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1.5 Models of Prescription Drug Distribution

Prescription Drug Marketing Act Report to Congress (2001): Back to Table of Contents 

Previous Section: 1.4 Statistical Profile of Wholesalers

ERG identified four broadly defined models of drug distribution although numerous additional variations can be defined. The models are delineated according to the number of times the drug product is resold.
Table 1-7 outlines the 1998 sales of prescription drugs by some of the distribution channels identified and by type of dispenser.


ERG did not consider mail-order distribution to be a separate and unique distribution model, but rather a separate dispensing model. Mail-order companies buy their drugs directly from manufacturers or, more commonly, from wholesalers. In either case, distribution occurs through a channel that is equivalent to Models 1 and 2 described below.

Table 1-7
1998 Sales of Prescription Drugs to Dispensers, by Channel of Distribution
   Channel of Distribution
  Total Sales Manufacturer Direct Chain Store Warehouse/
Mail Order
Wholesaler
Type of Dispenser $
Million
Percent $
Million
Percent $
Million
Percent $
Million
Percent
Health Care Institutions $24,959 24.5% $6,270 25.1% $22.4 0.1% $18,669 74.8%
 Hospitals $12,980 12.8% $2,622 20.2% $0.0 0.0% $10,358 79.8%
 Clinics $6,251 6.1% $2,494 39.9% $12.5 0.2% $3,744 59.9%
Long Term Care/
Home Health
$4,219 4.1% $447 10.6% $8.4 0.2% $3,763 89.2%
 Health Care Plans $1,509 1.5% $706 46.8% $1.5 0.1% $803 53.2%
Independent Drug Stores $19,291 19.0% $714 3.7% $57.9 0.3% $18,519 96.0%
Retail Chains $46,171 45.4% $1,031 2.2% $29,245.7 63.3% $15,924 34.5%
 Chain Drug Stores $30,288 29.8% $1,000 3.3% $22,292.0 73.6% $7,027 23.2%
 Mass Merchandisers $7,573 7.4% $15 0.2% $4,543.8 60.0% $3,014 39.8%
 Food Stores $8,310 8.2% $17 0.2% $2,409.9 29.0% $5,883 70.8%
Mail-order Pharmacies $10,972 10.8% $417 3.8% $7,153.7 65.2% $3,401 31.0%
Others $278 0.3% $225 81.0% $0.6 0.2% $52 18.7%
Total $101,671 100.0% $8,657 8.5% $36,480.3 35.9% $56,566 55.6%
Source: NWDA, 1999

 



1.5.1 Model 1--Distribution Directly from Manufacturer to Dispensing Organization

Manufacturers sell a portion of their output directly to dispensing organizations, such as large retail pharmacy chains or healthcare organizations. Table 1-8 provides a breakdown of the drug purchases prescription drug sales of innovator drug companies (i.e., excluding generic drug manufacturers) by class of customer. According to a compilation by PhRMA, 20 percent of all pharmaceutical drug sales went directly to dispensing organizations. Specifically, 12.4 percent of manufacturer sales went to retailers, 2.1 percent to private hospitals, and 1.4 to healthcare practitioners. The data include sales of both branded and generic drugs, as sold by PhRMA members.


In the past decade, institutional consumers of pharmaceutical drugs, such as hospitals and retail pharmacy chains, as well as independent retail pharmacies, have significantly decreased the percentage of pharmaceuticals purchased directly from the manufacturer. For these institutions, the value-added services of the distributor are more valuable than the price savings from dealing directly with the manufacturer. Conversely, mail order pharmacies have increased the volume of pharmaceuticals they purchase directly from manufacturers. Mail order dispensing of pharmaceuticals is the fastest growing segment of the industry. From 1990 to 1997, the sale of pharmaceuticals by mail order increased from 5.1% to 9.7% of the total sales (U.S. District Court for the District of Columbia, 1998). Mail-order is often used to dispense "maintenance" drugs regularly used by patients over an extended period of time. There are approximately 63 mail-order pharmacies and 32 retail companies with mail-order pharmacy operations in the U.S. (NWDA, 1999).


Some large dispensing companies, especially chain drug stores, perform "self-warehousing" wherein they assume the task of distribution itself. Instead of relying upon an outside distributor, these retailers buy directly from the manufacturer; store the drugs in one or more of their own warehouses; and deliver the drugs to their retail stores as needed. Retail chains with four or more stores (including chain drug stores, mass merchandisers, and food stores) have increased the percentage of drugs they now self-warehouse to 66.1 percent of their total drug purchases (U.S. District Court for the District of Columbia, 1998).(4) Thus, retail chains self-warehouse a majority of purchases made either directly from manufacturers or through wholesalers.

 Table 1-8
1998 Prescription Drug Sales of PhRMA Member Innovator Drug Manufacturers by Class of Customer
Class of Customer Sales
($ million)
Market
Share
Wholesalers $64,015.1 80.0%
Retailers $9,922.3 12.4%
Private Hospitals $1,680.3 2.1%
Practitioners $1,120.2 1.4%
Manufacturers, Repackagers $1,200.2 1.5%
Federal Hospitals $640.1 0.8%
Other Federal Government $880.2 1.1%
State and Local Government Hospitals $560.1 0.7%
Total $80,018.9 100.0%
Source; PhRMA, 2000
Note: Sales are reported net of rebates and discounts. Numbers and percentsmay not add to totals because of rounding.


1.5.2 Model 2--Distribution Through Major Wholesalers


The second model of drug distribution characterizes the movement of the large bulk of pharmaceutical products. Most drug shipments move from the drug manufacturer to several large wholesalers (i.e., the Big Five and regional wholesalers) and then on to dispensers (i.e., health care organizations, retail pharmacy chains, etc.). For these drugs, the number of transactions and the times that the drug product is handled and physically moved is the minimum necessary to reach an eventual consumer. Specifically, perhaps 2 transactions (manufacturer to wholesale distributor to pharmacy chain or other dispenser) are made before the product is consumed.


1.5.3 Model 3--Distribution from Large to Small Wholesalers to Dispensers


Additional tiers of distribution exist for drugs that are shipped to some of the smaller drug dispensers. As has been noted, the Big Five and even regional wholesalers often have volume requirements that exclude some small dispensers from using their services. In the case of physicians' offices or small healthcare facilities, their demand for drugs is also somewhat limited and/or specialized so that they do not require the services of a full-line distributor. Thus, a hypothetical small wholesaler might report that his customer base consists of several hundred physicians' offices, selected Federal health facilities, selected health care clinics, and miscellaneous other dispensers.

For this case, the number of drug transactions made from manufacturer to dispenser might be three or four (full-line to regional to small sub-regional to perhaps smaller wholesaler).


1.5.4 Model 4--Distribution of Discounted Drugs, Via Secondary Wholesalers


Discounted drugs are sometimes sold in substantial volumes and, in order to absorb the supply, dispersed widely throughout the distribution network. In these cases, the number of transactions made before the drug product reaches a dispenser can be quite large.

 

Discounted products are often sold to secondary wholesalers, although the Big Five or regional wholesalers also participate in such sales. The secondary wholesalers are notable, however, for their willingness to absorb the risk of large purchases of discounted products.


Representatives of secondary wholesalers described a considerably lengthy set of transactions for many of the drug products they handle. First, while manufacturers sell the bulk of their output to the Big Five wholesalers, they sometimes wish to sell additional products separately from these relationships. As noted earlier, manufacturers will often announce short-term sales of products for various reasons, such as to meet quarterly sales goals, or to reduce inventory before a price increase. Wholesalers might also hold drug sales to eliminate slow-moving inventory.


Such discounted drugs are then purchased by wholesalers, with many purchases by wholesalers other than the Big Five. In making these sometimes large purchases of sale merchandise, the wholesalers incur a substantial capital investment and, less significantly, also use warehouse space to hold the drugs. Furthermore, many of these wholesalers do not have a normal or routine distribution channel that can absorb the discounted product quickly. The wholesalers are interested, therefore, in turning over products quickly and can do so by passing on a portion of the original discount to other wholesalers or drug purchasers. Thus, the original purchaser makes a large capital investment and attempts to recoup it as quickly as possible by selling portions of the sale product, at a still somewhat discounted price, to other wholesalers.

The second tier of wholesalers are largely in the same position as the original purchaser, although they are handling small volumes of sale products. Nevertheless, they make relatively large capital investments and wish to turn over the discounted product as quickly as possible. In this fashion, the sale product is distributed rapidly and with broad dispersion, throughout the drug distribution industry. This second tier might include any drug wholesale organization, including the Big Five, regional, mail order, or other organizations.

The breadth of dispersion is indicated by the number of transactions that might occur before the sale product reaches the dispenser. According to one secondary wholesaler, it is not uncommon for his company to be among the third tier of distributors to purchase some of the sale product. Further, this executive judged it likely that the product would trade hands two or three more times before reaching the eventual drug dispenser. Thus, from 5 to perhaps 7 transactions involving the sale product are commonplace.

Footnote

(4) Defined in terms of the total dollar volume of pharmaceuticals purchased.

Prescription Drug Marketing Act Report to Congress (2001): Back to Table of Contents 

Next Section: 1.6 Topics Related to the Functioning of the Distribution Models