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The Citizens Fund Conference, Drug Industry Panel
Washington, D.C.
Christine A. Varney, Former Commissioner

The views expressed in these remarks are my own, and do not necessarily reflect those of the Federal Trade Commission or any other individual Commissioner. These comments are an abbreviated version of a longer speech given at the Annual Conference of the National Association of Retail Druggists on March 27, 1995, in Washington D.C.

I appreciate the opportunity to join you here today. I'd like to discuss some of the current changes in the pharmaceutical industry from an antitrust enforcement perspective.

Until quite recently, many physicians routinely prescribed pharmaceuticals without much regard to price. Physicians were often unaware of lower priced generic substitutes. 1 Even where generics were available, anti-substitution laws often prevented pharmacists from suggesting lower priced drug equivalents. Consumers generally ended up paying top dollar for whatever drug their physician prescribed.

The emergence of managed care has begun to change that landscape, primarily through eliminating fee-for-service or cost- based reimbursement in favor of delivery systems that encourage providers to control costs. Managed care organizations, especially HMOs, have developed a number of cost containment strategies for prescription drugs including; generic substitution, drug utilization review, formularies and therapeutic interchange.

The recent emergence of professionally managed prescription drug benefit programs ("PBMs") is an important force in the managed care revolution. 125 million Americans are currently participating in PBMs and that number is expected to increase to 200 million by the end of the decade. PBMs typically select participating pharmacists, drug manufacturers and suppliers, administer point of sale claims processing systems, negotiate quantity discounts with pharmaceutical manufacturers and pharmacists, administer plan record keeping and payment systems, and maintain quality control. They also attempt to control costs by negotiating discounts from manufacturers, usually in the form of rebates, in return for placing the manufacturer s drug on the PBM s formulary. 2

While recently, groups of pharmacies are beginning to form joint venture PBMs, single firms still own most PBMs. In the past year, drug manufacturers have acquired some of the largest PBMs -- Medco, PAID, PCS and DPS. These acquisitions are controversial because a manufacturers acquisition of PBMs may threaten the PBMs independence and, as a result, its ability to create purchasing efficiencies and secure lower prices for plan sponsors and their subscribers. 3 We worry that those manufacturers could use their PBMs to foreclose competitors products from the market. Or, that manufacturer owned PBMs will facilitate collusion in pharmaceutical manufacturing and PBM markets.

The FTC is currently reviewing Eli Lilly's proposed acquisition of PCS Health Systems. PCS is the largest PBM in the country and the proposed transaction is the third in a series of a manufacturer-acquiring a PBM. After an extensive investigation, the Commission concluded the acquisition presented some competitive risk and issued a complaint against Eli Lilly; charging that the PCS acquisition would harm competition in the national full-service PBM market. 4 The complaint alleged that the acquisition might foreclose non-Lilly products from the PCS formulary and that PCS would be eliminated as an independent negotiator of pharmaceutical prices. The complaint also alleged that the acquisition could facilitate collusion through reciprocal dealing, coordinated interaction, and interdependent conduct among Lilly and other vertically integrated pharmaceutical companies. In addition, the complaint alleged that the acquisition could raise entry barriers by effectively requiring a competitor to enter at more than one level. The complaint finally alleged that the acquisition would likely increase prices, diminish quality, and reduce the innovation incentives of other pharmaceutical manufacturers.

Lilly has offered to enter into a consent order with the Commission with respect to the acquisition. The proposed consent attempts to address foreclosure and collusion concerns in two ways: first, by requiring Lilly to maintain an open formulary, while allowing a closed formulary; and, second, by creating a "firewall" to preclude communications between Lilly and PCS concerning bids, proposals, prices or other information related to other drug manufacturers' products.

Under the proposed consent, the open formulary requires Lilly/PCS to establish an independent Pharmacy and Therapeutics Committee, to decide which drug products should be included on the formulary. It also requires Lilly/PCS to accept discounts and to accurately reflect such discounts on the open formulary, in order to keep the formulary competitive.

Theoretically, the open formulary allows new entrants into the industry at only the manufacturing level.

The Commission has recognized in related contexts that selective contracting -- limiting the suppliers in order to secure volume discounts -- can be procompetitive. For this reason, the proposed consent permits Lilly to offer closed formularies. PBM customers could then select between a lower priced closed formulary or an open formulary with greater drug choices.

The proposed consent also requires Lilly to maintain a firewall between the two businesses with respect to other drug manufacturers' or other PBM's bids, proposals, contracts, prices, rebates, discounts, or other terms and conditions of sale. This firewall is an attempt to minimize the possibility of price fixing or collusion.

This proposed consent is not yet final. We are still reviewing the comments.

I am concerned about the overall competitive impact of vertical integration by drug companies into the pharmacy benefits management market. Lilly reflects the Commission s recognition that vertical integration may cause competitive problems. Some have criticized these actions and suggest that any enforcement against vertical integration is misguided. Our hope is that through monitoring this proposed order and through analysis of these evolving markets, the Commission can better assess all the ramifications of vertical integration in these markets.

Just as pharmaceutical manufacturers are integrating "downward" into the PBM market, some pharmacies are trying to integrate "upward" into the PBM market. Of course, most community pharmacies do not have the breadth of geographic coverage and financial ability to do so on their own, and have sought to act collectively to compete in these new markets. Although there are some potential antitrust pitfalls, I believe that a pharmacy-owned PBM joint venture can operate consistently with the antitrust laws.

Antitrust enforcers would be remiss if they did not recognize the opportunities for efficiencies from collaboration, and I think there may be significant procompetitive benefits from the emergence of pharmacy-owned PBM joint ventures. These ventures increase competition by providing new PBM offerings. Moreover, these ventures often enable community pharmacies to bear the transactions cost internalized in the structure of a chain pharmacy. Absent these ventures, community pharmacies might be unable to participate in PBMs, and PBM consumers might have less choice in their selection of a pharmacist.

These ventures may also improve the efficiency and competitiveness of their members by aggregating buying power of both the pharmacies and the plan sponsors. A joint buying group alone could not achieve these savings, because only a PBM has the power to solicit discounts based on share shifting (e.g., preferential listing on the formulary). The savings from the joint buying arrangement should enable community pharmacies to compete more effectively.

Finally, it is important to recognize that the existence of independent PBMs may help deter the opportunities for collusion or foreclosure that are at the center of the concerns in the Lilly-PCS matter. This is not to say that an otherwise illegal venture is permissible where it provides a counterweight to potentially anticompetitive activity. Rather, it suggests that antitrust enforcers must act cautiously and not condemn, or indirectly inhibit, procompetitive collaborations that have the potential for improving the competitive process.


1 See Miller and Blum, Physician Awareness of Prescription Drug Costs, J. Family Practice (Jan. 1992).

2 A formulary is a PBM-produced list of FDA-approved drug products by therapeutic category, along with relative cost information. These formularies are made available to pharmacies, physicians, third- party payers, or other persons involved in the health care industry, to guide in the prescribing and dispensing of pharmaceuticals. An open formulary allows for the reimbursement of any drug a physician prescribes, whether or not it is actually listed on the formulary, whereas a closed formulary limits reimbursement to the specific drugs listed. Thus, closed formularies, by providing a mechanism for restricting reimbursement to certain drugs, can influence the prescribing patterns of physicians.

3 See The ABCs of PBMs, Drug Topics 67 (Sept. 5, 1994).

4 Eli Lilly & Co., File No. 941-0102 (Nov. 3, 1994).