Your margin is my opportunity

— Jeff Bezos

A little while ago, I was pointed to this job posting on LinkedIn in passing. I found that posting very interesting which led me to think about this blog post.

Summary

Drug Distribution

Healthcare was a $3.2 trillion industry in the US alone in 2015 and growing. A significant chunk of that dollar amount is pharmaceuticals (about 10%). To simplify ordering for providers, address various regulatory requirements and ease supply chain management, almost all (85%) drug distribution in healthcare is driven through three companies. Pricing continues to be opaque. I submit that there is a significant opportunity for price transparency based sales and distribution. Amazon would do well to participate in that. GPOs (Group Purchasing Organizations) are common in healthcare, which leverage economies of scale and pass on some of those savings to their members. Amazon acts as the go-to GPO in the consumer products sector and could leverage its existing supply chain and software capabilities to satisfy the needs of the drug distribution market.

Prescription Fulfillment

What if Amazon also had a prescription fulfillment business — AmazonRx? Rx fills by patients are rarely immediate and there is also the associated problems of primary and secondary medication adherence. Combine that with the recent innovations like Amazon Go and Alexa, as well as the traditional capabilities that Amazon is renowned for such as guaranteed tiers of delivery, subscriptions, the Dash button etc., the retail aspect of prescription fulfillment also seems to be a complementary strategy. It also aligns well with Amazon’s strategy of vertical integration around a specific domain.

Expect Amazon to get into healthcare in a big way in 2017 and beyond

Given the Bezos strategy around margins, the aforementioned job posting and some of the details on the numbers below, I submit Amazon is gearing up to enter the pharmaceutical distribution business. If they are not — they should.

The players

A million here, a million there, pretty soon, you’re talking real money

— Everett Dirksen, circa 1960

Circa 1960, a million was a lot of money (it still is) but in these times of unicorns and billions, it is a good reminder that this is still a lot of money we're talking about.

The big three players in the pharmaceutical distribution supply chain are, McKesson Corporation, Cardinal Health Inc. and AmerisourceBergen Corporation.

These three combined generate about 85% of all revenues from drug distribution in the United States. Several others combine to make up the remaining 15%. As expected, these three have very significant revenues but their margins are relatively low compared to pharmaceutical companies themselves. Distribution businesses have always had low operating margins. The big three have operating margins around 5% as shown in the table below which is comparable to Amazon’s retail margins in the US in 2015 of 4.3%. Very similar but you need to remember that Amazon’s 4.3% includes investments and expenditure that could be leveraged across industries. A Smiling Curve view of the pharmaceutical industry is shown below.

This model helps explain some of the recent moves by the three to move downstream i.e. to the right and up on the curve. For example, these larger players are also deepening relationships with retailers as they consolidate, vertically integrating into retail operations and focusing more on specialty drugs as they try to capture more of the value from those downstream or upstream from them.

Margin alone is not enough

Why not invest your assets in the companies you really like? As Mae West said, "Too much of a good thing can be wonderful"

— Warren Buffett

Margins are not the only requirement to jump into a business. Asset utilization and cost of sales are the two other key factors to consider. As we’ll see below, assets such as distribution centers, fulfillment networks, forecasting, inventory management, cold chain, international shipments, tracking, break bulk and more are all assets that Amazon can bring to bear. And while cost of sales is a big challenge, arguably, transparency and simplified pricing can overcome that barrier with some patience. Amazon, if anything, is patient as it embarks on an undertaking that leverages the assets it owns.

Amazon assets

Before discussing strategy, a list of Amazon’s assets is clearly needed.

Supply chain management

This is its forte. Well, one of them. It understands what data to capture, what data to aggregate, understands working capital trade-offs especially when the inventory is still owned by someone else, where to position inventory to provide “immediate” delivery and more. All these assets are immediately re-usable in the drug distribution context.
I’m not a 100% clear on inventory ownership at Amazon. But for companies that Amazon manages distribution as well i.e. “Fulfilled by Amazon”, my assumption is that the inventory is still owned by the company and not by Amazon. This model would work well in the pharmaceutical distribution case as returns due to excess inventory are usually absorbed by the pharmaceutical manufacturers regularly.

Forecasting & Inventory Management

The graphic below illustrates some of the challenges facing pharmaceutical distribution.

Some of the reasons for this inventory mismatch include:

• Physicians are biased towards certain pharmaceuticals or even medical devices and implants. There is a move to address these biases through formularies and supplier rationalization initiatives

• Distributors are one level removed from the end customer i.e. the patient. And the patient may or may not fill the Rx given to them

• Rx data flows through SureScripts and then to the retail pharmacies or to the pharmacies owned by the hospitals

Data exchange is a challenge, which is not all that surprising. Brand companies have to pay for every piece of data including shipments of their own drugs. But this trend is declining in other industries (such as traditional retail) so that less out of stocks happen and more sales are captured. Thus, sharing of information is a good thing and perhaps the pharmaceutical value chain can learn from the painful lessons of other value chains such as sports, clothing, electronics, grocery and more, which have all been on the receiving end of the Amazon juggernaut. In the meantime, Amazon can bring all those learnings to bear immediately and make the supply chain much more transparent. This would be a significant value add for pharmaceutical companies.

Cold chain

While certain drugs need a cold chain and temperature control during transport, it’s also important to remember that the overall percentage of drugs that require that require that are still small as shown by this graphic below.

I’ll hasten to note that the overall value of these drugs are likely to be much higher in a relative sense.

The net net being that, given its lower distribution impact, this could be done as a next step and not required for an initial foray into the industry. Given Amazon’s moves into the fresh supply chain (Amazon Fresh), this shouldn’t be too much of a stretch for them to follow up with.

Other distribution items

Distributors also manage other items associated with healthcare such as OTC (Over The Counter) drugs, DME (Durable Medical Equipment such as walkers, wheelchairs and much more), medical devices and much more. I’m sure Amazon is already in this business in some form but it all adds up as an overall service.

Regulatory Requirements

Given that this is healthcare, it will obviously come with a whole set of associated regulations. But Amazon has proven adept at trading off what it will do and what customers need against pricing for its services. It has done that well, for example, in the HIPAA space which I have some personal experience with.
Some things like lot level tracking and maintaining that history to help with REMS, recall and other similar requirements aren’t all that different from what other industries require. The drug industry is much more regulated of course. The latest regulation being the Drug Quality and Security Act (DQSA) 0f 2013 which “outlines critical steps to build an electronic, interoperable system to identify and trace certain prescription drugs as they are distributed in the United States” and will be implemented by 2023. Data, its authenticity and its provenance is what is key here or in other words, logging. Which is turns out AWS has a service for. More on AWS below.

One of the other requirements of the DQSA seems to be that 3PLs (third party logistics providers) also need to obtain state and federal licenses. If Amazon has aspirations in the 3PL business and it seems like it does, then “in for a penny, in for a pound”. Note also that the DQSA requires full tracking from source to destination. Given that a significant volume of drugs distributed are generics which are primarily manufactured overseas, international shipments and managing all the various aspects of that would be a key requirement. What with recent announcements around buying a fleet of Boeing 767s and registering as an ocean freight forwarder, it would seem that these would be additional assets that it could leverage. As the Wall Street Journal noted: “In a securities filing, Amazon for the first time identified “companies that provide fulfillment and logistics services for themselves or for third parties, whether online or offline” as competition. And it referred to itself as a “transportation service provider.” In both cases, it marked the first time Amazon included such language in its annual report, known as a 10-K.”

Retail

The prescription flow works as follows:

• Physicians diagnose what’s wrong with you
• They ask you which pharmacy they should send the Rx to per your convenience
• SureScripts (and others) gather that data and provide value added services around it

What if AmazonRx was one of those pharmacy choices? While this seems simple at face value, I’m sure SureScripts and its ownership could have some concerns. SureScripts is still an LLC and owned primarily by the National Association of Chain Drug Stores (NACDS), National Community Pharmacists Association (NCPA), CVS Health and Express Scripts with the first two owning an almost majority stake. The NACDS members and CVS I’m sure have seen some impact to their business from Amazon.

As a quick aside, I must confess that I came up with name AmazonRx as I was writing this and thought it would be a good idea to buy that. Seems it was already taken back in 2005 and the registrant is Amazon. So this has perhaps, been part of their overall strategy and it is just a question of timing.

Immediate Rx fill

As a consumer, we’re always annoyed by wait times. Immediate gratification is what seems to drive us all. I would argue that Amazon is well placed to address that market requirement as well. Consider the following factors:

• Adherence is a big problem in healthcare. Primary adherence (when you are prescribed a drug but can’t or won’t fill it) and secondary adherence (when you won’t take the drugs you’re prescribed as required) are consistent problems that healthcare systems and startups have tried and are trying to address.

• The mail order business for Rx fills is growing

• Amazon, through its Prime model, has managed to convince us to tradeoff immediate gratification vs guaranteed delivery. So that seems to be another asset that could be leveraged.

• Amazon Go allows you to pick up something from the shelf and walk out as long as you have a Prime membership. This one might be a little ways away in the Rx context given that pharmacists need to often explain or rather reinforce what you need to do with the drugs that you are picking up. Pharmacists are needed not only for this case but also if questions come up or even a courtesy call so expect Amazon to start hiring them.

Amazon Prime

Let’s say that the requirement for AmazonRx is Prime membership. The one other thing that falls out of this requirement for a Prime membership is that identity is verifiable. This is a big gap right now in healthcare because there is no universal identifier in healthcare. What if your Prime membership became that? You might not update your physician if your email address or phone number changes but you will, for sure, update your Amazon account with any and all of your contact information changes.

Prime has 54 million US members per some estimates and it could be larger (Amazon doesn’t report those numbers). Also consider that some, if not most of those 54 million memberships service the entire household i.e. significant others, children etc. So I would posit that the actual population covered is likely larger by a factor of at least 2x i.e. close to a 100 million individuals. I would think that’s a pretty good start re identity and Rx fulfillment.

The $99 membership cost could be high barrier for lots of individuals but what if it was actually covered by your health plan i.e. part of your pharmacy benefits. This might be somewhat wishful thinking because a per member per month (PMPM) calculation puts this on the very high end of what a health plan would consider reasonable. At the same time, what if your Amazon Prime membership (as long as included AmazonRx) was discounted by health plans including Medicare as long as you adhered to your Rx?

AWS

Amazon being a data driven company will naturally gather every piece of data that goes through its systems. So we have all this data and we need to derive insights from it. Yes, there are regulations like HIPAA to adhere to but what-if, AmazonRx got into the data business (identified with consent or de-identified) as well? That is a multi billion dollar industry in itself led by companies like IMS Health and others.

But much more importantly from the perspective of AWS itself, that’s a lot a cloud capacity waiting to be utilized at a very high margin by companies wanting to derive insights from that data. So something of a “twofer” i.e. AmazonRx gathers the data and provides value added services and AWS and it’s associated services is the way in which interested parties leverage it. It also helps that AWS is a very profitable business as evidenced by quotes like this, “For the second straight quarter, AWS earns Amazon more profit than its entire North American retail division”.

Some of the services that could be leveraged within AWS include:

• AmazonML: As more and more data is gathered and whether you are a pharmaceutical company, a health plan or a hospital system, here is a way that you can analyze and gain more insight into the data. Based upon which, you can then proceed to light up services such as post discharge reminders, prescription refills, medication reminders etc. using other AWS services such as Lex.

• Lex (that powers Alexa)that could be leveraged to set reminders for taking your medications (“Good morning John, please don’t forget to take your pills after breakfast. If you need more details, please say. tell me more” or for ordering refills (“Mary, a quick reminder, it’s almost time to refill your prescription. Should I go ahead and place that order or would you like to talk to your pharmacist first? Please say ‘yes or no’ or ‘pharmacist’.”). It is also interesting that the quote that you see on the Lex website is from Ohio Health.

• Rekognition: Moving refill orders from one pharmacy to another is a bit of a hassle but what if you could take a picture of the prescription bottle itself similar to how Walgreen’s allows you to order refills through its app. What if this capability was now available to every pharmacy out there but also provided by AmazonRx as a way to switch to them?

There are many more interesting services that could be leveraged but I just wanted to highlight some of the more interesting ones.

So what could Amazon do in 2017 and beyond

Prediction is very difficult, especially if it’s about the future.

— Neils Bohr

My hypothesis is that Amazon will do one or more of the following.

Hire pharmacists

This is a key need no matter if AmazonRx decides to be just in the distribution space or in the retail space. This will happen no matter what.

Provide a white label pharmacy solution to health systems

This is similar to the approach that Amazon took with its Amazon Campus offering in education. This just might be the first step that it takes as it tries to work out all the possible kinks in this business.

A Prime special for Rx fills and refills

This seems like a time tested approach that Amazon has done well with to attract users especially from its 54 million US members.

Partner with existing GPOs The top 10 GPOs in the industry are as follows: MedAssets, Amerinet, Novation/Provista, Premier, MAGNET, HealthTrust, Managed Healthcare Associates, Hospital Central Services Cooperative, GNYHA Ventures and United States Department of Veterans Affairs. GPOs act as demand aggregators and take a cut of the overall purchase volume. I would guess that one or more of them would be very interested in improving the efficiency of their supply chain as that could increase their margins.

Buy a small specialty distribution company This seems like a great place to start. Distribution company valuations are low. As an example, McKesson with a revenue of $190 Billion has a market cap of $31 Billion. Specialty seems to be business that the larger players are also interested in and is poised for growth.

I’m really curious to see what happens in the next several months. Would also love to hear your feedback @mohan2020

Thanks to Patricia Grossi, Kris Gosser, Kevin Lindberg and Joe Kirgues for reading through earlier drafts and providing feedback.