Skip to main content

Advanced Search

Advanced Search

Current Filters

Filter your query

Categories

Publication Types

Other

Area of Focus
Topics
Date Range
to

Area of Focus

Controlling Health Care Costs

Issue Briefs

/

Competition, Consolidation, and Evolution in the Pharmacy Market

Implications for Efforts to Contain Drug Prices and Spending

pharmacist with mask stands behind counter

A pharmacist speaks on the phone at Graves Drug in Arkansas City, Kan., on March 5, 2021. Independent pharmacies account for one-third of brick-and-mortar drug stores in the U.S., and the impact of a changing retail market on them has been the subject of much debate. Photo: Doug Barrett/Bloomberg via Getty Images

A pharmacist speaks on the phone at Graves Drug in Arkansas City, Kan., on March 5, 2021. Independent pharmacies account for one-third of brick-and-mortar drug stores in the U.S., and the impact of a changing retail market on them has been the subject of much debate. Photo: Doug Barrett/Bloomberg via Getty Images

Abstract

  • Issue: Pharmacies are at center stage in the U.S. health care market given their role in dispensing medications and, during the COVID-19 pandemic, administering vaccines. Understanding the dynamics among pharmacy types and what lies ahead for this industry is critical for U.S. policymakers considering policies aimed at increasing the cost-effectiveness and affordability of prescription drugs.
  • Goals: Identify and summarize industry trends in the pharmacy market and their implications for pharmaceutical prices and spending.
  • Methods: Literature scan of articles in peer-reviewed journals, government reports, and newspapers and interviews with experts from academia, pharmacy benefit managers, and the pharmacy industry.
  • Key Findings: The research uncovered four main aspects of the pharmacy industry that affect drug spending: 1) increased pharmacy consolidation and vertical integration, 2) rising challenges facing independent pharmacies, 3) growth of specialty pharmacies, and 4) the evolving role of mail-order pharmacies and e-commerce platforms.

Introduction

Pharmacies are where most patients receive prescription drugs and, increasingly, vaccines. Retail pharmacists advise patients on their medication regimens and help them avoid drug interactions and screen for possible side effects to medications. Interacting with both patients and physicians, the retail pharmacy sector plays a key role in the distribution and reimbursement of pharmaceuticals. Pharmacies affect drug spending by:

  • marking up wholesale drug prices
  • negotiating discounts and dispensing fees with pharmacy benefit managers
  • substituting generics for more expensive brand-name products
  • offering and accepting drug coupons and other non-insurance-based discounts.

Over the past two decades, the pharmacy market has changed significantly: there has been vertical and horizontal consolidation; new forms of pharmacies have emerged in addition to independent, chain retail, and mail-order pharmacies; services offered by retail pharmacies have increased; and new, potentially disruptive, entrants have emerged. There are conflicting theories on the impact of these market changes on competition, drug prices, access to pharmacy services, and the future of the industry. In this issue brief, we review these trends and identify how they may affect policy efforts to contain pharmaceutical prices and spending. A companion issue brief examines pharmacies’ role in making drug purchasing more efficient and in promoting access to preventive care.

Overview of Reimbursement to Pharmacies

Pharmacies buy drugs either directly from manufacturers or from wholesalers. They then contract with and are reimbursed by pharmacy benefit managers (PBMs), which act on behalf of health plans and employers, at negotiated rates plus dispensing fees. Patients also contribute to overall expenditures for prescription drugs through the copayments they provide to the pharmacy at the point of sale. Reimbursement rates between PBMs and pharmacies are based on different pricing benchmarks and vary depending on competitive dynamics and whether a drug is branded or generic (see Appendix).

Brand-name drugs account for approximately 10 percent of dispensed prescriptions,1 but about 75 percent of overall prescription drug spending because they are usually sold at high prices. During brand-name drugs’ market exclusivity periods, payers typically base reimbursement on the drug’s list price — the average wholesale price — minus a negotiated discount, plus a dispensing fee (on average, $2.05).

Generic drugs account for approximately 90 percent of prescription drugs dispensed in the U.S., with generics being dispensed 97 percent of the time they are available.2 Pharmacies traditionally derive a large share of their revenue from generic drugs. This reflects the large volume of generic drugs they dispense as well as the historically higher percentage markups on low-cost generic drugs compared to markups on brand-name drugs. In a recent study, gross generic margins3 for pharmacies averaged 42.7 percent compared to 3.5 percent for brand-name drugs.4

Reimbursement to pharmacies for generic drugs is based on maximum allowable cost (MAC) schedules. These schedules encompass a list of off-patent drugs that includes the maximum price the payer will pay for each drug. States establish their own MAC schedules for Medicaid generic drug reimbursement. PBMs also generate their own MAC schedules, but there is no industrywide standardization for how the benchmark is calculated or which drugs are included on the list.5

In addition to using a MAC schedule for generic drug reimbursement, PBM–pharmacy contracts increasingly include a total cap on generic drug spending called a generic effectiveness rate (GER). GERs stipulate that PBM reimbursement (net of patient copayments) for generics over the contract period does not exceed the average wholesale price, minus a specified percentage. (See Appendix for more on GERs.)

The pharmacy industry has undergone substantial changes over the past three decades. Vertical and horizontal mergers have resulted in a market dominated by large chain pharmacies, as well as supermarkets and mass retailers like Walmart.6 Of the roughly 60,000 retail pharmacies in the U.S., one-third are independent pharmacies and two-thirds are retail chains, supermarkets, or mass retailers,7 which generate 56 percent of retail prescription revenues. There is also a large mail-order industry that competes with brick-and-mortar pharmacies, accounting for 37 percent of retail pharmacy sales in 2017 (Exhibit 1).

Seeley_role_of_pharmacies_Exhibit_01_v2

The consolidation of the pharmacy industry may offer convenience for patients through features such as 24-hour availability or the option of picking up from alternate locations.8 Furthermore, chain or mass retail pharmacies may reduce prescription drug costs by leveraging their buying power to negotiate lower prices. For example, chain pharmacies may purchase their drugs directly from manufacturers, bypassing the wholesaler markup in the distribution chain. These lower pharmacy acquisition prices have the potential to reduce costs for the health care system through lower generic reimbursement under MAC and GER schedules, which should then be passed on to plan sponsors (health plans, employers, and other payers) and, ultimately, patients.

Researchers seeking to understand the impact of pharmacy consolidation on pharmaceutical costs have compared the price of prescription drugs across pharmacy types, including mass retail pharmacies, supermarkets, large chains, small chains, and independent pharmacies. While more research is needed, initial analyses indicate that pharmacies’ retail list prices, also known as “cash prices,” were higher for generic drugs at independent pharmacies and small chains than at large chain pharmacies, with mass market pharmacies having the lowest prices. The cash prices for brand-name drugs exhibited little variation across pharmacy type, suggesting that pharmacies have little control over prices established by brand-name manufacturers.9 While there is evidence that larger pharmacy chains can leverage their negotiating power to buy and sell drugs at lower generic prices, the extent to which these efficiencies are ultimately passed on to plan sponsors in the form of lower spending varies and cannot be fully assessed because of the proprietary nature of contracts.

Independent Pharmacies

While there may be price efficiencies associated with chain pharmacies, independent pharmacies remain a major part of the retail pharmacy business, accounting for one-third of brick-and-mortar pharmacies in the U.S. and 6 percent of retail prescription drug sales. In some rural and underserved urban areas, independent pharmacies may also be the sole providers of prescription drugs and other services such as vaccinations.

Independent pharmacies have traditionally relied on profits from the sale of generic drugs as their main source of revenue. However, PBM consolidation over the past decade has resulted in lower reimbursements to pharmacies.10 At the same time, experts we spoke with reported that mass retailers and supermarkets have undercut the market by selling generic drugs at prices lower than what they paid to acquire them, sometimes accepting losses on generic drugs in exchange for drawing more business to their stores. For example, starting in 2006, Walmart and others announced they would start selling a basket of commonly prescribed generic drugs at $4 per prescription for a 30-day supply.11 In turn, this pushed down PBMs’ reimbursement for generic drugs at other retail pharmacies through MAC schedules that reflect these low prices. To gain access to a PBM’s network of covered pharmacies, independents now must accept the lower generic reimbursement, making it difficult to remain financially solvent.12

The overall impact of a changing retail pharmacy market on independent pharmacies has been a subject of much debate, with differing reports on the extent to which independent pharmacies are struggling and whether they have increased or decreased in numbers.13 Where independent pharmacies have closed — often in low-income urban areas — patients’ access to prescription drugs has decreased.14 Thus, while increased consolidation among retail pharmacies and increased competition from mass retailers and supermarkets may increase efficiency in the distribution chain and help contain pharmaceutical spending, it is important to consider their impacts on independent pharmacies.

Pharmacies’ Roles in Dispensing Specialty Drugs

Over the past decade, more pharmaceuticals have been classified as specialty drugs.15 Specialty drugs are very expensive drugs, with a course of treatment in 2015 averaging $52,486.16 In 2019, only 4.9 percent of commercially insured patients took specialty drugs, but they were responsible for half of the total drug spend.17 Specialty drugs are also often complex biologic products, which may require special storage and additional training for pharmacists.

In response to the growth in specialty drugs, a niche type of pharmacy known as a specialty pharmacy has emerged. In 2018, 900 pharmacies in the U.S. had specialty accreditation.18 Specialty pharmacies operate separately from most retail pharmacies and are primarily owned and operated by PBMs, wholesalers, providers, or integrated delivery networks, though there are still some independent and small regional specialty pharmacies. Use of specialty pharmacies has been associated with higher rates of adherence than use of retail pharmacies for specialty drugs.

The large chain pharmacies such as CVS and Walgreens have been able to diversify to own both specialty and retail pharmacies, enabling them to create new integrated models aimed at improving medication adherence and other measures of clinical performance. For example, while most specialty pharmacies ship the drugs to patients, CVS’s “specialty at retail” model allows patients to access specialty drug patient management programs while picking up their specialty and traditional drugs at one location.19

Though quality is frequently used as a rationale for involving specialty pharmacies, it is difficult to determine the extent to which quality differs between specialty pharmacies and traditional retail pharmacies. Specialty pharmacies also may exacerbate drug spending if their prices are higher than those at retail pharmacies. There is little evidence on the extent of price competition within the specialty pharmacy sector and between specialty pharmacies, retail chain pharmacies, and independents. With specialty drugs driving growth in pharmaceutical spending, it will become increasingly important to ensure that as specialty drugs go off patent, the pharmacies selling them operate in a competitive environment that delivers the best quality at the lowest cost. More research will be needed to understand the impact that different pharmacy channels have on the cost and outcomes of these medications.

Mail-Order Prescription Drugs and E-Commerce Platforms

Mail-order pharmacies have grown to compose a substantial portion of the pharmacy market, increasing from 21 percent of retail pharmacy sales in 2007 to 37 percent in 2017.20 Drug formularies that incentivize use of mail-order prescription drugs are often criticized on the grounds that PBMs own mail-order pharmacies and therefore have incentives to steer patients toward them, rather than toward the lowest-cost and most appropriate drugs.

However, the mail-order drug market is evolving beyond PBM-owned entities. Advancements in information technology and the entry of new players such as Amazon/PillPack herald further changes in the pharmacy market. PillPack is an online pharmacy, launched in 2014, that ships patients monthly supplies of pills, organized in daily planners. These planners make it easier for patients who take multiple medications with complex and variable dosing schedules to follow their medication regimens. In June 2018, Amazon acquired PillPack. CVS Health and Walgreens followed suit in 2018 with the introduction of their own multidose packaging options with home delivery. While Amazon/PillPack’s revenues made up less than 1 percent of the prescription drug pharmacy market in 2019, its presence may continue to catalyze the integration of e-commerce platforms into pharmacy care (Exhibit 2).

The emergence of these online pharmacies also has converged with an increased demand for mail-order drugs during the COVID pandemic.21 Time will reveal what proportion of patients permanently shift to online/mail-order drug purchasing. Along with these changes in consumer purchasing, it will remain important to compare the prices of mail-order and online drugs to drugs purchased in brick-and-mortar retail outlets. Such information should help PBMs and their health plan sponsors steer patients toward the most efficient distribution channel.

Conclusion

The U.S. retail pharmacy market has undergone significant changes in the past two decades, with increased PBM and pharmacy consolidation resulting in a competitive market that has driven down reimbursement rates for many generic drugs. While lower reimbursement rates may offer improved purchasing efficiency, they also pose a challenge for independent pharmacies, which have traditionally relied on generics as their main revenue source. Specialty pharmacies also have emerged, adding another layer to the diverse pharmacy landscape. Finally, market disruptors with e-commerce platforms will potentially lead to even steeper competition in the retail pharmacy space.

As policymakers grapple with containing the cost of prescription drugs for the health care system, it is important that they understand the pharmacy market, its many distribution channels, and which channels offer drugs to patients at the optimal cost and best quality.

Appendix. Reimbursement for Prescription Drugs

PBMs

To manage their pharmaceutical budgets, payers typically contract with pharmacy benefit managers (PBMs) to negotiate pharmaceutical rebates with manufacturers and reimbursement rates with pharmacies. Pharmacies contract with PBMs so that their network of covered beneficiaries will be authorized by the PBM to fill their prescriptions at the pharmacy. Under these contracts, pharmacies agree on the reimbursement rates that PBMs pay them for the drugs they dispense. Each time a prescription drug is filled, pharmacies receive reimbursement to cover the ingredient cost of the drug (the price the pharmacy has paid to acquire the drug) and the dispensing fee (the operational cost of dispensing the drug). Dispensing fees average $2.05 per prescription for commercial insurers, but fees can vary by payer.22 For example, by basing reimbursement on the national average drug acquisition cost (NADAC), Medicaid pays a lower ingredient cost and a higher dispensing fee, ranging from $9 to $12 per prescription.23

Insured patients usually incur a copayment at the point of sale, with their PBM or plan sponsor reimbursing the remainder of the cost. The pharmacy then passes the copayment revenue back to the PBM.24 A small number of insurance programs, such as Medicaid, have little to no copayments.

MAC Schedules and GERs

The reimbursement rates between PBMs and pharmacies are based on different pricing benchmarks and depend on the drug type (brand or generic) and the pharmacy’s degree of market power. Manufacturers set a drug’s list price and sell drugs to wholesalers at the wholesale acquisition cost (WAC). Another benchmark, the average wholesale price (AWP), is typically calculated to be 20 percent higher than the WAC. Wholesalers — there are three in the U.S., AmeriSource Bergen, Cardinal Health, and McKesson — pass through the price with a small markup and distribute the drug to pharmacies, which are then reimbursed by public and private payers. Retail pharmacies derive 80 percent of their revenue from private insurers and 15 percent of their revenue from Medicaid.25 Private insurers (including those who administer Medicare Part D) base reimbursement to pharmacies on the AWP, minus a discount.

Maximum allowable cost (MAC) prices were originally intended by PBMs to set reimbursement for off-patent drugs at the level of the best price available across manufacturers selling that drug. In practice, pharmacies’ generic drug acquisition costs range significantly, with a Centers for Medicare and Medicaid Services (CMS) study reporting that generic drugs are acquired at a mean price of 78.4 percent less than AWP and a median price of 86.1 percent less than AWP.26 As a result of the large variation in pharmacies’ generic acquisition costs, MAC schedules may overestimate the acquisition costs of some generic drugs and underestimate the costs of others. In addition, when some pharmacies, such as independent pharmacies, do not have leverage to acquire drugs at the lowest cost, they may face MAC schedules that reimburse at prices below their acquisition costs. Another challenge for pharmacies is that the MAC schedules may not reflect sudden WAC price increases imposed by manufacturers. A recent review found that one of five generic drugs experienced a price spike (doubling in price in one year) by at least one manufacturer from 2014 to 2017.27

Low MAC generic reimbursement rates can improve efficiency in the pharmaceutical distribution chain by containing overall pharmaceutical spending. However, independent pharmacy groups have criticized these reimbursement methods on the grounds that they can negatively affect the bottom line for pharmacies. In response, some states have responded with legislation that requires increased MAC transparency and MAC schedules that more frequently update the prices PBMs pay. Federal legislation was also proposed in 2017 and 2018 that would have mandated PBMs update MAC schedules to reflect generic drug price increases, though Congress has yet to pass such a law.

Generic effectiveness rates (GERs) cap total spending for generic drugs by stipulating that reimbursement in the aggregate cannot exceed a percentage discount below AWP. This may result in lower overall generic reimbursement rates to pharmacies than is specified under the MACs. Similar to the use of MAC schedules, the GER methodology can improve pharmaceutical purchasing efficiency by containing spending on generic drugs. However, GERs also can drag down the bottom line for pharmacies if the level of discount specified under GER formulas results in net PBM reimbursement prices that are lower than the prices pharmacies have paid to acquire generic drugs. Furthermore, GERs may be calculated up front and applied at the point of sale or may be applied retrospectively, potentially further complicating pharmacies’ abilities to forecast their net generic revenue. MAC schedules and GERs have become the subject of much controversy between PBMs and independent pharmacies, with some states passing legislation to address these issues (see our issue brief on pharmacy reimbursement).

Medicaid and the Uninsured

Medicaid reimbursement to pharmacies is based on the NADAC, a price metric that CMS established in 2012 to estimate pharmacies’ actual acquisition costs of drugs. The NADAC is obtained from a pharmacy survey on the prices pharmacies pay to acquire drugs.28 Patients without insurance (who composed 4.1 percent of consumers in the prescription drug market in 201729) face the highest pharmaceutical prices — the usual and customary (U&C) retail list prices that vary significantly across pharmacies,30 but are always higher than the reimbursement rates negotiated between drug manufacturers and third-party payers. One study estimates that these retail list prices are at least 33 times higher than the NADAC.31

NOTES

  1. Statista, “Proportion of Branded Versus Generic Drug Prescriptions Dispensed in the United States from 2005 to 2019,” Aug. 18, 2020.
  2. IQVIA Institute for Human Data Science, Medicine Use and Spending in the U.S.: A Review of 2018 and Outlook to 2023 (IQVIA, May 2019).
  3. Gross margins are defined as the difference between pharmacies’ revenue from generic drugs and the cost pharmacies incur in acquiring the generic drugs.
  4. Neeraj Sood et al., The Flow of Money Through the Pharmaceutical Distribution System (University of Southern California Leonard D. Schaeffer Center for Health Policy and Economics, June 2017), 5.
  5. National Community Pharmacists Association, “The Need for Legislation Regarding ‘Maximum Allowable Cost’ (MAC) Reimbursement,” n.d.
  6. Examples of horizontal mergers include Walgreens acquiring Alliance Boots in 2014 and Rite Aid in 2018. Examples of vertical mergers include CVS Health acquiring PBM Caremark Rx in 2007 and Aetna in 2018.
  7. Matan C. Dabora, Namrata Turaga, and Kevin A. Schulman, “Financing and Distribution of Pharmaceuticals in the United States,” JAMA 318, no. 1 (July 4, 2017): 21–22.
  8. Dima Mazen Qato et al., “The Availability of Pharmacies in the United States: 2007–2015,” PLOS ONE 12, no. 8 (Aug. 16, 2017): e0183172.
  9. Jing Luo et al., “Variation in Prescription Drug Prices by Retail Pharmacy Type: A National Cross-Sectional Study,” Annals of Internal Medicine 171, no. 9 (Nov. 5, 2019): 605–11.
  10. Elizabeth Seeley and Aaron S. Kesselheim, Pharmacy Benefit Managers: Practices, Controversies, and What Lies Ahead (Commonwealth Fund, Mar. 2019).
  11. Nicole Maestri, “Wal-Mart Expanding Its Low-Priced Drug Program,” Reuters, May 5, 2008.
  12. Adam J. Fein, “New Data: Pharmacy Owners’ Profits Fall as Industry Competition Rises,” Drug Channels (blog), Jan. 9, 2018; and Jeffrey Woldt, “NCPA Aims to Change Rx Payment Model,” Chain Drug Review (blog), Nov. 18, 2019.
  13. Brian Nightengale, “What Was, Is No More: Community Pharmacy Economics,” Journal of Managed Care & Specialty Pharmacy 26, no. 6 (June 2020): 703–5; Adam J. Fein, “The State of Retail Pharmacy: Independent Pharmacy Economics Stabilize — But Dropping, Owners Salaries Are,” Drug Channels (blog), Dec. 3, 2019; and Pharmaceutical Care Management Association, Independent Pharmacies in the U.S. Are More on the Rise Than on the Decline (PCMA, Mar. 2020).
  14. Jenny S. Guadamuz et al., “Assessment of Pharmacy Closures in the United States from 2009 Through 2015,” JAMA Internal Medicine 180, no. 1 (Oct. 21, 2019): 157–60.
  15. Huseyin Naci and Aaron S. Kesselheim, “Specialty Drugs — A Distinctly American Phenomenon,” New England Journal of Medicine 382, no. 23 (June 4, 2020): 2179–81.
  16. Sharon Phares, “Highlights from PBMI’s 2018 Trends in Specialty Drug Benefits Report,” PSG, Mar. 6, 2018.
  17. Sharon Phares, “Highlights from the 2019 PBMI Trends in Specialty Drug Benefits Report: Specialty Drug Benefits by the Numbers,” PSG, Apr. 9, 2019.
  18. Gannon Vanscoy, “Stratification and Differentiations of Specialty Pharmacies,” Pharmacy Times, Mar. 10, 2020.
  19. Janice M. Moore et al., “The Adherence Impact of a Program Offering Specialty Pharmacy Services to Patients Using Retail Pharmacies,” Journal of the American Pharmacists Association 56, no. 1 (Jan.–Feb. 2016): 47–53.
  20. Dabora, Turaga, and Schulman, “Financing and Distribution,” 2017; and National Association of Chain Drug Stores, Chain Member Fact Book 2018–2019 (NACDS, May 2019), 55.
  21. Jared S. Hopkins, “Mail-Order Drug Delivery Rises During Coronavirus Lockdowns,” Wall Street Journal, May 12, 2020.
  22. Pharmacy Reimbursement Continues to Drop,” Medscape, n.d.
  23. Rachel Dolan and Marina Tian, Pricing and Payment for Medicaid Prescription Drugs (Henry J. Kaiser Family Foundation, Jan. 2020).
  24. Sood et al., Flow of Money, 2017, 2.
  25. NACDS, Fact Book, 2019, 62.
  26. Dolan and Tian, Pricing and Payment, 2020.
  27. Aayan N. Patel, Aaron S. Kesselheim, and Benjamin N. Rome, “Frequency of Generic Drug Price Spikes and Impact on Medicaid Spending,” Health Affairs 40, no. 5 (May 2021): 779–85.
  28. Adam J. Fein, “Why Retail Pharmacies Still Overcharge Uninsured Patients — And What That Means for Amazon,” Drug Channels (blog), Apr. 19, 2018.
  29. NACDS, Fact Book, 2019, 62.
  30. Adam J. Fein, “How GoodRx Profits from Our Broken Pharmacy Pricing System,” Drug Channels (blog), Aug. 31, 2020.
  31. Fein, “Why Retail Pharmacies,” 2018.

Publication Details

Date

Contact

Elizabeth Seeley, Adjunct Lecturer on Health Policy and Management, Department of Health Policy and Management, Harvard T.H. Chan School of Public Health

[email protected]

Citation

Elizabeth Seeley and Surya Singh, Competition, Consolidation, and Evolution in the Pharmacy Market: Implications for Efforts to Contain Drug Prices and Spending (Commonwealth Fund, Aug. 2021). https://doi.org/10.26099/exwh-r479