Today, JP Morgan, Berkshire Hathaway, and Amazon announced a health care joint venture. They plan to use their organizations as guinea pigs to seed the initial usage, technology development, and business model, and then expand from there. Immediately, shares of CVS and ExpressScripts, the two largest pharmacy benefit managers (PBMs) were down by over 5 percent. Shares of United Healthcare and other health care networks were also down.
So, what kind of platform would Amazon be interested in launching?
Over the course of 2017, multiple rumors have been swirling around a direct-to-consumer approach to facilitate drug deliveries through Amazon’s existing, centralized distribution infrastructure. Aside from getting state licenses, this model would be relatively plug and play and would let Amazon chip away at the roughly $400 billion industry. Amazon could build it from scratch or make an acquisition, ranging from the leading startup PillPack or a group purchasing organization or other options.
Building from scratch requires consumer adoption and scale, which a joint venture along with Berkshire and JP Morgan certainly helps to solve. If initial results are promising, these three companies have the ability to convince other large, Fortune 100 companies to sign up. They’re going to need all the help they can get.
Platforms Thrive With Fragmentation, Not Consolidation
The top three PBMs control at least 80 percent of the industry: ExpressScripts, CVS, and United Healthcare’s OptumRx. Notice a pattern with the stocks that are down today?
Over the years, the industry has become more consolidated, while the profits of PBMs have been increasing, despite their efforts to hide those profits with alternative accounting practices.
A platform business model thrives in industries where there are a large number of producers, drug manufacturers, and consumers. The platform creates value by reducing search and transaction costs, just like Amazon’s marketplace does today. But when the existing incumbents control such a large portion of the distribution chain, it becomes a lot harder to get producers–drug manufacturers in this case–to participate. Why? Because the producers fear the PBMs might take retribution and refuse to buy from them.
Given the huge market share of leading PBMs, drug manufacturers can’t afford to risk losing that business. The new platform needs to offer enough potential scale to outweigh those risks, otherwise manufacturers may be too afraid to join.
Generics Versus Branded Prescription Drugs
According to research, for every $100 spent on generic drugs, $64 goes to the supply chain comprised of PBMs and retailers/wholesalers, while only $36 to the manufacturer. Compare this to branded drugs–where manufacturers take home $76 from every $100 spent–and it’s clear that there’s a lot of cost savings to be had from reducing transaction costs around generic drugs. Currently, there’s a lot of bloat going to the middle men. If Amazon’s initiative succeeds, by focusing on generics, it could have a huge impact on health care prices. According to Statista, in 2016, 84 percent of all prescriptions in the United States were for unbranded generic drugs.
A marketplace like Amazon creates value by centralizing all the sellers in one market. In doing so, it provides much more transparent fee structures and transaction costs in the market. We could easily see that $64 on generics fall to $20. (If you look at typical Amazon transaction fees, that might even be on the high side.) Additionally, a marketplace will let producers, in this case manufacturers, compete against one another on price. In short, both prices and transaction costs should come down. Consumers should get much cheaper generics than they do with the current supply chain.
Whether or not drug manufacturers will be willing to participate in such a marketplace is still to be determined. However, as more and more consumers participate, through Amazon’s joint venture signing up more major employers, it will become easier for drug manufacturers to justify joining such a marketplace.
If consumer savings can be realized in a tangible way, then consumer growth should explode. If that happens, PBMs will start to lose their stranglehold on the market. And it would become harder, but still possible, for PBMs to effectively penalize the drug manufacturers. Once again, Amazon could be about to redefine a major part of our economy.