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Disrupting the Pharmacy

from the magazine

Disrupting the Pharmacy

Innovative technology could eliminate the inflated costs that Americans pay for drugs. Spring 2019
Health Care
Technology and Innovation

A team of Internet entrepreneurs in downtown Manhattan wants to revolutionize how Americans get prescription drugs. Their company, Blink Health, has a crazy idea: let customers shop for the best deal.

In any other industry, of course, this would not be revolutionary, but it’s a foreign concept at the pharmacy counter and a distasteful prospect to the businesses now shielded from marketplace competition. Politicians and activists routinely decry the resulting high prices, but their preferred solution is to impose price controls that would stifle the development of new drugs. Democrats—joined, at times, by President Trump—argue that government control is necessary because the free-market system has failed patients. But the real problem with prescription drugs, as with the rest of the health-care system, is that the free market hasn’t been tried.

A functioning market requires price signals to provide consumer guidance; but at the pharmacy, neither the buyer nor the seller knows what the price is. In choosing among drugs to prescribe, your doctor doesn’t know how much each will cost you or your insurance company. You can’t find out what you’ll pay until after you’ve chosen a pharmacy to handle the prescription. The pharmacist must contact the insurance company to find out how much to charge you—and even then, he doesn’t know whether the transaction will be profitable.

All that information is available only to the middlemen, who have exploited the system’s secrecy and complexity to profit at the expense of patients, local pharmacists, drug manufacturers, and taxpayers. While politicians denounce the supposed power of Big Pharma, the pharmaceutical manufacturers are a puny, disorganized force compared with the companies that control the pricing and availability of drugs—Big Pharmacy, as the executives at Blink Health call these middlemen. They’re the ones who decide whether your insurance will cover a drug, how much you’ll pay for it at the counter, and how much of that payment the drugstore will keep.

Big Pharmacy is essentially an oligopoly dominated by several businesses that administer the drug benefits provided to most Americans by health-insurance plans. By negotiating with drug manufacturers on behalf of the insurers, these companies set the terms for most prescriptions, and they’ve gained further leverage through what economists call vertical integration: merging or forming partnerships with insurers, wholesale distributors, and chain pharmacies. In other industries, big-box chains use economies of scale to undersell small stores, but CVS and Walgreens get away with charging higher prices than local drugstores because they’re part of the oligopoly.

Thanks to all this leverage, Big Pharmacy has created a byzantine system governed by secret contracts that make it impossible for outsiders to know the true cost of a drug. Manufacturers publicly set an artificially high list price—and get pilloried in the press for it—but then privately agree to kick back a large chunk of it. These legal kickbacks, politely known as rebates, go to the middlemen, along with other fees. As a result, too many patients pay inflated prices for prescriptions, especially the sickest patients and those lacking good insurance.

The founders of Blink Health offer an alternative: the chance to eliminate the middlemen and comparison-shop at their website to see if you can get a better deal than what’s being offered by your insurance plan or the drugstore. The website features video and written testimonials from grateful customers, who say that they’re saving hundreds of dollars a month at the pharmacy and no longer have to choose between groceries and medicine. “I am almost in tears,” a young mother in Nebraska says, “because of the joy and relief I feel.”

But Blink’s executives want to do more than just lower prices. By introducing capitalism to the pharmacy and moving the business online, they want to change the way that health care is delivered. They envision therapeutic innovations in personalized medicine that are impossible in America today and will never be possible in Europe’s government-controlled systems. But first, they’ll have to prevail against the current American oligopoly, which won’t go quietly.

The best way to understand what Blink is up against—and what kind of revolution might be possible—is to consider what’s happened in the airline industry. In the pre-Internet era, buying an airline ticket presented some of the same challenges as filling a prescription today. The airlines offered varying fares and options, and the only practical way to comparison-shop was to go through middlemen. You had to consult a travel agent, who had access to the airlines’ schedules, available seats, and fares on a centralized computer-reservation system—typically, the system run by Sabre, which dominated the industry.

The travel agent was supposed to guide you to the best deal, but only he could see the options, and your interests weren’t necessarily his top priority. Besides collecting a standard commission for each ticket, travel agents could earn bonuses by steering passengers to certain airlines. Just as today’s travelers get frequent-flier miles, a travel agent who booked enough passengers on an airline would get extra commissions. So when a choice existed between a flight on United or American, the agent’s decision—unknown to you—might well depend on which airline offered him a higher fee.

It was a bad deal for the airlines, too, because so much of their passengers’ money was being siphoned by the travel agencies and by Sabre, which collected fees from the airlines for each flight booked on its computer system. These middlemen came to control the reservations business, extracting higher and higher fees, though their own costs declined as computers got cheaper. In one year, 1993, the airlines shelled out nearly $8 billion to the middlemen—ten times the combined annual profit of all the airlines.

The airlines often reported annual losses, but Sabre was so consistently profitable—and so well protected from competition, thanks to federal airline restrictions—that its president once described the system as the “legal ability to print money.” As the Internet came of age, Sabre extended its market dominance by starting Travelocity, the first online booking site for the public, and striking deals with AOL, Yahoo, and other major portals. For years, regulatory obstacles and heavy lobbying by Sabre and the other middlemen stymied the airlines’ efforts to bypass Sabre, but eventually, a consortium of airlines established a competitor, with much lower fees: Orbitz. They also improved their own websites so that more passengers could book directly with them.

Those changes, along with the rise of competing websites like Kayak and Priceline, have been good for everyone except the middlemen. Passengers can now easily see what their options are, and the airlines get to keep more of their customers’ money, so they can make a profit while charging less. The industry has become more transparent and efficient, which has led to more choices and lower prices for consumers—the same story repeated in industry after industry as the Internet has promoted competition, eliminated middlemen, and forced companies to treat customers better.

The pharmacy business, however, remains largely untouched because customers haven’t easily been able to shop online for a better price. They’re buying drugs the way they bought them in the predigital age—at the drugstore. The middlemen still flourish, at the expense of everyone else. Just as the airlines once chafed at Sabre’s power and profits, the drug manufacturers resent the middlemen that dominate their industry, determining which medicines are sold to which patients at what price.

“The middlemen’s share of drug revenue has been rising five times faster than the list prices of brand-name drugs.”

The dominant middlemen are the pharmacy benefit managers, or PBMs, which are hired by private and government health-insurance plans to administer drug benefits. Dozens of small PBMs once competed for business, but today three large firms—Express Scripts, CVS Caremark, and OptumRx—together control more than 75 percent of the market. Like travel agents, they’re supposed to get the best deals for their clients, but they, too, have conflicting incentives. Thanks to their purchasing power and market share, the PBMs have the leverage to extract price concessions from drugmakers, but those savings don’t go directly to the customer at the counter. The PBMs pressure the manufacturers to set an artificially high list price for a drug and then offset it through rebates, discounts, and other payments to the PBMs, based on how many of their patients buy the drug. Again, like travel agents, they can make bigger profits by steering customers to certain purchases.

How much bigger? That’s a mystery, because these rebates and discounts are shrouded in secret contracts. Drug manufacturers typically collect less than $60 for a drug with a list price of $100, but only the PBMs know where the rest of the money goes. They say that they pass on nearly all the direct rebates to their clients—the employers and unions and government programs that sponsor health-insurance plans—but the PBMs pocket additional money through various “administrative fees,” “service fees,” and “inflation payments.” They profit from arcane tactics like reclassifying a drug so that they can charge a client a higher price than they pay for it.

In Ohio, Iowa, New York, and other states, government officials and pharmacist associations have accused PBMs of using their leverage to underpay local pharmacists, while overcharging the Medicaid plans that reimburse them for the prescriptions. A report commissioned by the Pharmacists Society of the State of New York found that PBMs billed the state’s Medicaid plans about $3.50 more per prescription for generic drugs than they paid to pharmacies—a 32-percent markup that amounted to more than $300 million annually. Similar disclosures in West Virginia and Ohio prompted those states to eliminate such markups in their Medicaid programs.

These tactics have produced a large pool of money for the middlemen—and it’s been growing rapidly. Adam Fein, who covers the industry on his Drug Channels website, calculates that the middlemen’s share of drug revenue has been rising five times faster than the list prices of brand-name drugs and now exceeds more than $150 billion annually. This means less money for pharmaceutical companies to invest in research and development of new drugs—and, of course, less money in patients’ pockets.

While other twentysomethings were launching Internet startups, Geoffrey Chaiken was wondering why there was no Uber or Airbnb in the pharmacy industry. After dropping out of Yale to start a company developing epilepsy drugs, he began studying the industry’s supply chain. “From the 1990s on, prices were going down in every other industry as transactions moved online,” he says. “But drug prices were rising because the industry was protected both by its lack of price transparency and by the high switching costs for customers—the difficulty of trying to move your prescription to another pharmacy if you wanted to shop for a better price. I figured we could solve both problems on the web.”

Together with his younger brother, Matthew, he started Blink Health in his downtown apartment four years ago. Today, it has 600,000 customers and an office in SoHo with 220 employees. To help them run the company, the Chaikens brought in veterans of online companies like Kayak as well as the drug industry, including Bill Doyle, who’d spent decades working for Johnson & Johnson.

“It became pretty clear to me,” Doyle says, “that Blink could help more people than all the people I’d helped in the first part of my career developing new drugs.” More than 100 million Americans—the ones with high-deductible insurance plans or no insurance at all—can get stuck paying the full retail price at the pharmacy counter, which may be so high that they either don’t buy the pills or scrimp by taking them less often than prescribed. Even if you have a generous insurance plan, what you pay at the counter is often unnecessarily high because it’s based on a percentage of the inflated list price.

In fact, your “copay” is often a misnomer because you’re paying more than what the pharmacy is charging your insurance plan. A study led by Karen Van Nuys of the University of Southern California found that this happened with about a quarter of the prescriptions filled at the pharmacy counter. For instance, most copayments for the generic version of Ambien sleeping pills (zolpidem tartrate) were higher—typically by $6—than what the PBM paid for the pills. Patients don’t realize that they could often save money by paying cash (instead of using their insurance) because PBMs have worked hard to keep them in the dark. Until President Trump signed a law in October outlawing the practice, PBMs enforced “gag clauses” forbidding pharmacists from telling customers that there was a cheaper way to get the drug.

The system has been especially unfair to the sickest patients, who use the most medication, because they shell out more money at the pharmacy and reap relatively little benefit from the secret rebates and discounts. Even when the PBM passes most of the rebate on to its client, the health insurer, the money is typically used to keep monthly premiums lower for everyone in the insurance plan. So the sick are effectively subsidizing the healthy—precisely the opposite of how insurance is supposed to work.

Blink solves this problem by passing the savings directly to each patient. Like a PBM, it negotiates with drug manufacturers, using its purchasing power to extract discounts off the list price. Then, instead of collecting secret rebates or steering patients to a preferred drug, it posts all the discounted prices on its website (and makes money by charging the patient slightly more than it reimburses the pharmacy). Instead of forcing patients to turn over their prescription to a pharmacist to find out what it will cost, Blink lets doctors and patients shop on the web before making a commitment.

Suppose you have high cholesterol and your doctor wants to prescribe a statin. If you’re paying the full retail price at the counter, a month’s supply for the generic version of Lipitor (atorvastatin) would typically cost more than $100 at CVS and more than $200 at Walgreens. The generic version of Crestor (rosuvastatin) would cost more than $175 at either chain. You could probably get it for less at an independent drugstore or by using a discount coupon, but the price would vary widely, depending on where you live. You’d pay less if you have good insurance, but the price would again vary, depending on your plan’s coverage and copayment policies. If your plan covered the Lipitor but not the Crestor generic, you might spend between $5 and $40 for the Lipitor, but you’d have to pay the full $175 for the Crestor—so you might not buy it, even though it would be the better option for you.

At Blink’s website, you can typically find the Lipitor generic priced under $9 and the Crestor under $12. If you buy it from Blink, you can get it delivered to your home or pick it up at a local drugstore. Independent pharmacies have been eager to work with Blink because it’s simpler and more profitable than dealing with insurance plans. Blink makes straightforward payments for the drugs and doesn’t impose complicated contracts (or gag clauses). The PBMs often pay less, and they impose various fees, like charging pharmacists $5 if they call their help desk to deal with a prescription. The PBMs can decide months after a transaction that the pharmacy must give back part of the reimbursement—a retroactive penalty called a “clawback”—which can cause the pharmacy to lose money on the prescription.

Local pharmacists complain that they’re being driven out of business by these and other tactics of the Big Pharmacy oligopoly. Investigations by Pennsylvania’s auditor general as well as Bloomberg News and Ohio’s Columbus Dispatch have found that PBMs often reimburse pharmacies less than the cost of the drugs. Bloomberg last year reported that the CVS PBM was charging an Iowa county government $4,500 a month for medications while paying just $1,500 for them to the local pharmacy, which was losing money on the transactions.

Consumers have benefited from technology in many industries, but they still buy their drugs the way they did decades ago—through their local pharmacies. (CLASSICSTOCK/ALAMY STOCK PHOTO)

“The PBMs started out as small companies that simply processed claims, but now they’ve consolidated into a $315 billion industry that’s in the middle of every transaction,” says Monique Whitney, executive director of Pharmacists United for Truth and Transparency, a group advocating for state and federal laws restricting the PBMs’ tactics. “They design the benefit plans, negotiate the prices, collect the rebates, make the reimbursement rules, fill the prescriptions at their own pharmacies, and make money at every step of the process.”

Independent pharmacists and drugmakers welcomed the Trump administration’s decision in February to halt rebates from being paid to PBMs that administer benefits for Medicare and Medicaid plans. The pharmacists and drug companies hope to see rebates eliminated in private health-insurance plans, too, an idea supported by Scott Gottlieb, until recently the commissioner of the Food and Drug Administration. Gottlieb criticized the “Kabuki drug-pricing constructs” and the “monopoly rents” collected by the PBMs, wholesale distributors, and large pharmacies as these middlemen have consolidated their power through mergers and partnerships.

The Express Scripts PBM steers patients to its own mail-order pharmacy and is owned by Cigna, one of the major health-insurance companies. The OptumRx PBM is owned by the largest health insurer, UnitedHealthcare. The CVS Caremark PBM recently merged with Aetna, another major insurer, and steers patients to its affiliated CVS pharmacies. CVS and Walgreens already control more than half the drugstore market in most metropolitan areas, and they’ve increased their dominance by buying up more pharmacies and vertically integrating with the wholesalers that distribute more than half the drugs in the U.S.

The result: “undue market power” and “outsize profits” for the middlemen, as the White House Council of Economic Advisers concluded last year. It recommended reforms to make drug prices transparent and to increase competition—reforms heartily endorsed by Blink’s CEO Chaiken. In Blink’s early days, its customers could pick up their prescriptions in most drugstores, but its discounted prices soon produced a backlash from Big Pharmacy: CVS and Walgreens ended their arrangements with Blink, refusing to fill its customers’ prescriptions.

“If there were a competitive market with transparent pricing, Blink would be working with every pharmacy in the country,” Chaiken says. “But Walgreens and CVS have so much market power that they could effectively say to us, ‘No, Blink, we like the system just the way it is. We like charging our patients more than everyone else, even though we are able to buy our drugs at lower prices than smaller pharmacies.’ If the federal government wants to lower drug prices, it could do so immediately without any legislation simply by putting a moratorium on any more mergers across the pharmacy supply chain.”

The Trump administration has promised to take more steps to promote market competition in the prescription-drug industry, but it has also floated ideas for increased government intervention, like forcing drugmakers to charge the same prices in America as in Europe. Drugs are priced lower in Europe because the nationalized health systems function like PBMs, with a legal monopoly in each country. The government decides which drugs to provide at what price, so it can offer a drugmaker exclusive access in exchange for a steep discount. That saves lots of money for the government, but it leaves patients with fewer choices at the pharmacy.

That’s the sort of system that appeals to Democrats advocating Medicare for All. They stress the lower costs of Europe’s systems while ignoring the statistics showing that patients with heart disease, cancer, and other ailments fare worse in Europe than in the United States, in large part because Americans can choose from a wider assortment of drugs. (See “What the Prescription Drug Debate Gets Wrong,” Autumn 2018.)

When pressed, fans of nationalized health care argue that this trade-off of less choice in return for lower costs is worthwhile and inevitable—that the prescription-drug business is so complex and opaque, so impervious to market forces, that only the government can ensure that medicine will be provided at an affordable price. It’s the same rationale that Obamacare’s architects used to justify new federal authority over what medical procedures to provide and at what cost. Liberal economists have been arguing for half a century that health care cannot function like a normal market because consumers don’t have the expertise to choose the right treatment at the right cost.

“The same market forces that liberated airlines and passengers can liberate drugmakers and patients.”

But Blink Health has shown that the same market forces that liberated airlines and their passengers can liberate drugmakers and patients. These forces could transform the rest of the health-care industry. The prices of most medical procedures and hospital stays are as complex and opaque as they are for prescription drugs. The prices are known, again, only to the middlemen, so it’s not surprising that costs keep rising.

But when patients have the opportunity and incentive to do direct comparison-shopping, as when they’re spending their own money for laser eye surgery or cosmetic surgery, market forces have led to lower prices and innovations that have improved treatment. Conservative economists have been trying to expand this “consumer-driven health care” by encouraging people to use health savings accounts to pay directly for routine care, reserving health insurance for catastrophic expenses. Most people, though, have been loath to make that switch—understandably, because it’s so difficult for them to shop for medical care on their own.

But the Internet is easing those difficulties, providing patients with a wealth of information about medical treatments and the track records of hospitals and doctors (including ratings by patients). New federal and state policies are forcing hospitals to post prices online. If public officials, consumers, and companies like Blink keep up the pressure for price transparency, providers will face more competition and the middlemen will have to settle for smaller profits. Americans, who already get better health care than Europeans do, would enjoy low prices as well, and they could benefit from other innovations not possible in government-run systems.

The United States has a chance to leapfrog Europe in health care,” says Chaiken. “People think that free-market economics has caused our current health-care problems, but actually the problem is the lack of a free, transparent market. Every day at Blink we see customers shopping for their medication at the best price. Once you move transactions online, you give patients and doctors the information to make choices.” Instead of being steered to a drug favored by a PBM or a national health plan, people can choose one tailored to their needs, and the outcomes of those choices can be analyzed because the data get collected online. “The future of health care,” Chaiken says, “is leveraging all this big data in the United States to innovate and personalize medicine in a way that is not going to be possible anywhere else in the world.”

The nationalized systems of Europe, long hailed by progressives as a model for America, were built on the assumption that only centralized authorities had the expertise to manage people’s health care. Now that the web has democratized information, that model looks increasingly obsolete. The one-size-fits-all system may still appeal to central planners and to the entrenched interests benefiting from it, but there’s a better way forward. Give capitalism a chance.

Top Photo: Express Scripts, one of three huge pharmacy benefit managers that, together, set the terms for about 80 percent of the prescriptions in the United States (KRISTOFFER TRIPPLAAR/ALAMY STOCK PHOTO)

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