Drug Price Wars, Episode IV: A New Value-Based Hope.

Drug Price Wars logo-Episode IVThe previous episodes of Drug Price Wars focused on the challenges around Hepatitis C virus (HCV), manufacturer and pharmacy benefit manager (PBM) deals, and the evolving generic drug market. These first episodes never managed to address a glaring problem with the way we pay for drugs. The problem I’m referring to is the purely cost-based pricing model that has plagued pharmacy throughout its existence.

In my 2012 article for U.S. Pharmacist entitled, “Understanding Drug Pricing,” I made an attempt to explain the alphabet soup of drug reimbursement models that seem to center around the different steps in the supply chain to determine price.[1] For pharmacy reimbursement, incentives have weighed heavily on the starting cost of the drug making it more financially beneficial to pharmacies to dispense higher cost products in many cases. The easiest way to describe this point is to look at a hypothetical scenario between two pharmaceutical products (one single-source brand, one multi-source generic) for a common disease state.


Cost-Based Pricing Example for Prescription Drugs
Drug A – Simvastatin 20mg Drug B – Crestor® (Rosuvastatin) 5mg
AWP* = $147.12 AWP* = $246.92
WAC* = $4.13 WAC* = $205.77
FUL** = $2.61 FUL** = Not available for Brand Name
*AWP & WAC are available via REDBOOK Online®[2]

**FUL are available on Medicaid’s website, these are based on a 3-month rolling average[3]


A typical retail pharmacy contracts with a PBM using a set of formulas for brand & generic drugs. For brand name drugs, the pharmacy is typically reimbursed based off of a calculation from available databases that have Average Wholesale Price (AWP) or Wholesale Acquisition Cost (WAC). An example may say something like “AWP – 10% for brand name” so in our Crestor® example, a pharmacy will be reimbursed $222.27 for a 30 day supply for a patient. Assuming the pharmacy bought the drug at WAC, the gross profit for the pharmacy will be $16.50 or 7.4% of sales. For multi-sourced generic drugs, the PBM may set a Maximum Allowable Cost (MAC) for the product which may be proprietary or derived from the publicly available Federal Upper Limit (FUL). A PBM-pharmacy contract may say something like “MAC + $4.00 Dispensing fee” so in our simvastatin example, a pharmacy will be reimbursed $6.61 for a 30 day supply for a patient. Assuming the pharmacy bought the drug at WAC, the gross profit for the pharmacy will be $2.48 or 37.5%. Now the percentage of gross profit is HIGHER for the generic medication, but the actual dollar amount that you are able to deposit in the bank (since banks do not accept percentages as currency) nearly 7x as much.

Shifting to Value-Based Care in Pharmacy

Recently, a few brilliant physicians from the Costs of Care team decided to publish a book, Understanding Value-Based Healthcare, to tackle similar cost-based pricing perversions throughout the United States’ health system.[4] While the book hit on many key points around medication costs, it missed a few of the nuances of pharmacoeconomics. The silly incentives explained in my cholesterol medication example only scratches the surface to some of the variables that have expanded drug expenditures.

The real question: How do we make the shift from cost-based pricing to value-based pricing in pharmacy? Modeling pharmacy payment in a way that rewards improved outcomes per dollars spent may be extremely challenging. It is also important to define appropriate methods to measure outcomes in a way that also doesn’t incentivize pharmacies to prefer healthy patients to sick patients, or vice versa.

Take the following hypothetical example with a diabetic patient on Lantus® and metformin.

Figure 1: Pharmacy reimbursement before hitting outcomes bonus.

Figure 1: Pharmacy reimbursement before hitting outcomes bonus.

Figure 2: Pharmacy reimbursement with improved outcomes bonus.

Figure 2: Pharmacy reimbursement with improved outcomes bonus.

Could we reimburse the pharmacy in a way that incentivizes routine reviews or interventions to drive improved outcomes and then bonus the pharmacy when those outcomes are achieved? When pharmacies hit the bonus, maybe the managed care plan has to spend more money, but it is a great value trade-off.

[1] Mattingly J. Understanding drug pricing. US Pharm. 2012;37(6):40-45.

[2] REDBOOK Online®

[3] Federal Upper Limits. Centers for Medicare & Medicaid Services. Available at: http://www.medicaid.gov/medicaid-chip-program-information/by-topics/benefits/prescription-drugs/federal-upper-limits.html, accessed on April 8, 2015.

[4] Moriates C, Arora V, Shah N. Understanding Value-Based Healthcare. New York, NY: McGraw Hill Education; 2015.

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Joey Mattingly, PharmD, MBA is an assistant professor at the University of Maryland School of Pharmacy located in Baltimore, Maryland. Joey has managed retail and long-term care pharmacy operations in Kentucky, Illinois and Indiana. Leading Over The Counter is a blog of Joey's views and opinions on the topics of pharmacy leadership and management and do not represent the University of Maryland, Baltimore. Joey can be followed on Twitter @joeymattingly.

One Response to “Drug Price Wars, Episode IV: A New Value-Based Hope.

  • Ben Urick
    2 years ago

    Great blog post. The perverse incentive matches with what my study in JAPhA which found that on average gross margins were $5 more for a brand name product than a generic product looking back at dispensing records at a local independent pharmacy: http://japha.org/article.aspx?articleid=1795160.

    I agree that an alternative reimbursement system would create more value for the healthcare system. Have you heard of any commercial payors experimenting with systems like the one you’ve suggested?

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