Why did health systems decide to make their own generics?

Recently, there was an announcement that some major health systems were banding together to make their own generics. At the outset, it looks like the health system wants to be an insurance company and then a pharma company – what is next? Is this their core competency?

When you step back, the strategy behind it is simple and obvious. To better understand it, let us shift focus and look at a completely different industry – the luxury automobile industry. Assume you have owned a luxury car for a few years and the manufacturer’s warranty has expired. Let us say you need your oil replaced or you need a new tire because the right rear tire has its treads worn out. What do you do?

In all likelihood, you expect to drive to a retail store (e.g., one of the fast lube companies) and get the oil change for an inexpensive sticker shock. For the tire replacement, perhaps you expect to run into a wholesaler who happens to sell tires or a specialty retailer of tires and buy a tire and replace the one with the worn-out tires. You behave this way because you own the incremental expense. It comes out of your pocket. You want to control the costs.

A health system is in a similar spot. In today’s world of risk-based health, the system gets paid a fixed amount for the patient per month or they have an alternative payment model that still caps their revenue. The system needs to identify elements of its costs that it can reasonably control. Keeping patients healthy involves seeing them at the PCP more and intervening before the medical needs of the patient becomes acute and incur higher costs. The system knows how to do that very well. However, one of the drivers of costs is medication. Health systems need to purchase drugs from manufacturers and the cost of medication in a risk-based scenario are borne by the health system. Any method to control that costs or reduce them puts the savings directly to the bottom line.

The traditional methods of cost control of medications have involved the health systems banding together to form purchasing groups. Some have staff that actively monitor prices. Others use physician committees to identify lower priced drugs that can substitute the higher ones and provide efficient care. It was only a matter of time before a health system decided that they may want to get into the business of making such drugs. However, patent laws prevent a health system from manufacturing brand name medication. Such is not the case with generic drugs. Generic drug manufacturers sell them at a profit to health systems today and the announcement earlier today is an indication that health systems are trying to reduce the total cost of care by manufacturing generics.

Where will the industry go from here? I happen to think that cost control in pharmaceuticals is just the beginning. Let us pick up at the luxury automobile scenario to see where we are in that industry. When you pulled up at your lube company or tire store, what happened? Were you able to get an oil change or your tire replaced?

In all likelihood, you got a shocking reply. The oil change can be done, but there is a special computer signal that will not turn off and thus, your car will continue to think that the oil is old. The filter has a special component that is not sold to the 3rd party service shop. You have to go to the dealer for it. In the tire scenario, even if the tires are a national brand, the treads are custom to the luxury car maker and you cannot purchase them in the market. You have to get the replacement time at the car dealer. What does it all mean? The luxury car manufacturer has found a way to keep you captive in some ways.

Why does this matter? I believe that in healthcare, the large health systems that have research prowess will start making custom implants or splints that can only be purchased at their facilities. Perhaps a brace that can only be put on and taken off at one of their provider facilities. What if there was even a medical device where the patent enables the health system to only offer it at their facilities? These are ways for the health system to differentiate themselves and keep their costs low, while also creating a strong relationship that is somewhat captive to them. A less-intensive version of this is already in play today. There are certain surgery techniques that are practiced in some nationally renown facilities and are captive to them.

As health systems grapple with being a risk-bearing entity, look for more ways in which they will try to build competitive advantage in the top line (unique procedures, unique splints, etc) and ways to build competitive advantage in the bottom line (make generic drugs, make simple medical devices themselves, etc.). The future is looking like a branded experience for patients.

Contact Badri Narasimhan [email protected] to discuss more...