Supply Chain

International Journal of Physical Distribution & Logistics Management
Forces, trends, and decisions in pharmaceutical supply chain management

Christian L. Rossetti, Robert Handfield, Kevin J. Dooley,
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Christian L. Rossetti, Robert Handfield, Kevin J. Dooley, (2011) "Forces, trends, and decisions in
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Pharmaceutical
Forces, trends, and decisions supply chain
in pharmaceutical supply chain management
management
601
Christian L. Rossetti and Robert Handfield
College of Management, North Carolina State University, Received March 2010
Raleigh, North Carolina, USA, and Revised July 2010
Accepted July 2010
Kevin J. Dooley
W.P. Carey School of Business,
Arizona State University, Phoenix, Arizona, USA
Abstract
Purpose – The purpose of this paper is to identify and examine the major forces that are changing
the way biopharmaceutical medications are purchased, distributed, and sold throughout the supply
chain. This will become important as healthcare reform moves forward, and logistics will be
transformed in this industry.
Design/methodology/approach – Multiple interviews with key informants at each level of the
value chain were combined with manifest text analysis from practitioner articles to derive key insights
into the primary change drivers influencing the future of the biopharmaceutical supply chain.
Findings – The research discovered radical shifts in the structure of the biopharmaceutical supply
chain. Future research into biopharmaceutical supply chain practices will need to explore three
primary issues: How will supply chain member compensation influence the power of parties within the
network? How will the role of supply chain intermediaries change the landscape of medication delivery
to the end customer? What impact will the role of regulatory constraints on product pedigree and
proliferation have on this network? The relationship between these forces is mediated by operations
strategy concerning inventory policy, supply chain visibility, and desired service levels.
Research limitations/implications – The research was based on multiple interviews with a
convenience sample, as well as text analysis from practitioner articles. These findings are an initial
step to guide future more in-depth research for this dynamic and contextually rich supply chain
environment that impacts consumers in every country in the world.
Originality/value – The paper adds insights into the pharmaceutical supply chain, examining this
from multiple perspectives.
Keywords Biopharmaceutical, Supply chain, Intermediaries, Supply chain regulation,
Distribution strategy, Supply chain management
Paper type Research paper
Introduction
Biopharmaceutical distribution is highly complex and fragmented. (Throughout the
remainder of this article, we refer to biotech and pharmaceutical solutions as one and the
same, given the blending of these industries from a product development perspective,
and will be referred to as pharmaceutical supply chain (PSC).) Prescriptions are filled at International Journal of Physical
more than 140,000 outlets in the USA, but only 6 percent of sales are sold direct by Distribution & Logistics Management
Vol. 41 No. 6, 2011
manufacturers. And, although consolidation has lowered the number of firms, the pp. 601-622
Biopharma supply chain continues to increase in complexity. This complexity also q Emerald Group Publishing Limited
0960-0035
stretches on a global level, with every country in the world being part of this network. DOI 10.1108/09600031111147835
IJPDLM On-going macro-economic and regulatory events are constantly changing the shape of
41,6 the competitive and operational environment in which supply chain managers make
their strategic and tactical decisions. However, we have limited our analysis to the USA,
due to the particular complexities that are emerging in this market (the largest market for
pharmaceutical products in the world). For example, within the USA, recent changes in
Medicare/Medicaid reimbursement have changed compensation for many supply chain
602 participants, and actions by non-conventional players, such as third-party logistics

(3PLs) service providers (Reisman, 2002; Mullin, 2003), threaten to dis-intermediate
conventional wholesalers. Simultaneously, regulators are demanding that wholesalers
and manufacturers increase transparency and reveal costs for purchase and prices sold
to customers, as well as demanding greater insights into true cost drivers associated with
pharmaceutical distribution (Scott, 2005). Market channels such as mail order, direct
shipping and web site pharmacies are also becoming important competitive channels
and are disintermediating a number of traditional market channels (Shah, 2004).
These changes have pushed the PSC in a state of flux. Unfortunately, standard
logistics strategy models that have been useful to guide managerial policy in other
distribution industries are not easily applied to PSC. In a PSC, the number of
consumption points, the role and number of intermediaries, and the long lead times and
highly unpredictable nature of bio-pharma manufacturing have created a web of
contingencies, interdependencies, and uncertainties (Goetschalckx et al., 2002). Because
existing research does not address the realities of PSC, there is an acute need for supply
chain researchers to begin investigating these phenomena. For example, inventory
positioning models assume a positive inventory holding cost (Whybark and Yang,
1996; Moinzadeh, 2002; Huang et al., 2005). Yet, for the past decade, the majority of PSC
wholesalers have garnered 90 percent of their profits from inventory appreciation – in
effect a negative holding cost. Strategic models such as Porters’ (1979) Five Forces or
Miles and Snow (1978) typology discount the complexity of the costs of entry and the
intangible knowledge-based assets held by entrenched PSC members (Zahra and
Pearce, 1990). In contrast, our research data will show that entrenched wholesalers,
pharma manufacturers, and potential entrants greatly underestimated the cost of
reverse logistics associated with returns in the PSC.
The generation of new theories concerning PSC can be guided by macro-economic
analysis of the nature of forces affecting the supply chain’s change. Classification of
these forces can concentrate research efforts, and also enables prediction of where the
industry, and thus research, will head. Employing a case study approach combined with
a meta-analytic review of the literature, we sought to explore the question: what are the
major forces influencing the future of the PSC as perceived by supply chain participants,
and what are the major research questions emanating from these perceived forces of
change?
Interviews were conducted with 55 informants from firms representing each node in
the value chain, from manufacturers to retailers. Within-case and across-case analyses
were used to identify similarities and differences between chain members’ views of forces
and trends. The practitioner press was then scoured for articles relating to the PSC in order
to explore the press reaction to these elements. About 751 articles were identified and
manifest text analysis using centered resonance analysis (Corman et al., 2002) was
performed on the research abstracts. The text analysis is used to increase the external and
internal validity of the participant findings and validate the resulting research trends.
Both the cases and the text analysis are used to support a framework for future PSC Pharmaceutical
research. Examples from the supply chain and operations management literature are supply chain
reviewed and future research opportunities are identified.
In order to focus the nature of the study and develop an interview protocol for case management
study participants, we conducted a focus group study (Flynn et al., 1990) at one of the
largest pharmaceutical wholesalers, involving 12 senior executives representing
purchasing, legal, analyst communications, finance, distribution management, and 603

sales. Individual forces of change were identified and categorized into three major
categories:
(1) Compensation forces. Increased use of inventory management agreements, fee
for service (FFS) models, and pricing pressure applied by government agencies
and third parties.
(2) Channel forces. The increasing use of direct sell models by pharmaceutical
manufacturers and the threatened entrance of 3PLs providers.
(3) Product and regulatory forces. Increasing levels of product diversity requiring
specialized handling and delivery coupled with increasing concerns about the
pedigree – legitimacy – of goods being distributed in the PSC.
These categories were applied as the core constructs for our historical discussion of
context, and also to guide the collection of data from PSC participants. The paper is
organized as follows. Research methods used for the case analysis and text analysis of
literature are discussed. The results of within-case and across-case analysis are then
presented. The discussion of these results focuses on the nature of future PSC decisions
and where future academic research may be helpful. The managerial and research
implications of the research are then presented. We close the paper with limitations and
conclusions.
Methodology
Conceptualizing the evolution of the PSC
In order to develop a robust analytic framework for understanding the changes
occurring in this industry, we conceptualized the PSC as a complex adaptive system
(CAS) (Choi et al., 2001) whereby agents (participants) in the PSC are coupled in a value
chain of production, and any agent’s actions can potentially affect any other agent. As a
CAS, its evolutionary path emerges through agents’ actions and interactions, and
environmental (e.g. regulatory) effects. By studying the perceptions of each participant
in the PCS, we can observe whether forces of current change tend to local or global. If
participants across the PCS perceive very different sets of forces, it indicates the PCS is in
an “edge of chaos” state (Dooley and Van de Ven, 1999) in which the evolution of the PCS
will be highly unpredictable and sensitive to small perturbations. In this case, we might
expect market forces (e.g. consolidation or specialization) and technology to be causes of
future change. Thus, our case study method will focus on the participant’s role within
the PCS as the unit of analysis.
Case study approach

A case study approach is an appropriate methodology when one wishes to answer the
study’s research question from the perspective of current practice, versus theoretical
reasoning (Yin, 1994). The case research was exploratory in nature and wished
IJPDLM to identify a consensus of opinions on the forces facing the PSC. The unit of analysis
for the case studies is PCS role. For example, all data collected on firms identified as
41,6 retailers are considered to relate to a single case. This fits with the goal of the research:
identifying the predominant views of the forces and trends facing the PSC from
multiple perspectives within the supply chain. Table I shows the roles within PCS that
were considered and the number of firms representing each case.
604
Interviews
In order to ensure that the majority of the content of our research area was covered, we
used a semi-structured interview approach. Based on the focus group, there were three
major areas that we wanted each participant to cover. Table II shows the interview
protocol that was used. Each interview was taped and transcribed for reliability
purposes. Interviews ranged from 35 to 45 minutes. Please see the Appendix for a copy
of the interview protocol.
A stratified sampling technique was followed. The largest firms in terms of revenue
at each level of the PSC were identified and contacted. As data collection began,
a combination of opportunistic and snowball sampling was followed. Various
tradeshows and industry sponsored meetings were also attended. Interviews with
respondents often led to contacts with respondents within the same company, stratum,
or in another stratum of the PSC. The final sample consisted of over 100 interviews with
representatives from 56 organizations. All interviews took place in 2005.
Practitioner articles
The second phase of the research involved the analysis of the practitioner press. Two
databases, ABI Informs and Business EBSCO Search Premier, were searched using the
following two sets of terms:
Case Number of firms
Manufacturers 21
Pharmacies 5
Hospitals/GPO’s 8
Table I. PBM’s/HMO’s 4
Cases and number Wholesalers/3PLs 10
of firms Outside experts (financial analysts/legal experts) 8
1. Drug Store News 62

2. Chemical Market Reporter 36
3. Chemical Week 35
4. Drug Topics 26
5. Pharmaceutical Technology 26
6. Manufacturing Chemist 21
Table II. 7. Traffic World 15
Sample of publishers and 8. Packaging Magazine 14
frequency of appearance 9. Pharmaceutical Executive 14
in analysis 10. Chemical and Engineering News 12
(1) pharma *, drug; and Pharmaceutical
(2) supply chain, distribut *, wholesal *, RFID, radio and frequency, and logistic *. supply chain
Wildcards were used to ensure that all combinations of the pertinent search words management
would be identified in the database. The search was not meant to identify all articles
available, but to provide a large enough sample for adequate content area coverage and
manifest text analysis. In all, 751 usable articles were identified dating from 1994 to 605
2006. The following table shows the top ten journal titles and their frequency. This list
represents 35 percent of all the titles in our sample.
Data analysis
Two different qualitative datasets need to be analyzed, the interview data and the
practitioner literature. Because of the volume of practitioner literature, manifest
(computerized) text analysis is used to analyze the content of the qualitative data.
Computerized text analysis employs natural language processing algorithms to identify
the most important words in a text, and how those words interrelate to one another. As a
form of manifest content analysis, computerized text analysis is wholly reliable, but
must be supplemented with sound human judgment and multiple sources in order to
ensure validity (Kippendorff, 2004). We also read all of the interview data and a sample
of the practitioner literature, and two coders performed latent content analysis on the
interview data in order to enhance validity. A descriptive report of the interviews was
written for participants and used as a (latent) summary of the interview data.
Computerized text analysis was performed using centering resonance analysis
(CRA) (Corman et al., 2002; McPhee et al., 2002), a manifest content analysis method
which represents text as a network (Carley and Kaufer, 1993; Danowski, 1993). CRA
draws on centering theory (Grosz et al., 1995) that states that competent authors or
speakers generate utterances that are locally coherent by focusing their statements on
conversational centers. It uses natural language processing to identify centers (noun
phrases) in text, and links the component words (tokens) into a network.
Computerized text analysis results

Interviews
All interviews representing a case were aggregated into a single text and analyzed
using CRA. For each text (case), CRA yields an influence value (0-1) for each word
found in the text. In order to link individual words to our three categories of forces,
themes were identified through latent coding of the list of the most influential words.
First, the 250 words with the highest average influence across the cases were identified;
the influence of these words constitutes over 80 percent of the sum of all word influence
in the texts. Second, two coders identified words associated with each of the three
categories of forces (compensation, channel, and product) and also words associated
with specific PSC participants. If a specific word could not be unambiguously placed
into one of the categories, it was not included. Third, a second level of detail was
added to the coding scheme by emergently identifying themes within each category.
It is important to note that any form of content analysis does not yield results that
are statistical per se, because the sample is equivalent to the population. Thus, word
and theme influence values, and resonance values representing similarities between
cases can only be interpreted relative to one another.
IJPDLM Within the compensation category we found words indicative of included three
41,6 themes: general compensation issues – prices, value, etc. FFS – relating to fees and
pricing models proposed by wholesalers, and clear – relating to clear pricing and rebate
structures related to Medicare and Medicaid. Channel forces consisted of alternative
channels – direct mail, direct ship, internet sites, etc. logistics – required infrastructure
and inventory management terms, and service – satisfying demand, customers,
606 patients, etc. Product forces included: products – specific products listed, regulations
and rules related to products, generics included specific reference to generic drugs, and
technology – RFID, track and trace technology, cold chain technology, etc. For each
theme, the influence values associated with words in the theme were summed in order to
calculate a theme influence for each case (PSC role) (Table III).
In addition to examining what themes (sub-forces) were present and how they
differed in influence across the PSC, we also examined the similarity between each case
(role) at the level of the whole text. Whereas similarities and differences found in Table III
depend on only a fraction of all words and involves some element of human judgment
(in coding words to themes), the measure of resonance between the cases involves all
words and is completely mechanical. Resonance varies between 0 and 1 and can be
roughly thought of as a measure of correlation. A resonance of (e.g.) 0.10 implies that two
texts share 10 percent of their influential words with one another, indicating some level
of commonality of content. Table IV shows the resonance between each case. Overall, the
resonances are fairly low, indicating that there are significant differences in how
members of the PSC perceive sub-forces resonance values above 0.05 are italicised for
interpretive purposes.
When we consider category 4 (PCS members), Table III shows that wholesalers,
manufacturers, and retailers have a dominant position establishing distribution
contractual language and terms throughout key nodes of the PSC. The resonance
analysis also shows that wholesalers, manufacturers, and retailers shared many of the
same influential words and sub-networks. Cluster analysis using these resonance values
and Ward’s hierarchical clustering method confirmed two clusters: manufacturers,
wholesalers, and 3PL; and hospital, pharmacy benefit managers (PBM), regulators, and
retailers. This confirms many of the evidence established through observation and
inquiry in the research: the primary of change will be driven by powerful channels
members in manufacturing, wholesale distribution, and possibly retail within the PSC.
The remainder of our analysis explores the characteristics of these two channel
members in more detail.
Table III also indicates that FFS, service, and product sub-forces are the most
influential drivers of change in the channel. An analysis of relative influence variance
across the cases yields additional insights. Although manufacturers are plausibly most
affected by FFS within the channel, influence measure is low, suggesting that
participants simply did not bring up the topic as much as theory might dictate. The
latent analysis of the interviews led to the same conclusion. However, regulators and
analysts used FFS as a major theme and linked it to topics such as government
regulation, product pricing, and customer service. In addition, service levels were a
major concern among retailers and 3PLs for similar but opposite reasons – 3PLs
believed that retailers were being “over-served” in terms of high shipment frequency and
on time delivery, whereas retailers worried that 3PLs would be unwilling to maintain
current service levels which had now become an integral part of their business model.
Force Theme 3PL Wholesalers Hospital Manufacturers PBM Regulators/analysts Retailers Influence Total
Compensation Comp 0.11 0.16 0.20 0.19 0.11 0.19 0.25 1.22 6.165
FFS 0.53 0.39 0.62 0.34 0.61 0.81 0.41 3.71
Clear 0.04 0.12 0.11 0.08 0.34 0.51 0.05 1.24
Channel ALT 0.03 0.01 0.00 0.05 0.01 0.00 0.01 0.11 4.082
Logistics 0.21 0.25 0.21 0.20 0.14 0.23 0.22 1.46
Service 0.41 0.32 0.32 0.35 0.35 0.32 0.44 2.51
Product Product 0.10 0.19 0.29 0.25 0.58 0.18 0.25 1.85 3.208
Generics 0.00 0.00 0.04 0.01 0.19 0.02 0.01 0.28
Tech 0.15 0.18 0.12 0.12 0.12 0.18 0.20 1.07
SC member WHL 0.24 0.20 0.21 0.21 0.12 0.21 0.28 1.46 3.686
3PL 0.09 0.03 0.00 0.01 0.00 0.00 0.01 0.13
MFG 0.22 0.25 0.11 0.10 0.20 0.15 0.22 1.25
PBM 0.00 0.00 0.00 0.00 0.05 0.00 0.00 0.05
Retail 0.05 0.04 0.08 0.02 0.14 0.03 0.27 0.63
Hosp/GPO 0.00 0.00 0.10 0.05 0.00 0.00 0.01 0.17
Pharmaceutical
management
Theme influence
supply chain
versus PSC role

Table III.
607
IJPDLM (This disconnect is emphasized later in the paper in discussion of relative forces). PBM
used products, particularly pricing, as a theme throughout their interviews. And as the
41,6 interview notes bear out, this member of the supply chain has great influence on product
flow. Next, we turn our attention to the analysis of the practitioner press.
Practitioner articles
608 One difficulty of case research is providing external validity for observations. In order to
increase external validity of this study, we analyzed a large sample of the practitioner
press using CRA. This analysis provides a synopsis of the PSC from journalists and
experts. In this case, the unit of analysis is an individual article, and results were then
aggregated into years in order to determine if there were any trends present. Cluster
analysis of the annual texts showed that the articles fell into two distinct temporal periods,
1994-2001 and 2001-2006. In order to understand how the content between the two periods
differed, we found the word and theme influences associated with each period.
Comparing the influential words in each epoch revealed, a change in the lexicon
associated with certain themes as well as shift in the PSC’s focus. Terms that decreased
in influence included: customer, distribution, supply, appointment, pharmacy, industry,
and inventory. Terms that increased in influence included: technology, government,
production, chemical, RFID, service, operation, facility, product, and supplier. In general,
it appears that the focus of the PSC has shifted away from the management structure
necessary to facilitate customer/patient service. In its place is a focus on technological
and operations infrastructure designed to improve service.
To check for external validity as well as identify the future trends in the PSC, we
combined the influential words around the previously developed forces (themes) and
PSC members. We then extrapolated the influence scores using linear regression to the
year 2010 to give us an indication of future influential forces. The following table
shows these results.
Table V shows that product forces and manufacturers dominate the press coverage.
Additionally, influential words related product forces and manufacturers are the only
ones predicted to increase influence. Terms related to compensation have retained a
fairly constant influence in the press. However, logistics-related terms have dropped in
influence. It appears that the practitioner press is more focused on information
technology-enabled integration. Interestingly, FFS was not an influential term.
Although service was influential, it was not closely linked to compensation terms. Either
the press has yet to cover this change in compensation in large numbers, or perhaps like
the members of the PSC in our study, they do not believe that it will greatly change
supply chain practices.
3PL Wholesalers Hospital Manufacturers PBM Regulators Retailers
3PL 0.00 0.07 0.05 0.08 0.04 0.02 0.04

Wholesalers 0.07 0.00 0.05 0.12 0.06 0.05 0.07
Hospital 0.05 0.05 0.07 0.06 0.04 0.07
Manufacturer 0.08 0.12 0.07 0.00 0.08 0.07 0.09
PBM 0.04 0.06 0.06 0.08 0.00 0.03 0.07
Table IV. Regulators 0.02 0.05 0.04 0.07 0.03 0.00 0.05
Resonance of cases Retailers 0.04 0.07 0.07 0.09 0.07 0.05 0.00
Pharmaceutical
Force Theme 1994-2001 2002-2006 2010 Total 2002-2006
supply chain
Compensation Comp 0.132 0.135 0.145 management
FFS
Clear 0.017 0.009
Channel ALT 0.038 0.034 0.484
Logistics 0.456 0.265 609

Service 0.348 0.185
Product Product 0.516 0.649 0.905
Generics 0.008 0.002
Tech 0.237 0.254
SC member WHL 0.025 0.017 0.413
3PL
MFG 0.256 0.277
PBM 0.048 0.021 Table V.
Retail 0.161 0.087 CRA analysis
Hosp/GPO 0.009 0.012 practitioner press
In the next section, we explore the forces in more detail. We use the results of the CRA
analysis, both interviews and press, as well as our interpretation of the interviews to
develop trends regarding the future of the PSC.
Findings
Changes in compensation structure
Analysis of the interviews revealed that compensation forces had a high influence in
the discussions with PSC members. However, the analysis of the press showed that this
force was not as influential as channel forces and product forces. General compensation
issues such as pricing and contractual agreements between firms were relatively the
same across all members of the PSC as well as in the press. The majority of this
difference can be found in the reactions to the FFS pricing model and changes to
pricing regulations. In the following sections, we explain these differences.
Fee for service model. FFS is a relatively recent addition to the PSC lexicon. As stated
in the introduction FFS is in response to changes in inventory management policies
enacted by many pharmaceutical manufacturers coupled with lower margins
experienced by wholesalers. FFS is based on applying activity-based cost accounting
to the prices charged to customers (Lere, 2000; Vokurka and Lummus, 2001). By linking
actual value add activities to the prices charged for services, activity-based
pricing provides service companies with a mechanism for justifying prices as well as
increasing openness and trust in inter-organizational relationships (Pirttila and
Hautaniemi, 1995; Stevenson and Cabell, 2002). The wholesalers in our study as well as
the 3PLs have offered a variety of activity-based pricing models where they are
compensated for logistic services.
As seen in Table III, all participants viewed this as an important force. However,
reactions to FFS are not uniform. Interestingly manufacturers, the type of firm which
our focus group thought would be most impacted by FFS, showed the lowest influence.
Examining the within-case interviews, we found that this group had the greatest
variety of responses. It appeared that instead of promoting openness and trust, the FFS
was in many cases viewed as unfair or at best another pricing gimmick.
IJPDLM The insights from a 3PL that shed the most light on the possible reason why
41,6 manufacturers may be reluctant to accept FFS:
The wholesaler model is just at a high-level fee for service and manufacturers have no idea
what they are paying at a comprehensive level. We asked them how many shipments they
make, and large pharmas had NO idea! They sell in bulk to the wholesaler, and buy
market-service data, but have no direct shipment level detail. So they have no concept of what
610 is actually happening in terms of sales and service for their product!
Interestingly, regulators and analysts viewed FFS as an integral part of Medicare and
Medicaid reform (Danzon et al., 2005). In our study, analysts were of the opinion that
new regulations would demand accountability at all stages of the PSC. If this was the
case, then a form of activity-based pricing would be required into receive government
reimbursement:
Trend 1. Manufacturers in the PSC will continue to view FFS skeptically unless
regulation or competition create transparent of cost of service associated
with distribution value-added activities.
Clear pricing and reimbursement. A closely related issue with the previous trend
involves the complexities associated with reimbursement in the channel, and the
muddied and complex set of regulatory requirements that have evolved in the channel
in response to the healthcare crisis in the USA. In addition to the FFS model between
manufacturers and wholesalers, the PSC in the USA must also contend with Medicaid
and Medicare reimbursement. Only PBM and regulators and analysts viewed this as
changing the PSC, yet the reality of the regulatory policy climate is that all members
will be impacted dramatically! Ironically, terms related to reimbursement and clear
pricing barely registered in the practitioner press in our analysis.
The majority of states base their calculation of estimated acquisition costs on
published average wholesale prices (AWP). These AWP’s are the subject of much
debate by the Office of the Inspector General, which alleges that Medicaid is paying too
much for prescription drugs. Robert A. Vito, Regional Inspector General for Evaluation
and Inspections, Philadelphia, commented that:
Our analysis comparing actual pharmacy acquisition costs to AWP for calendar year 1999
revealed that pharmacy acquisition costs for brand name and generic drugs were 21.8% and
65.9% below AWP, respectively.... and that the different between actual acquisition costs and
the amount the Medicaid program would have paid using the States’ average estimated
acquisition cost formulas was $1.5 billion in 1999. (personal communication, 2005).
One PBM we interviewed noted that:
We have adopted an above the board policy to develop an agreement pass through on all new
products, so everyone knows the exact amount of the rebates coming from the manufacturer.
We will now pass on 90% of the rebate to customer. We have an open-books policy that
allows the payer to come in and audit our contract down to the wholesaler NDC numbers.
PBMs also receive rebates in the form of administration fees. The OIG concludes that
there is significant interest in changing Medicaid reimbursement for prescription drugs
by aligning pharmacy reimbursement more closely with pharmacy acquisition cost. The
changes proposed in the President’s 2006 budget would make Medicaid reimbursement
consistent with Medicare by basing reimbursement on actual sales transactions:
Trend 2. Government pricing mandates will reduce wholesaler, manufacturer, and Pharmaceutical
PBM margins. supply chain
Channel compensation. One of the more interesting findings from our study was the management
relationship between service levels and risk in the PSC. Though we will examine the
service component in more detail in the logistics section, it is difficult to decouple it from
risk associated holding inventory. The inventory risk which has primarily been born by
wholesalers, is unrecognized by the majority of members in the PSC. When one 611
examines the activities currently performed by wholesalers, associated risks generally
fall into two categories, risks associated with inventory and customers (Gupta et al.,
2002; Xianghua et al., 2005). Both require investments in transaction specific assets that
cannot be redeployed regularly should business with customers cease (Grover and
Malhotra, 2003).
Table VI identifies services as well as risks associated with current wholesaler
activities.
As wholesalers’ revenues have switched from being derived from inventory
speculation to fees based on efficient operations, there have been tradeoffs in inventory
and staffing levels. This has impeded the ability of wholesalers to act as a buffer
between supply and demand and in worst case scenarios offer the pharmaceutical
industry supply chain continuity.
Some manufacturers were aware of the infrastructure required to maintain these
service levels, but most neglected the risks associated with the owning the assets
necessary to maintain these service levels. This may explain why many of the PSC
members that felt the fees charged in the FFS model were too high. Those that rejected
the FFS model believed that vertical integration or a switching to 3PL’s was a viable
alternative. Many of the manufacturers have explored alternatives, not because they
are not happy with the service, but that they truly fail to understand the complexity of
the channel. Multiple observations from multiple channel participants reflect the fact
Activity Associated risk
Forecasting demand Forecast errors

Specialized data systems and personnel
Inventory management systems Specialized information systems
Ordering systems Specialized information systems
PO systems (purchase order systems that only bill for Specialized information systems
shipped items)
Carrying 20 or more days of inventory for pharmacies at Underage and overage
no cost for high-moving drugs
Delivery 5 £ per day, 24/7, 365 days a year Specialized distribution assets
Warehouse and cost structure to ship to multiple Specialized distribution assets
locations
Business continuity requirements (multiple warehouses Assets deployed for mitigation rather than
distributed nationally to decrease probability of delivery efficiency
disruptions or inventory loss)
Credit, billing, collections – particularly collecting Cash flow Table VI.
receivables and taking on credit risk Services and associated
Returns and recalls Liability risks of pharmaceutical
Providing pedigree Liability wholesalers
IJPDLM that there is a poor understanding of the true complexity and cost of the services
41,6 provided by wholesalers:
Trend 3. Current service levels and continuity of medications to consumers is a
function of effective compensation of wholesalers for bearing a majority
of channel risk in the PSC.
612 Channel forces and channel changes

Channel forces include alternative channels, logistics infrastructure, and service. Our
analysis reveals that alternative channels are not an influential theme, but logistics
infrastructure and service are indeed very important themes. Interestingly, all
members of the PSC viewed each of the sub-forces somewhat equally. The practitioner
press has emphasized that channel forces, although influential, are decreasing in their
impact on strategic decision making in the channel. Detailed analysis of the interviews
points towards a contingent view of many of the channel forces. We next explore this
in the discussion of each sub-force.
Emergence of alternative channels. Although “alternative channels” was not an
important theme in the PSC interviews or the press, there are three viable alternatives
that merit discussion: the entrance of alternative wholesalers in the channel, direct
sales, or product focused channels. In considering the first option, there are three
distinct possibilities: consolidation of smaller wholesalers, entrance of 3PLs as a new
entrant in the channel, or vertical integration by a manufacturer of a smaller
distributor. Each of these appears to be somewhat unrealistic, given the frank
evaluation and exploration of these possibilities in our interviews with subject matter
experts in the PSC.
Although 3PLs appear to present a viable alternative, our research results lead us to
believe that the 3PL’s are unable to offer logistic services on par with the wholesalers.
They excel at point-to-point distribution, but current service levels require holding
inventory, something 3PLs seem reluctant to do. This was validated in our interviews
with two major 3PL providers who are actively engaged in pursuing market share in
the pharmaceutical wholesaler space. These organizations are clearly focused on
developing capabilities in this space. The largest 3PL has developed some early
successes in pilots in a large metro area, but does not seem aware of the complexities
associated with the channel. A second 3PL has initiated early pilots as well and
is approaching the market with a cautionary approach, focused on building consensus
and identifying opportunities. The third 3PL has decided to focus on niche services
such as cold chain and track and trace, in an effort to target the growing biotech sector.
Mail order is now the fastest growing sales channel for prescription drugs. In 2005,
mail order drugs grew 18 percent to $33.9 billion, according to IMS Health, accounting
for 14.4 percent of the total US prescription market – up from 11.8 percent in 2001.
Meanwhile, drug sales at chain stores grew only 6 percent. Mail order also threatens
the retailers’ high margin “front-end” merchandise, because customers who receive
drugs in their mailbox are not in their local drugstore shopping for cosmetics and
candy. The lion’s share of mail order sales is being generated by PBM’s like Medco and
Caremark. Highly automated and hugely profitable, PBM’s can fill and mail a
prescription for as low as $2.5, a fraction of what it costs drug stores. Owing to these
cost advantages and their ability to control pricing in the PSC, we believe that PBM’s
will continue to have a great influence in the channel.
Perhaps, the most innovative alternative channel being explored is direct shipment Pharmaceutical
combined with patient management. A cancer drug manufacturer initiated a program in supply chain
the mid-1990s in response to a significant channel problems. One of the senior executive
from this company stated that product manufacturers should accept the responsibility management
that they own the supply chain. With this ownership comes the responsibility of
ensuring that necessary value-add services are provided to patients. The services
offered by this company include real-time data regarding administration of product, 613
compliance, and on-going monitoring of patient health. This service will be limited only
by the human factor: many patients are willing to pay a higher price in order to discuss
pharmaceutical side effects, problems, and issues with a caring pharmacist through
direct clinical intervention:
Trend 4. Of the three alternative channels (3PL, mail order, and direct shipment),
mail order will have the greatest potential for market share growth in the
channel, limited only by the public’s willingness to accept lack direct
contact with human pharmacists.
Logistics infrastructure. Logistics infrastructure was an influential theme in both the
interviews and the press. Influential words in this sub-force related to inventory,
management, systems, order, returns, etc. This sub-force was influential across all of the
cases. However, analysis of the press showed that logistics concerns were decreasing in
influence over the last few years. It would appear that logistics may be viewed a
competency with diminishing returns with future investments. Although systems
designed to help with track and trace got a lot of press, this technology is being
implemented to ensure drug pedigree not to improve efficiency – practically an
afterthought.
In general, logistics infrastructure remains with the wholesalers, a few PBMs that
have invested in highly automated warehouses for their mail order business, and large
retailers. Manufacturers have neglected logistics for over a decade and the opinion is
that they cannot get build these skills back up quickly:
Trend 5. Wholesalers are the only members of the PSC that have the logistics
infrastructure to service hospitals and retailers requirements for
emergency shipments, single picks, and high service levels, given these
members’ current distribution and storage facilities.
Service levels. The service theme contained such influential words as service, patient,
customer, level, demand, handling, delivery, support, etc. It is difficult to decouple
service levels from the logistics infrastructure that support them. In the interviews,
service’s overall influence was higher than the logistics sub-force. It was slightly lower
in the press (0.348-0.456). The press showed a marked drop-off in service influence
between the two periods, consistent with the other channel sub-forces. Perhaps, this
indicates that the press has accepted channel standardization in the PSC which may
lag many of the concerns of the participant in our interviews.
Within our interviews, service was the highest influential sub-force. The two
members of the PSC most concerned with service were 3PLs and retailers, although it
was influential in all PSC members’ dialogue. This may reflect a deeper understanding
within members of the PSC of what was called the over-servicing of retailers and
hospitals by wholesalers.
IJPDLM Other retailers we interviewed agreed that a reduction in service levels was not
41,6 likely to be acceptable through alternative channels than wholesalers:
The majority of retailers receive two or three orders per week. That is a very good level of
service. At (Large Retailer) the difference between 3 and 5 a week was not that significant, but
it was often the kind of thing we would look at as a tiebreaker. We first looked to see if they
had to have best bottom line price. If they had 3 deliveries a week and were better on price –
614 that would be better. The majority of retailers have a secondary supplier where they can pick
up shorts, in cases when the primary has an out of stock or demand that is out of stock.
Trepidation in the PSC about manufacturers playing larger role in logistics service
may be well founded. In our conversations, we learned that when manufacturers are
designing DCs they are focusing on efficiency and trying to curtail service.
The recent period of wholesalers competing on service is most likely coming to an
end. The days of three deliveries a day to major retailers and hospitals will be under
increasing pressure for cost reductions in upcoming FFS negotiation renewals. The
previous trends all point to a new period of lower service in the PSC where logistics
infrastructure and service requirements will be points of contention. Manufacturers
that attempt to gain greater control of the PSC through forward integration will be
pushing for lower service levels. The three large wholesalers cannot reduce their
margins and clearer pricing agreements, perhaps forced by the government, will
remove rebates – perhaps the last form of alternative revenue. These forces all should
result in hospitals and retailers being forced to accept lower service levels:
Trend 6. Service levels in the PSC will drop as FFS models are rationalized and
manufacturers take a larger role in PSC logistics. This relationship will
be moderated by the increasing power of retail pharmacy consolidation
and GPO/hospital consolidation.
Product forces
The last set of forces we evaluate are product related. The first sub-force involves
changes in PSC management to effectively deliver new types of drugs to customers. In
addition, lower prices in certain drug categories change inventory management
decisions. Generics and over the counter (OTC) drugs are driving a large part of these
price changes. Lastly, increased drug pedigree concerns are driving new technological
solutions to the old problems of track and trace – knowing where products are in the
PSC. Product forces were very influential in the dialogue with PSC members. And
within the press, it was one of the few sub-forces that is increasing in influence.
Product proliferation and customer segmentation. One of the major problems facing
the PSC is the proliferation of products, many of which require specialized distribution
networks. When Pfizer spun off its OTC drug line to Johnson & Johnson, Pfizer stated that
there was not enough synergy between the resources required to develop new brand name
drugs and the continued support of OTC medicines. In addition, generics are increasingly
being sourced directly by large retailers who are treating these drugs the same way they
procure other commodities. Lastly, a new host of biological and human plasma-based
drugs require a completely different supply chain. Referred to as the cold chain, these
family of drugs must be kept in controlled environments and have very specific shelf-lives
often tied to temperature and humidity of their surroundings. The fact that production
and consumption are now occur globally has only increased the complexity of the PSC.
Interviews with one of the largest cold chain providers reinforced two big problems: Pharmaceutical
scale and scope of product problems facing the PSC: supply chain
To meet these requirements (cold chain distributor) established DC’s and partners with management
(container company) – to develop a skid mounted shipping container easily moveable by
forklift, with a compartment for dry ice and a battery powered fan and control system. This
covers temp control – but also required customized transportation. The company went with
(specialty truck line), a specialist trucking firm with nine customized trailers all standardized, 615
which includes a backup 32,0000 BTU refrigeration unit if the main 50K BUT fails.
The trailer becomes the secondary packaging.
Therapeutics are “boutique” drugs customized to patient requirements. Manufacturers
are currently creating drugs that would be customized based on success of clinical
trials in a sub-population. The segments would correspond to therapies best suited for
specific individuals. A patient seeking treatment would be tested and segmented into a
category of treatment, and the physician would then recommend the therapy best
suited to the individual’s particular condition, including their recommended dosage,
etc. The PSC then plays an important role in creating specific “boutique” customized
therapies to align with individual requirements, genetic characteristics, etc. In this
manner, a customized set of therapies that is most effective would evolve. However,
this requires follow-on technologies that must be used to monitor patients as they
follow through with prescribed therapies. An executive at a major PBM described their
company’s vision for sustained profitability using therapeutics:
[. . .] smart drug will be much more of a designer drug. Are there certain medications that would
work better in the AfroAmerican population? If you are a manufacturer and you have 4 varieties
of Zoloft – we will have to serve more of the population through diverse product offerings.
These above statements appear to point towards a PSC that is moving towards niche
markets that cater to specific individuals, or at least sub-segments of the general
population. These examples contrast sharply with the recent moves by large retailers
to improve operational efficiency.
Further, the share of generic drugs is likely to increase sharply in the next two to
three years. Since wholesalers are more likely to carry branded products, it is likely
that there will be a reduction in revenue for wholesale distribution. Some estimates are
in the range of 10 percent reductions. This is driven largely by the pharmacy benefits
managers, who will purchase directly from generics manufacturers rather than
wholesalers. One PBM executive we interviewed noted that:
From the data I have seen and IMS data[1] – a lot of branded product will come off patent, and
the trend will continue. We are also seeing a new type of single source generic coming into the
market – with some exclusivity for some period of time. That hurts us – we have guaranteed
generics discounts we make to our customers which is based on the assumption of lower cost.
If a single source generic comes to market, however, it is difficult to get to a discount generic
market price. For example (Large Mfg) could single source and not allow others to manufacture
the generic. In terms of the Average Wholesaler Price, we would only get 25% off instead of
80% – but would still have to reimburse our market at 80% discounted price.
Therefore, it appears that generics are following the path of OTC medications. Where
brand names are being supplanted by store brands and active ingredients are more
important than manufacturer. Coupling this with price pressures from PBMs and
retailers, we believe there is strong evidence that the PSC is fragmenting:
IJPDLM Trend 7. The PSC will fragment along three major product types: OTC and
41,6 generics, brand name drugs and therapeutics, and cold-chain. Retailers
and PBMs will control the OTC/generics PSC and manufacturers will
control the brand name/therapeutics/cold-chain PSC.
Implications
616 This research covered multiple levels of the pharmaceutical value chain. Each of the
trends we identified has implications for all members of the PSC. Given the scope of
this research, it would be difficult to provide specific implications and research
agendas for each type of firm or relationships that this research covered. Instead, this
section will focus on the three major forces in the sequence that we feel will they will
impact the PSC. In doing so, we feel we can better guide managers and researchers
towards more immediate decisions versus long-term decisions.
Short-term decisions and research

From our research, we believe that the changes in wholesaler compensation are the
most immediate force facing the PSC. Although recent information from follow up
interviews indicates that FFS is being accepted by manufacturers, there are strong
indications that acceptance is contingent upon lower prices with the same level of
service. The PSC still appears to want to have its cake and eat it too. Currently,
competition among the three major wholesalers is keeping margins in check, but it is
likely that one will take the role of price leader and prices will then rise. In addition,
margins are being maintained by increasing efficiency. As we discussed, this is
lowering the ability of the PSC to withstand disruptions.
There are several managerial implications surrounding balancing risk adjusted
compensation in the PSC. In the immediate future, manufacturers should count on
further increasing inventory levels. As the executive at a manufacturer that is currently
using a direct sell model for some of its products, manufacturers will need to accept the
responsibility of ensuring that there products are arriving to customers when they need
them. Recent evidence shows that manufacturers are already increasing inventory
levels; however, macro-indicators of inventory in the PSC show that this has not been a
strategic reaction. Increasing inventory levels at the manufacturer level are almost
exactly equal to inventory reductions at the wholesale level. Inventory has just been
shifted up the chain. If manufacturers wish to ensure supply chain continuity, they will
need to treat inventory more strategically. Either by compensating PSC partners to carry
it or by changing their manufacturing processes towards more flexible production
standards. However, if manufacturers take this approach, they will have to engage in
some form of collaborative planning such that the PSC can ensure that drugs reach
patients when they need them, even during disasters.
From a research standpoint there a need to address how compensation should be
structured in the PSC. Agency theory is particularly useful in examining the
contractual relationship between manufacturers, distributors, and retailers (Frazier,
1983; Eisenhardt, 1985; Rey and Tirole, 1986). When products require specialized
knowledge and skills, behavior-based contracts is the norm (Eisenhardt, 1988).
This research can and should follow both analytical and empirical tracks.
Analytically, it is important to prescribe the correct contract structure that balances
compensation and risk accordingly (Iyer et al., 2005; Maloni and Carter, 2006).
However, since it is likely that practices will lag academic prescriptions, it is important Pharmaceutical
that researchers stay abreast of current practices in the PSC. As compensation and supply chain
incentives change in the PSC, it will be vulnerable to stockouts and disruptions
(Baumer et al., 2004). Ideally, policy makers will be able to create guidelines that ensure management
that supply chain continuity is not compromised as market forces come to bear on
changing supply chain environments (Monaghan and Monaghan, 1996; Menon, 2001).
617
Long-term decisions and research
From our research, we feel that fragmentation of the PSC should be considered as part of
strategic and operational planning. As mentioned previously, Pfizer’s decision to spin-off
its OTC business and J&J’s decision to buy it reveals that several members of the PSC
are already moving in this direction. The decisions relating to specialization or to
maintenance of a portfolio of products and the assets needed to support them is extremely
difficult. The PSC is very different from supply chains in other industries and drawing
parallels is questionable (Fein, 1998; Danese et al., 2006). Furthermore, there is evidence
from high tech, automobiles, heavy equipment, and aeronautics can support either
decision. However, complexity theory may provide insights into alternative strategies.
In the introduction, we stated that the PSC appears to be behaving as a CAS. Using
this viewpoint, there are a number of recommendations that PSC members may
consider. Choi et al. (2001) offer a number of propositions based on this view. The two
that appear most applicable to all members of the PSC involve simplification and
flexibility (Gale and Sabourian, 2005; Tinham, 2005). By simplification, the authors
refer to the number and complexity of rules that govern inter-organizational
relationships (Dooley and Van de Ven, 1999; Choi and Krause, 2006). Regarding the
PSC, this may be thought of as government regulation and contractual relationships.
There is already movement on the simplification and clarification of
Medicaid/Medicare reimbursement. Rather than resisting this form of regulation,
members of the PSC should embrace it and work to make the rules as simple and as
clear as possible. Although this may negatively impact revenue and profits for some
members of the PSC, it may diminish the probability of a chaotic transition. CAS
systems are prone to behave non-linearly (Choi et al., 2001). The strength of the forces
currently impacting in the PSC coupled with the degree of interconnectedness between
members and activities points towards a difficult transition between current and future
states. CAS theory prescribes that proactive simplification of regulations with
scheduled implementations should help ease transition points. As a case in point, the
governments insistence on RFID implementation followed by a wait and see approach
creates a complex environment. In such environment, agents may forego decisions.
Those that react quickly may later be penalized for their decisions.
The second principal is flexibility. With increased consolidation and centralization,
it may be argued that the PSC is losing flexibility. For example, the advanced
distribution centers currently in use by large retailers are limited by the number and
types of products that they can handle (Meijboom and Obel, 2007). As wholesalers,
manufacturers, and retailers migrate towards larger centralized distribution centers, the
transportation network connecting manufacturers to patients becomes more susceptible
to increases in fuel prices or natural/man-made disasters (Elkins et al., 2005).
Researchers can help guide PSC managers by engaging in research examining the
effects of the forces we identified. Autonomous agent simulation perhaps coupled with
IJPDLM game theory may provide insights into transition points in the PSC’s evolution
41,6 (Swaminathan et al., 1998). Various supply chain configurations may be modeled and
their fitness evaluated. Lastly, game theory can provide insights into optimal dyadic
contracts that include delivery and price (Meca et al., 2003; Pennings and Smidts, 2003).
Coupling this with autonomous agent simulation may indicate where dyadic optimal
contracts lead to suboptimal supply chain outcomes (van der Zee and van der Vorst, 2005).
618
Conclusions
This research examined the PSC from multiple perspectives. A focus group identified a
number of forces that they thought would impact their supply chain decisions.
Interviews with key informants from 56 firms in the PSC as well as a large sample of
the practitioner press were analyzed using crawdad, a computerized manifest text
analysis that utilizes centered resonance analysis. The results indicate that the three
major forces identified: compensation, alternative channels, and product forces would
all be influential. Our research yielded eight trends relating the evolving forces in the
PSC. Based on our analysis of the cases and the literature, we believe that product
forces, particularly increased product segmentation along two major lines will have the
greatest effect on PSC manager’s decisions.
Note
1. IMS Health is a consulting company that tracks pharmaceutical manufacturing and sales.
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Management Studies, Vol. 16 No. 4, pp. 751-68.
Appendix. Example of interview protocol Pharmaceutical
Question
Can you describe channel complexity for pharmaceutical distribution? supply chain
Is your company considering other 3PL’s to ship direct to customers and by-pass wholesalers? management
Which of the 3PL’s has the capability to do so?
What do you believe are the true service requirements for providers, in terms of number of
deliveries, service levels, etc?

What do you understand are the future reimbursement requirements, and how will they change? 621
What do you believe is the budget to create a model to by-pass wholesalers?
What do you believe are the projected savings?
If a wholesaler were to become more involved in the returns and recalls business, would it be a
big value-add to your business?
Which of the following processes are you capable of providing today to pharmacies and/or
hospitals?
.
forecasting demand;
.
inventory management systems;
. ordering systems;
.
PO systems (only bill for what is shipped);
.
carrying 20 or more days of inventory for pharmacies at no cost for high moving drugs;
.
delivery 5 £ per day, 24/7, 365 days a year;
.
warehouse and cost structure to ship to multiple locations;
.
business continuity requirements (multiple warehouses distributed nationally);
.
credit, billing, and collections;
.
collecting receivables and taking on that risk;
.
returns and recalls; and
.
providing pedigree.
What do you believe are the likely scenarios in 1, 3, 5, and 10 years?

Are you considering forming an independent channel agreement with a 3PL? if so – who is it?
What do you believe the cost savings will be, and how will these be achieved (e.g. in what form?).
Have manufacturers been approached by FedEx/UPS?
Impact for Pharma mfrs – shipping to only 11 points (UPS) compared to 150 (current).
Is there a trend toward less/more direct buys from manufacturers?
Who has the most leverage – manufacturers, wholesalers or providers ?
Which parties exploit the pedigree requirements, or who is able to respond?
Impact of cold chain regulations?
Impact of RFID?
What is the probability of manufacturers “doing in on their own”?
What is the current thinking on their capability to do so?
About the authors

Christian L. Rossetti is an Assistant Professor of Supply Chain Management at North Carolina State
University, and a Graduate of the Doctoral Program at Arizona State University. He is conducting
work in supply chain disintermediation, multi-agent simulation modeling, and strategic sourcing,
and has a number of published articles in these areas. Christian L. Rossetti is the corresponding
author and can be contacted at: christian_rossetti@ncsu.edu
Robert Handfield is the Bank of America University Distinguished Professor of Supply Chain
Management at North Carolina State University, and Director of the Supply Chain Resource
IJPDLM Cooperative (www.scrc.ncsu.edu). He also serves as an Adjunct Professor with the Supply Chain
Management Research Group at the Manchester Business School. Robert Handfield is the
41,6 Consulting Editor of the Journal of Operations Management, and is the author of several books
and multiple articles on supply chain management.
Kevin J. Dooley is a Professor of Supply Chain Management, and a Dean’s Council of
100 Distinguished Scholar, in the W.P. Carey School of Business at Arizona State University.
Dr Kevin J. Dooley is a world-known expert in the application of complexity science to help
622 organizations improve. He has published over 100 research articles and co-authored an award
winning book, Organizational Change and Innovation Processes. He is currently Director of the
Electronics Sector in The Sustainability Consortium. He has been awarded two patents
concerning CRA, a novel form of network text analysis, and is Co-founder and CEO of Crawdad
Technologies, LLC, a provider of text analysis software for academics.
To purchase reprints of this article please e-mail: reprints@emeraldinsight.com

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International Journal of Physical Distribution & Logistics Management

Forces, trends, and decisions in pharmaceutical supply chain management

*Related content and download information correct at time of download.

602 participants, and actions by non-conventional players, such as third-party logistics

purchasing, legal, analyst communications, finance, distribution management, and 603

Case study approach

Case Number of firms

1. Drug Store News 62

Computerized text analysis results

versus PSC role

3PL Wholesalers Hospital Manufacturers PBM Regulators Retailers

3PL 0.00 0.07 0.05 0.08 0.04 0.02 0.04

Logistics 0.456 0.265 609

Activity Associated risk

Forecasting demand Forecast errors

612 Channel forces and channel changes

Short-term decisions and research

Fein, A.J. (1998), “Understanding evolutionary processes in non-manufacturing industries: 619

deliveries, service levels, etc?

What do you believe are the likely scenarios in 1, 3, 5, and 10 years?

About the authors

To purchase reprints of this article please e-mail: reprints@emeraldinsight.com

Indian Pharmaceutical Company 259-279. [Crossref]

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