chain and the trend toward business consolidation mean that the pharmaceutical sector is undergoing change.

The Drug Supply Chain Security Act requires companies to take measures to ensure the identification and tracing of certain prescription drugs by 2023.

Innovative startups are rapidly filling this gap, aiming to help established companies comply with policies and streamline the processes of pharmaceutical distribution, payment, and price negotiation.

In an industry where integration has become the mainstream trend, these startups are removing barriers and streamlining the entire pharmaceutical supply chain process for stakeholders.

Biologics are an emerging class of drugs, including vaccines, blood and blood components, and gene therapies. They represent a strong use case for startups focused on supply chain analytics and cold chain logistics. “These treatments are often complex, expensive, and significantly more sensitive to temperature fluctuations and microbial contamination than other medications.”

Startups such as TemperPack and Vericool have raised $13 million and $5 million, respectively, to provide solutions for the safe transport of temperature-sensitive pharmaceuticals.

Other startups are leveraging blockchain and distributed ledger technology.Hashed HealthandChronicledEquipping its prescription drug products with seals, labels, and other anti-tampering technologies to give clinicians and patients confidence in the authenticity and quality of their medications.

Some supply chain logistics companies specialize in the seamless transportation of pharmaceuticals from manufacturing facilities to pharmacies, while others focus on direct-to-patient home delivery.

For example, online pharmaciesPillPackMedications are categorized and packaged according to patients’ medication schedules, then delivered directly to their homes. In June of this year, the company was acquired by Amazon, marking one of the tech giant’s largest acquisitions to date.

Logistics startups can help ensure product integrity, allowing online pharmacies to fully replace brick-and-mortar pharmacies as intermediaries.

Several companies are planning to enter the market through pharmacy benefit management (PBM). These companies negotiate on behalf of their clients—or simply on behalf of the general public—and have garnered increasing attention and support.

GoodRx provides up-to-date medication prices and negotiates discounts at pharmacies across the United States. The company completed a new round of financing in early August, reaching a valuation of $2.8 billion and becoming a unicorn in this sector. GoodRx’s competitor, Blink Health, has raised $170 million in public funding since 2015 and offers discounts on more than 15,000 medications at its partner pharmacies.

These companies may replace pharmacy benefit managers (PBMs) in negotiating discounts for manufacturers that sell directly to pharmacies or patients.

Some companies have bypassed intermediaries in the pharmaceutical supply chain, even skipping the need for in-person visits to doctors’ offices by prescribing and delivering medications directly to patients.

Startups such as Hims (which provides medications for conditions like baldness and erectile dysfunction), Nurx, and The Pill Club (which provide contraceptive medications) allow patients to place orders directly via computers and mobile phones.

These health companies recruit patients via online platforms and mobile applications, prescribe generic and over-the-counter medications, and deliver the securely packaged drugs directly to patients’ homes.

These companies have effectively bypassed the entire supply chain. Patients no longer need to go through physicians, payers, pharmacy benefit managers (PBMs), wholesalers, and pharmacies to access these generic drugs; instead, they can use an app to receive and fulfill their subscriptions.

Given the current pharmaceutical market model and the development of telemedicine, companies may expand their business into similar areas, such as acne treatment (a market projected to reach $14 billion by 2023) or hearing aids (a market expected to reach $9 billion by 2023).

The current landscape of the pharmaceutical supply chain is extremely complex. Intermediaries in the supply chain—wholesalers, pharmacy benefit managers (PBMs), pharmacies, and payers—all benefit from a combination of scale and opacity.

However, technologies such as blockchain, logistics software, online pharmacies, and remote diagnostics can help reduce costs while improving efficiency and reliability. Many fast-growing startups with innovative products and business models are poised to lead this technological innovation.

Similar to the situation in the United States, China’s pharmaceutical supply chain also faces challenges such as multi-tiered structures, multiple distribution channels, and market fragmentation. The key difference lies in the fact that medical expenditure in China is predominantly covered by public health insurance schemes. Consequently, cost-containment efforts are less driven by market forces, which has prevented the emergence of large-scale Pharmacy Benefit Management (PBM) organizations akin to those in the United States.

In terms of market channel structure, the United States implemented the separation of prescribing and dispensing early on, with out-of-hospital channels dominating; China presents the opposite scenario. In recent years, policies such as the “Two-Invoice System,” “Zero Markup Policy,” and “Outflow of Prescriptions” have been implemented in China, fundamentally reshaping the pharmaceutical distribution channel structure. Cost containment in pharmaceutical retail and at the drug level is increasingly aligning with the U.S. model.

The greatest variable stems from the implementation of the “Internet + Healthcare” policy, which permits internet hospitals to conduct follow-up consultations for patients, issue online prescriptions, and provide medications. This will fundamentally alter patients’ healthcare-seeking and medication-purchasing behaviors. While the United States also has telemedicine and digital health services, its focus is largely on adjusting existing structures and upgrading technology. In contrast, China represents a purely incremental market, with a broader scope of impact and greater influence.

It is also valid to upgrade the business logic of pharmaceutical logistics through informatization. The pharmaceutical logistics industry itself has a low level of intelligence, and information integration, resource sharing, and resource allocation can be achieved through internet platforms, thereby improving the efficiency of pharmaceutical supply chain operations. Currently, some companies in China have already laid out their strategies in the track of smart supply chain upgrades and have achieved positive results.

Looking ahead, startups seeking to streamline the pharmaceutical supply chain will have to contend with regulators, corporate inertia, and large, vertically integrated companies. But if they succeed, new approaches to price negotiation and drug distribution will reduce the number of intermediaries in the supply chain from many to just one, benefiting health insurance programs, payers, and patients.