Wal-Mart's (NYSE:WMT) announcement last week that it's planning to sell nearly 300 generic medications for $4 per month is a clarion call for rolling back prescription-drug prices. It may also mean that, instead of continuing to be on the receiving end of bad press on a variety of issues, Wal-Mart may become a champion of lowering health-care costs.
The company's most recent 10-K noted that pharmaceutical sales make up 8% of its sales in discount stores and Supercenters, and you can bet that the folks in Bentonville are planning to add to that total and take a bigger slice of the $250 billion that Americans spend on prescription drugs each year with this program. The discount program begins in Tampa and is expected to expand nationwide next year.
Clearly, Wal-Mart is planning to drive millions of Americans into its stores to pick up their monthly prescriptions. And maybe, it surely hopes, a few of those shoppers will pick up an additional item or two during their visit. Meanwhile, consumers -- particularly the 45 million-plus Americans lacking health insurance -- will be thrilled with the program. But how will it affect other companies?
Adverse drug reactions
We already have an idea, since reaction to Wal-Mart's announcement came quickly from fellow retailers. Target (NYSE:TGT) said it would match prices in the Tampa area, where the program is starting. Kmart, a subsidiary of Sears Holdings (NASDAQ:SHLD), touted its existing plan, in which patients can buy 90-day supplies for $15, as being a better program, since customers do not have to go to the store as often. And major drugstore chains, including Walgreen (NYSE:WAG), CVS (NYSE:CVS), and Rite Aid (NYSE:RAD), did not immediately comment on any plans they may have for changing their generic-drug pricing.
The fundamental problem facing chain drugstores is that if the likes of Walgreen, CVS, and Rite Aid match Wal-Mart's prices on generic prescription drugs, the group will be slashing profits on one of its most lucrative products. Yet any customer who no longer goes to the local drugstore to pick up a prescription each month because the prices are higher is also a customer who will no longer be buying magazines, drinks, groceries, or other products there. Drugstores, in fact, may face a situation similar to music stores' conundrum years ago, when Best Buy began selling CDs cheaply to drive customers to its stores.
Pharmacy benefit managers (PBMs) -- the companies that facilitate the bulk of prescription-drug sales in the United States -- traded lower after Wal-Mart's announcement. Look at your health insurance card, and you will likely see a symbol for Medco Health Solutions (NYSE:MHS), Express Scripts, or Caremark Rx. These are the PBMs, and they have contracts with insurance carriers, pharmaceutical companies, and drugstores to allow someone covered under their plan to go to a wide variety of drugstores, pick up a prescription, and pay a co-payment. These companies perform claims adjudication for the drugstores and pharmaceutical manufacturers. PBMs also develop formularies -- lists of which drugs different plans provide to their customers -- and run mail-order pharmacies.
An article by Barbara Martinez originally published in The Wall Street Journal gave examples of how selling generics is much more profitable for PBMs than selling brand-name medications. Wal-Mart may be taking aim at them, but they are not as direct of a target as local and chain drugstores are, since PBMs generate revenues in many ways that Wal-Mart does not.
The economics of your medicine chest
How did making and selling prescription drugs become so profitable? Consider that most of us purchase our prescriptions at the most convenient store. While we might drive a few extra blocks to save a penny or two on gasoline, or spend hours researching the best price before buying a consumer appliance, we seldom shop around for the best price among pharmacies.
What's more, prescription-drug prices are rarely, if ever, advertised, and relative to other products, it's difficult to find drug prices on the Internet. Costco's online pharmacy allows for easy checking of drug prices without a password, but that's the exception to the rule. Walgreens' and Wal-Mart's online pharmacies do not offer that service.
So, in short, lack of consumer information is a major reason why drug prices have stayed expensive while the prices of other consumer products have fallen. Do you remember how much air travel cost in the 1970s and 1980s, back when you had to call a toll-free number to find out the price of airfare? Propagation of information and transparency of pricing via Internet travel agencies, such as Expedia, led to falling prices. And now Wal-Mart may be following that lead, by starting to make prescription-drug prices cheaper and better known.
A look behind the label
Wal-Mart's announcement dealt with generic drugs. Just what are generic drugs, and how can Wal-Mart sell a month's supply for just $4?
Generic medications are FDA-approved copies of brand-name drugs that are essentially a bioequivalent of the brand-name medications. After a period of time, the manufacturer of a medication loses its patent-protected right to be the only seller of that medication, and generics spring up as alternatives to the name brand. When the generics become available, prices fall.
For example, Claritin is a commonly taken brand-name medication for treating allergies. The tablet contains 10 mg of the drug loratadine. Previously, you needed a prescription to buy Claritin, and it was patent-protected. It was pricey, too -- about $3 per tablet -- and in 2001, this blockbuster racked up sales of $2.7 billion.
The patent on Claritin expired in 2002, and the FDA allowed it to be sold over the counter beginning in 2003. Drugstores now sell generic store-brand versions of the 10 mg tablet for a fraction of the price of brand-name Claritin, sometimes for less than a dime per tablet.
Multiple drug companies usually sell the brand-name copies, and some of these generics -- such as Claritin and Advil -- are available without a prescription. But the generics that Wal-Mart will sell for $4 are available only with a prescription. So how can Wal-Mart slash the price so deeply?
Well, there's a lot of profit in selling generic drugs. Patent-holding drug companies are the only ones that can produce brand-name versions of their drugs, so they are able to charge a fairly fixed price to all buyers of that drug. The drug store, meanwhile, sells the brand-name drug with a modest markup. But it can make a hefty profit on generics, which are much cheaper, because multiple drug companies compete against each other to sell their version of a generic to the drugstores. As a result, the prices of generic drugs decline for the drugstores that buy them. In fact, Walgreens' most recent 10-K states that "Generic drug sales and better purchasing terms contributed to an increase in pharmacy gross margins."
One of the most widely prescribed generic medications is the blood-pressure medication hydrochlorothiazide (HCTZ), which is usually taken as a 25 mg tablet daily. My pharmacist friends tell me that pharmacies can buy 1,000 HCTZ 25 mg tablets for between $25 and $50. That works out to a 30-day supply for about a buck, representing 300% gross margins if it's being sold for $4.
At most pharmacies, you would pay around $10 for a 30-day supply of HCTZ -- or maybe you would pay a $5 co-payment if you had prescription-drug insurance. Soon, however, you might be able to buy the same 30-day supply at Wal-Mart even cheaper.
The fine print and the future
While the brochure on Wal-Mart's website lists "over 290 quality generics available," many of those 290 generics are duplicate versions of the same drug, so the actual number of different drugs available is substantially less than that for now.
But that means this initial Wal-Mart announcement could be just the beginning. It has many more generic drugs it could still sell for less, and it could also consider branding its drugs as a Sam's Choice product if it thought that might make consumers more comfortable in choosing generics.
Wal-Mart could also partner with respected Consumer Reports and its Best Buy Drug Program to promote awareness about the effectiveness of prescription drugs. It could prominently display prescription-drug prices within its stores, or it could more widely advertise those prices. Making the prices of all of its prescription medications easy to find on its website, for example, could start a deluge of shoppers asking local pharmacies whether they would be willing to match Wal-Mart's prices. You can even try doing that now. I know that some pharmacies will sometimes match others' prices.
The good news in this announcement is that, depending on its aggressiveness in low-cost pricing and its commitment to expanding the $4 generic drug program, Wal-Mart will make it easier for many people to afford their prescription drugs. The bad news is that it may have just become a lot tougher for drugstores and PBMs to remain as profitable as they are now.
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Dr. Michael P. Cecil is a cardiologist and the author of Drugs for Less: The Complete Guide to Free and Discounted Prescription Drugs. He is a big fan of helping patients find the drugs they need at prices they can afford.Dr. Cecil does not own any of the stocks mentioned in the article. The Fool has a disclosure policy.
