Elephant or Specialist?

The Medicare Modernization Act (MMA) of 2003 is about much more than providing a new drug benefit to the elderly. The Bush Administration has put in place the groundwork for new market forces that will forever change how pharmaceuticals are commercialized. Although the long-term impact of this change is not known, unprepared companies are at a serious disadvantage.

State Waiver programs

The industry is already vividly aware of the impact Medicare drug formularies might have. The 34 formularies will be reviewed and monitored by the Centers for Medicare & Medicaid Services (CMS). They must use clinical evidence to justify drug use, provide step therapy starting with lower-priced medications, guarantee access to generics and other low-price medications, and not be discriminatory.

The formularies will change the drug business, because:

• Each patient group must have equal access to low-price medications, which will make it difficult for drug companies to obtain a preferential position.

• High-price therapies without clear clinical differentiation may have the same reimbursement as lower-priced medications.

• Medicare drug choices may spill over to impact all business segments, because 98 percent of all physicians treat Medicare patients.

• Some drug benefit mangers may manage both Medicare and Medicaid populations, possibly resulting in consolidation of public sector drug purchases.

Most important, the act allows CMS to veto any formulary approach that does not provide enrollees appropriate access to low-cost drug therapies.

But these formularies are not the end of the process—they're just the beginning. To truly bring market forces to bear on pharmaceuticals, whether in the context of Medicare or in the wider healthcare marketplace, more changes are necessary. The Bush Administration recognizes that real change requires transparency about pricing, incentives for healthcare providers and patients to go with lower-cost alternatives, and outcomes data to support decision making.

Medicare is pursuing all these ideas and more in a series of demonstration programs—some complete, some in process, and others just beginning. Pharma has not yet paid much attention to these programs, but they promise to yield massive changes to the industry. Some will help set the rules and procedures for the country's emerging public sector in healthcare. This sector already makes up 28 percent of the US population, and in some chronic-care market segments, accounts for more than 50 percent of drug use.

Some of these new rules will be written into law. Others will spill over from Medicare and affect the ways payers deal with drug utilization. And with a projected Medicare bankruptcy date of 2020, we have not seen the end of these initiatives— additional and tougher Medicare (and Medicaid) legislation is probably on the horizon.

Already, the demonstration projects contain a detailed sketch of how Medicare intends to change the very nature of pharmaceutical marketing over the next decade. For companies willing to look ahead, some key survival strategies are already clear.

Transparency, Incentives, and Data

Medicare sponsored many demonstration projects over the last decade, and the 2003 MMA legislation created more of them. These programs fall into four broad categories:

E-prescribing The e-prescribing demonstration project will start to be implemented by 2007-2008. The system will link all payers, providers, and pharmacists by an electronic system. It will render all drug choices and prices transparent—and make it tough for products without a clinical advantage to command a price premium.

E-prescribing offers real benefits to some pharma players, especially those with a specialty business. Today, physicians are not fully aware of the prices of all drugs with a similar therapeutic profile. That gives a distinct advantage to drugs with larger marketing budgets, regardless of their reimbursement cost. E-prescribing will give greater physician access to less-expensive products—possibly without large commercial expense.

Financial incentives Several demonstration projects use financial incentives or capitated payments to healthcare providers to encourage the use of inexpensive drugs. These projects will be completed between 2006 and 2008, and they are "budget neutral," meaning physicians are compensated only if they reduce overall Medicare costs.

Financial incentives may create a new medical triage in the physician's office. Doctors can choose between a less expensive "satisfactory" treatment and an expensive "optimum" treatment. Physicians can reduce their Medicare costs by choosing less expensive drugs, and thereby receive greater financial remuneration. Medicare intends to use these incentives to replace physician fees, which Medicare expects to reduce by an annual rate of 5 percent for the next six years.

These particular programs are now being evaluated on an experimental basis; implementation is not guaranteed. But Medicare has initiated several financial incentive projects:

• A mix of 280 rural and urban hospitals began implementing financial incentives in October 2003. More than 200,000 patients per year are expected to be affected.

• Ten to 12 large group practices started a program in April 2005 with at least 5,000 physicians and 200,000 enrollees per year. This program will be underway through 2008. Each provider uses a different technique to treat fee-for-service enrollees, which Medicare hopes will prove to be an innovative cost-containment approach.

• Nine insurance and disease management programs will begin implementing programs this year, affecting 150,000 to 200,000 patients per year.

• Capitated fee-for-service payments were initiated for several providers in a three-year program, started in 2003, that aims to reduce chronic disease costs.

This means that today, some sales representatives are already detailing physicians who are compensated for prescribing low-price drugs. Commercial programs must identify whether a physician is participating in a Medicare program, and then assess how that impacts field force productivity and promotion response.

Disease outcomes data Medicare has implemented outcomes trials for several years. These studies encourage greater drug use (to prevent disease and avoid hospitalization) and evaluate whether low-price therapies can be used instead of high-price drugs. Results will be available starting next year, and continuing through the decade, and can be used by payers to adjust physician incentives and formulary priorities. The studies include:

• Drug Replacement Program, which evaluates the cost-effectiveness of replacing high-price drugs with low-price alternatives.

• High Medical Cost Beneficiary Program, which identifies how physicians can reduce hospital and drug costs for the most expensive Medicare enrollees.

• Chronic Care Improvement Project, which identifies how to reduce hospital and drug costs for Medicare enrollees with chronic diseases.

• Disease Management Demonstration, which evaluates whether disease management and drug use reduces Medicare enrollee costs.

• Cardiovascular Prevention, which provides financial incentives for lifestyle modification services that reduce severe coronary artery disease.

Pharma companies may use these outcomes studies to document how their medications provide cost-efficient treatment to a Medicare population. Companies with truly innovative therapies should incorporate Medicare endpoints into their clinical programs. Similarly, Medicare demonstration projects could allow mid-sized companies to document cost-effective use of their drugs.

Healthcare delivery projects Medicare is implementing many projects that improve the cost-effectiveness, quality, and reach of healthcare in medical settings that vary by geography (rural versus urban settings), customer segment (long-term care, home care or hospice), and disease (renal dialysis or chiropractic care, for example). Including the so-called State Waiver programs (see explanation below), there are more than 40 demonstration projects focused on healthcare delivery.

In addition to the long-term effects of these programs, there may be short-term effects as well. For example, sales representative productivity and promotion response may change if a provider participates in a Medicare demonstration project. Drug companies should align some commercial programs with the providers' goals, such as improved medical outcomes or increased cost-effective drug utilization, so they can capitalize on emerging business opportunities.

What to Do Today

The new Medicare rules will evolve slowly, and companies must temper their reaction to them. The drug benefit program faces many tough challenges, because:

• Medicare is being implemented by a government bureaucracy that is not experienced at managing drug formularies.

• Some regions may take a more aggressive posture toward drug prices than other regions.

• Due to budgetary constraint (or because they cannot identify an appropriate budget until Medicare decides on the final formulary structure later this fall), states that lack budgets to fully support this program may stall implementation.

• The e-prescribing system will take several years to implement.

To manage their long-term Medicare exposure, senior pharmaceutical managers must do two things: choose a core strategy and then develop tactics aligned with that approach.

What's the exposure? All companies have exposure to Medicare because almost all physicians participate in the program. Non-Medicare businesses will have spillover because drug formularies and demonstration projects are set up to influence all providers.

Every company must determine its business exposure to Medicare. Some companies, such as those specializing in women's health or childhood vaccines, have little exposure. They may not feel an immediate business impact, but they still need to make important decisions:

• Estimate how the spillover effect will affect the business.

• Selectively invest in technologies that support the franchise and risk profile.

• Build flexibility into the company's infrastructure so it can proactively react to spillover.

In contrast, companies with substantial Medicare exposure, especially those with large primary care business (such as cardiovascular or osteoporosis), must radically examine their business approach.

Elephant or specialist? "Elephants" are companies that have developed large infrastructures to support technologies with substantial market potential. "Specialists," on the other hand, have more modest infrastructures that support technologies with a narrow customer base. It is difficult for elephants to promote specialist products because their cost structures are so different. Each strategy has its own requirements, opportunities, and risks.

To be an elephant, you need a portfolio of innovative technologies that requires a large commercial operation. Elephants can achieve substantial profits if they have innovative therapies with reimbursement premiums. The risk is that bigger may not be better in markets with Medicare exposure and when many competitor compounds have comparable efficacy. E-prescribing systems that provide transparent drug choices may reduce the need for large field forces and brand promotion programs. Companies may not react smoothly to the new paradigm, resulting in a weaker competitive position and wasted resources.

A specialist requires technologies with a more modest commercial investment. Companies may be able to leverage e-prescribing in order to encourage therapeutic substitution for their products. On the other hand, the new Medicare business may evolve slowly, and the company may be attacked by larger competitors.

The real challenge will be for companies with both elephant and specialist technologies. These companies may become stuck in the middle if they choose not to adopt a clear approach. This can be dangerous, because the company's cost structure may no longer be aligned with commercial requirements. For example, a specialist technology with too much infrastructure may not be profitable, while an elephant technology that competes in segments with large Medicare exposure may lose share to low-cost competitors.

A New Business Environment

Certainly many companies will use the tried-and-true tactics of:

• Postponing and delaying in order to maintain the status quo.

• Implementing commercial programs that are better focused on Medicare issues.

• Selectively investing in infrastructure that protects the technology base.

However, the real issue is that action must be taken and companies need to align these tactics with their Medicare core business plan. After deciding on the business approach—elephant or specialist—each company can selectively pursue three activities:

Monitor Companies need to develop comprehensive systems that track commercial and clinical performance. These internal systems must mirror approaches used by providers, track individual drug status in each formulary, and determine how formulary changes affect detailing and product promotion. Companies must invest in clinical programs that focus on Medicare populations. Medicare will continue to implement outcomes and disease management programs, especially for chronic therapies and specialty customer segments (such as rural hospital and long-term care settings). Systems must be redesigned to better track drug utilization, drug compliance, adverse events, and other medical outcomes in each region.

Invest The trick here is to target products and technologies that either target the Medicare population or have little Medicare exposure. The Medicare population offers new business opportunities for some companies. In the future, products with a new delivery system and price discount may be promoted without a large expense, because pricing and clinical profile will be transparent. Some Medicare customer segments (long-term care, home care, hospice, or rural clinics) may benefit from unique programs that expand market presence. These investments must be aligned with your company's risk profile, because some investments may be more speculative than others.

Realign In the long run, it is important for organizational resources to account for the unique needs of Medicare enrollees. To accomplish this, companies must reassess all aspects of their business including:

• Research and development: Which products offer the greatest return?

• Clinical trial design: Which endpoints fit the Medicare population?

• Outcomes research, epidemiology, and clinical surveillance: How can systems best mirror the Medicare population to track and measure disease outcomes, drug utilization, and adverse events?

• Managed care contracts and drug pricing: How to target each formulary.

• Sales force targeting: Where to target sales representatives.

• Other commercial promotion programs: What is the best resource allocation?

Opportunities in Transition

The Bush Administration has initiated complex market forces to contain drug costs, rather than implement price controls. Implementation will be slow and uneven because the government is not experienced at managing drug formularies. This legislation also creates a structure that future administrations can use to directly control drug prices, which could happen if Medicare expenses continue escalating. In the near term, manufacturers must develop innovative approaches and systems so they can take advantage of local market opportunities.

Of the three tactical responses (monitor industry change, invest in new technologies, and realign organization infrastructures), companies must first develop a comprehensive Medicare monitoring system. Businesses must understand how new industry trends affects their business before implementing a new initiative.

New Medicare rules also create business opportunities. After ascertaining their Medicare exposure, companies must choose whether to be an elephant or specialist in the Medicare business, and then selectively invest in resources to achieve that end. For some companies, new Medicare rules may provide a unique opportunity to quickly build a new franchise without making a huge investment in infrastructure or commercial resources.

Companies must understand how the productivity of their commercial programs will change in reaction to new formulary priorities. Some formularies are likely to be more aggressive than others at setting reimbursement levels. Competitors will experiment with new commercial programs, and each company must evaluate the impact of these initiatives on its business.

Market structure shifts can be painful, and it may be four to five years before these Medicare initiatives become fully implemented; for political reasons, some initiatives may undergo substantial revision. However, drug companies can take advantage of market discontinuities caused by uneven implementation if they understand the nature of the market change and design clever responses.

Eric Felker is president of Apollo Consulting Group in New York. He can be reached at eric.felker@apollohconsulting.com.