Wal-Mart's Generic Prescription Plan: The Connection to Pharmacy Benefit Managers and The Big Drug Chains

 |  Includes: CMX, CVS, ESRX, MHS, WBA, WMT
by: Larry Abrams

Consider this quote from a Barbara Martinez article in the Wall Street Journal on May 9, 2006 based on transcripts from an Ohio Teachers suit against Medco Health Solutions (NYSE:MHS) for breach of fiduciary duty:

"Medco says that after overhead its profit margin on mail-order generic drugs for the retired Ohio teachers was only 23 percent and its total margin, after losses on brand-name drugs, was 1 percent."

In other words, the Big 3 Pharmacy Benefit Managers - Medco, Express Scripts (NASDAQ:ESRX) and Caremark (CMX) - have been cross subsidizing low to nil margins on mail order brands, and no general management fees, with high margins on mail order generics.

Furthermore, the Big 3 PBMs basically set the price of their retail competitors -- Walgreen (WAG) and CVS (NYSE:CVS) -- an example of conflict of interest and self-dealing if there ever was one.

Wal-Mart (and for that matter Costco) know of this cross-subsidy and do not need high margin generics to cross-subsidize other lines (eg. mail order brands for PBMs and the front store operations of WAG and CVS).

The pressure for better prices on generics will come from plan sponsors that contract out to PBMs -- the United Healthcare (NYSE:UNH), the Blues, Principal, Humana, GM, Ford, IBM, Medicare, Medicaid.

This will force PBMs to respond by reducing their margins on mail order generics, will force WAG-CVS to do likewise at retail, and to make up the shortfall with higher prices elsewhere (management fees, mail order brand margins for PBMs, and front store margins for WAG and CVS)

That is the connection between the Wal-Mart (NYSE:WMT) announcement and its effect on stock prices of other drug supply chainers.

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