For the past few years, the United States has been wrestling with the cost of health care. Our system is shifting toward outcomes-based payment models, and falling reimbursements are encouraging efficiency. As the industry seeks and implements lower-cost models, health care profitability is under pressure throughout the prescription drug value chain.
To shed light on this struggle, we reviewed publicly available financial performance and industry-level data from more than 21 U.S. companies, which represent 76% of total revenues from 2018.
We found that the U.S. prescription drug industry saw only a 1% increase in revenues and an 8% drop in profits between 2016 and 2018 (see figure 1).
Generic drug manufacturers saw the largest drop in both revenues (14%) and profitability (23%). Branded drug manufacturers saw a 7% decline in profitability, a sign of greater pressures on drug pricing. Meanwhile, the least pressured subsector, payers and pharmacy benefit managers, saw a 7% increase in revenues and a 5% decrease in profits.
The subsectors that are generally more concentrated have grown their share of available profits, even if only modestly. For example, the top three U.S. drug wholesalers are very concentrated and have grown their share of sector profits from 88% to 92% between 2016 and 2018. By contrast, the brand and generic drug manufacturer segments are less concentrated, with the top three branded drug companies representing 30% of subsector profits and generic drug manufacturers representing only 22%. However, brand and generic manufacturers still comprise more than 60% of the industry’s overall profits.
As the industry’s profits have shrunk over the past two years, concentration has generally increased (see figure 2). This makes sense. As profitability falls, companies — especially the best-capitalized companies — look to quickly scale their efficiencies with horizontal integration and reduced transaction costs while using vertical integration to embrace innovative business models (see figure 3).
Four trends explain most of these profitability changes. The first is mergers and acquisitions. Although this has helped payers and PBMs, it has hurt manufacturers as a result of bigger drug buyers imposing their purchasing scale on fragmented manufacturers.
Second, price and volume trends are affecting the profitability of particular segments. These trends have a few characteristics. Generic drug deflation has had significant benefits for patients, even if unit costs for these drugs have fallen 5% to 10% a year — severely hurting generic drug makers’ profits. At the same time, the generic dispensing rate continues to rise, shifting unit volume from brand drugs to generics. Broadly, this has helped patients, payers, PBMs, pharmacies and generic drug makers, but has hurt the traditional branded manufacturers as long-dominant brands have gone off patent.
Patent erosion has been partly offset by a rapid shift to specialty medicines, which target much smaller patient populations and are generally higher priced but with much lower volume. Patients have seen substantial benefits from these new therapies. Payers and PBMs’ profits have also benefited, as the higher prices have allowed them to keep more gross profit dollars. Specialty medicines have unquestionably helped sustain branded manufacturer margins, and their impact for other players’ profitability appears neutral to negative.
Third, the gross-to-net bubble is shifting profitability. Rebates from invoice-to-net prices are growing as specialty and traditional branded drug prices rise yet net prices remain more stable. The profitability transferred from branded manufacturers to others in the form of rebates appears to be captured mostly by payers, with other industry participants trying to divide up the scraps. Of course, the lack of transparency in gross-to-net pricing makes precise external estimates impossible.
The final trend shifting industry profitability is the growing number of Food and Drug Administration drug approvals and applications. More new drugs are entering the pipeline for FDA approval, including specialty drugs and brand-to-generic conversions. This benefits patients’ health and seems to benefit payers and PBMs, which can help plan sponsors manage the cost of expensive new drugs.
Jerry Cacciotti is a partner for the Americas in the health practice of A.T. Kearney. Todd Huseby is a partner for the Americas in A.T. Kearney’s health practice and leads its pharmacy sector.