The Slippery Slope
In the tightly managed segments of the Medicare eligible population, pharmaceutical executives should anticipate a similar
evolution leading to price instability. This is particularly true for the largest and most crowded therapeutic classes such
as statins, proton pump inhibitors, antihypertensives, COX-2s, and selective serontonin reuptake inhibitors. Like the infant
formula business, the stakes for winning and losing access to these segments for any therapeutic class could lead to very
Lessons for Pharmaceutical Companies
The industry may have already have seen a glimpse of the future in 1998 when Pacificare solicited therapeutic class "capitation"
proposals from manufacturers. At that time, many pharma companies studied the "request for proposal" and declined to participate.
Perhaps they saw utilization risk or the possibility of exceeding "best price" as too great. Or perhaps they saw the slippery
slope that would follow this first step. Will Pacificare or the state of Florida be able to change the rules again? Category
capitation and utilization risk-sharing proposals are very likely to be seen again in 2005. In certain therapeutic classes,
third- and fourth-place competitors will certainly have the incentives to discount deeply in exchange for taking on price
and utilization risk.
Soon, new pricing and segmentation models will emerge. Before 2006 arrives, pharma companies will need to develop an understanding
of how spillover and carry-over effects (retention of chronic patients) of their product discounting and couponing will affect
their Medicare cohort. They will also have to use far more complex customer segmentation. Patient and physician responses
to pricing and promotion will differ not only by therapeutic class but also by co-morbidity status and previous payer history.
Patients who take three or more chronic medications (and are thus exposed to the coverage gap) will behave differently from
those who have no chronic prescriptions. Patients who come into Part D or managed care after losing generous drug coverage
(and there will be many) can be expected to behave quite differently from those who have always paid cash for their drugs.
In any event, traditional models trading off discounting and share will be insufficient. Companies calculating the potential
payoffs from winning or losing a bid must incorporate this new complexity or risk losing their bids on a consistent basis.
Cost Structure Shifts
As these changes take place, planning and resource allocation models will shift from maximizing national volume to optimizing
state-based profit margin. Pharma companies have already acknowledged differences in geographic markets, principally because
of managed care penetration and reduced physician access. But even though they know the single national model is becoming
obsolete, they have opted to retain the simplicity of mirrored territory alignments, uniform sample allocations, and standardized
Differences in the underlying distribution of Medicare beneficiaries, the expected future growth rate of Medicare enrollment,
payer history, and the influence of state government agencies all vary significantly. The Medicare drug benefit will push
the relevance of a national planning and resource allocation model past the tipping point.
As a result of all those changes, cost rationalization will be required for pharma companies to sustain their US earnings.
To stay profitable, they will have to streamline their sales operations, followed by marketing and other customer-focused
areas. Ultimately, the Medicare benefit could lead to a fundamental restructuring of US pharmaceutical operations.
Learn From Experience
In hindsight, the infant formula companies can now see that the WIC program and the competitive dynamics it set in motion
changed the economics of their business forever. Had they known the endgame, they might have restructured more aggressively.
However, like a terminally ill patient, their business models and strategies had to go through Kubler-Ross' five stages of
dying—denial, anger, bargaining, depression, and acceptance—before a new strategy (and cost structure) could be put in place.