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Pharmacy benefit management firm research, Panos Kouvelis. Blog illustration.

Prescription drug consumers confounded by the cost of their medications can get a peek behind the curtain thanks to new Olin research into the complex “co-opetition” — cooperation and competition — among drug makers in the middleman-controlled US drug supply chain.

But, as Olin’s Panos Kouvelis explains, the system is so complex and opaque, it may be headed for government regulation.

Kouvelis’s research describes the complicated dynamics between drug manufacturers and “pharmacy benefit management” firms — massive companies like St. Louis’s Express Scripts or CVS Caremark that manage drug benefits and dispense medications for millions of patients as part of their employer-supplied healthcare coverage.

Kouvelis says his research shows that on one hand, drug makers compete with each other to build their brands and increase sales for similar medications. On the other hand, in the complicated world of PBMs, drug makers unwittingly cooperate. That’s because their price competition and volume-leveraged negotiations with the PBMs lower costs to PBM clients — employers — which increases the market for PBMs and the patients they serve, thus benefitting all drug manufacturers.

Deciphering a Complicated System

In fact, Kouvelis says the industry is destined to end up regulated by the government because the system is more opaque than almost any other supply chain. Consumers can pretty easily discern how automobile manufacturers and their suppliers make money, for example. But fewer understand how their $20 copay for anti-cholesterol medication gets split between the drug maker, the insurance company, and the pharmacy benefit manager.

“In a complex environment, we have to figure out how the prices are set when drug manufacturers work with PBMs,” said Kouvelis, director of The Boeing Center for Supply Chain Innovation and Emerson Distinguished Professor of Operations and Manufacturing Management.

“This is exactly the time that the government has to decide,” Kouvelis said, in light of the planned acquisition of Express Scripts by Cigna and the considered acquisition of Aetna by CVS. “The PBM is controlling three things: The price its clients pay, the copay patients pay, and the negotiated wholesale price charged by the manufacturer. What we’re finding out is that for a profit maximizing PBM it does make sense for some drugs, the drug cost to be actually lower than the copay.”

The research paper, entitled “Drug Pricing for Competing Pharmaceutical Manufacturers Distributing Through a Common PBM,” Kouvelis and his coauthors created a mathematical model of strategic interactions of the drug makers with the PBM. They use that model to measure the effect of the many variables at play in the system, including drug prices, tiered formularies (the list of drugs the PBM provides) with different copay levels, rebates to PBMs, demand, price sensitivity among patients, and market size.

The researchers — who included Yixuan Xiao at the City University of Hong Kong and Nan Yang at the University of Miami — used data from publicly accessible sources to test the mathematical model as much as possible. The paper has been published in the Production and Operations Management journal.

“The only thing we can calculate here are the profits of everyone in the game,” Kouvelis said. “From a competitive perspective, what is going to happen when we have rational players in it? How will drug manufacturers set prices? How will PBMs leverage their formularies for rebates and controlling costs to clients? To what extent is everyone benefitting? And who finally pays most of the drug costs?”

Turmoil in the Industry

The research is particularly timely: Express Scripts — No. 22 on the Fortune 500 with 2016 revenues of more than $100 billion — is now a merger target by insurance company Cigna. It’s the latest sign of turmoil in the industry. Express Scripts’s stock has been buffeted since its largest client, Anthem Inc., announced it would drop Express Scripts in 2020 in favor of launching its own PBM called IngenioRx.

Express Scripts is one of the three major players in the PBM industry, including OptumRx, owned by UnitedHealthcare, and CVS Caremark, which is in the process of acquiring insurer Aetna Inc.

One thing is clear from the research, Kouvelis says: PBMs seem to have very good returns on their invested capital. For one thing, they have sizable leverage over drug manufacturers through their decisions about which drugs are available through their services — the PBM’s “formulary.”

Drug makers with competing medications must therefore “play ball” with the PBMs in order to be included on the preferred tiers of the formulary, which means lower copays and a tendency to be used more often by the corporate employees who are served. Typically, PBMs have a three-tiered formulary allowing patients to pay a lower copay for generic drugs, for example, a middle-tier copay for certain “preferred” branded drugs, and a higher out-of-pocket cost for “non-preferred” medications.

The Middlemen Win

Meanwhile, PBMs earn revenues from two sides of the equation: First, from the fees their clients pay to manage their employee prescription drug plans. Second, drug manufacturers rebate a portion of their sales revenue to the PBMs for the business they receive. The PBMs often pocket much of those rebates, sharing a portion with their clients to help keep costs down for employers.

His paper describing the “co-opetition” among drug makers is Kouvelis’s second in a series of papers on pharmacy benefit managers. His first looked at how PBM clients make decisions about which middlemen to select and how that selection process drives formulary decisions and the fees competing PBMs charge for their plans.

As PBMs now merge with insurance companies, he is embarking on research to examine what that will mean for consumers and clients. His previous research substantiated why vertical integration of drug manufacturers and PBMs — which ended in the late 1980s — was not increasing social welfare.

That research also offered insights on conditions under which mergers of competing PBMs might not always translate into lower drug costs. Now, with the PBM ownership model focused on insurance companies or pharmacy chains, it is time to decipher their implications for drug prices and social welfare.

“The role of the PBM and how its ownership aligns with the overall drug supply chain is not very well understood. Other supply chains are a little more linear, a little more transparent,” Kouvelis said. “That’s what we were trying to understand in this paper — the role of the PBM in this process, how these negotiations happen among PBMs, drug manufacturers, and clients.

“Who makes most of that money in the drug supply chain? Hard to always say, but the middlemen in the industry — wholesalers, PBMs, and insurance companies — appropriate quite a lot for the investments they make in it,” Kouvelis said. “The benefits of further merging of such middlemen in an opaque supply chain are far from a no-brainer.”

A day hardly passes without an urgent headline focused on the economic transformation underway wrought by blockchain technology. The software is the power behind bitcoin and other cryptocurrencies, but Olin experts have been plumbing the deeper implications of the technology.

Here are five things business leaders should know right now about blockchain from Panos Kouvelis, director of Olin’s Boeing Center for Supply Chain Innovation, and Ohad Kadan, H. Frederick Hagemann, Jr. Professor of Finance and Associate Dean for Global Degree Programs. Then, watch for a way to learn more.

Peer-to-Peer Transactions—Like Cash

Blockchain technology has been developed as an efficient method for completing financial transactions, based on the principle of peer-to-peer involvement and fully decentralized and shared networks. It functions as a distributed ledger that provides visibility of all transactions to all parties in the chain, and it is built on an immutable database.

Early Applications

Beyond cryptocurrencies such as bitcoin, etherium, and litecoin, the blockchain has been used in supply chain finance in areas such as clearing financial payments, using digital ledgers, and executing “smart” contracts.

Digital Inventory Tracking

Key inventory and asset resources can take on a digital footprint, which provides additional security and tracking capabilities. Applications have been built, relying on the blockchain, to track and trace goods involved in the supply chain for industries such as the diamond trade, food, and pharmaceuticals.

Applications Still Being Conceived

Blockchain has the potential to revolutionize supply chains and it requires the immediate attention of supply chain managers. Many are scrambling to understand how a technology developed to support cryptocurrencies might be applicable to supply chains and, in particular, to the supply chains of their companies. Experts say the technology will reduce friction in global shipping operations and complex supply chains that involve goods flowing across borders, through ports, and involving governmental agencies, manufacturing, and retail firms.

Kouvelis and Kadan will help business leaders get further up-to-speed on the ways blockchain technology will enhance (or disrupt) their industry in a two-day seminar May 22-23 called “Blockchain Innovation Strategies: Early Lessons from an Emerging Technology.” Click for more about this workshop.

The workshop is structured as a forum to learn more about the technology and equip attendees to know what questions to ask as they explore the implications of blockchain for their business. Coming out of the workshop, attendees should better understand the potential application of the technology in their supply chains, gain inspiration about possible immediate benefits the technology can provide, and confront obstacles and challenges in implementing it.

Imagine you and your significant other finally carved out some time for a vacation getaway. You did your research—booked flights, picked a few promising restaurants, dug up your favorite fanny pack—and now it’s time to find a place to stay.

You’ve heard a lot about Airbnb, so you decide to give it a try. After some deliberation, you’ve both agreed on a place within walking distance of all the local attractions, so you send a request to the owner.

But after a couple hours, you get a message from Airbnb saying that your request has been denied without explanation. For a significant number of Airbnb users, this scenario is all too real.

Dennis Zhang

Dennis Zhang

In the Boeing Center for Supply Chain Innovation’s latest video, Dennis Zhang, Olin assistant professor of operations and manufacturing management, discusses the topic of racial discrimination on peer-to-peer platforms.

According to Zhang, Airbnb requests made by accounts with distinctly African American names were 19 percent less likely to be accepted compared to other accounts. However, if those accounts have additional review data (i.e., at least one positive or negative review), all accounts are equally likely to be accepted.

Zhang believes that people require a bit more information to nudge them in a non-discriminatory direction. He thinks that if Airbnb offered more information within the platform, it would reduce the likelihood of discrimination by those looking to rent out their space.

Zhang goes on to mention that platforms conducting business via peer-to-peer transactions face a higher likelihood of discrimination. He says that discovering how discrimination happens on those platforms is a critical step to ensuring equal consumer treatment. Zhang’s research emphasizes the importance of information, and hopes it will be effective in the fight against discrimination.

[RELATED: Airbnb nondiscrimination policy may backfire]

Jorge Calvo, Professor of Operations Strategy at GLOBIS University Management School and former President & CEO of the Global Supply Chain Management Division of Roland DG Systems, recently sat down with the Director of The Boeing Center for Supply Chain Innovation, Panos Kouvelis, to talk about Industry 4.0 and its implications on the future of global manufacturing.

Industry 4.0 was a term coined to describe a program to support the local industry in Germany and France. It is considered to be the fourth major phase of the industrial revolution, characterized by its use of emerging technologies to enhance manufacturing techniques and supply chain processes.

In his experience, Calvo has found that there are two different approaches within the scope of Industry 4.0: the German approach, focusing on machine-to-machine production practices and supply chain management (i.e., the “smart factory” and the Internet of Things), and the Japanese approach, which focuses on cloud-based technology designed for process optimization through the use of artificial intelligence and machine learning.

For more supply chain digital content and cutting-edge research, check us out on the socials [@theboeingcenter] and download our app on iOS or Android for access to exclusive content and events!

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A Boeing Center digital production

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John Stroup, President & CEO of Belden Inc., explains the major global trends driving investment in automation for manufacturing. Some factors contributing to automation’s increased adoption are rising labor costs, the need for increased productivity, and changing consumer behaviors.

Automation enables manufacturers to become better at producing to meet consumer demand because it significantly shortens changeover, resulting in greater flexibility. Stroup goes on to explain that, due to rising labor costs in Asia, many manufacturers are moving production to the United States and using automation to replace human labor. Productivity is more elusive than ever in the current post-recession landscape, which increases the need to focus on maximizing productivity and ROI.

All of these factors are generating a great deal of interest in the adoption of automation in manufacturing—a process Stroup says will be “evolutionary, not revolutionary.” Stroup estimates automation adoption will reach 74% in 6-10 years. The automotive industry is already at that mark.

For more supply chain digital content and cutting-edge research, check us out on the socials [@theboeingcenter] and download our app on iOS or Android for access to exclusive content and events!

• • •

A Boeing Center digital production

The Boeing Center

Supply Chain  //  Operational Excellence  //  Risk Management

Website  • LinkedIn  • Subscribe  • Facebook  • Instagram  • Twitter  • YouTube