Drug deal hurts consumers

Pub date June 4, 2008
WriterG.W. Schulz

› gwschulz@sfbg.com

City Attorney Dennis Herrera made San Francisco the first government entity in the nation to accuse two major players in the pharmaceutical drug industry of conspiring to illegally manipulate the price of prescription drugs when he filed a lawsuit May 20. Connecticut followed Herrera’s lead days later, and filed an almost identical suit making the same charges.

The cases could have far-reaching implications. If Raymond Hartman, an economist and visiting professor at Boalt Hall School of Law who testified in a related case filed by a group of East Coast labor unions two years ago is correct, then consumers, insurers, and Medicaid administrators nationwide have overpaid for prescription drugs by billions of dollars as a result of the price manipulation scheme (see “Big Pharma’s Shadow,” 12/20/06).

To explain the highly complex litigation, consider how goods are usually priced. Take the 99¢, three-ounce bags of chips that are reliably available at the corner store near your house. Cool Ranch Doritos. Chili Cheese Fritos. Sour Cream and Onion Ruffles. It wouldn’t be a true bodega if there wasn’t a rack of them situated near the front door or register.

For as long as anyone can remember, it seems, they’ve cost just 99¢, regardless of the local cost of living, from Richmond, Va. to San Francisco. That’s because the suggested retail price of 99¢ is printed ubiquitously by the manufacturer on the packaging.

So you’d notice if a sticker suddenly appeared, lazily affixed to your bag of Sun Chips, stating a new price: $1.99. The manufacturer didn’t place it there because behind the sticker you can still see the old printed price. And the counter clerk didn’t place it there, because he knows the true suggested retail price is still just 99¢ and the laws of supply and demand never called for a price increase.

Instead, a local company that buys chips from the manufacturer and distributes them to the bodega in your neighborhood put it there. The bodega owner didn’t complain because now it’s possible for him to earn an extra dollar for each bag. In fact, as a result of the new sticker, he’s more likely to take his business back to that particular distribution company over a competitor since that company is willing to artificially inflate the retail cost of a bag of chips on his behalf simply by putting a new price tag on the bag.

Now imagine that the product isn’t a cheap bag of chips but billions of dollars worth of pain-reducing or life-saving pharmaceuticals. And the distributor isn’t a local guy who drives a delivery truck full of boxes of chips but a multinational corporation, headquartered in San Francisco, that’s ranked 18th on the Fortune 500 list, with $93.6 billion in annual revenue and a CEO, John Hammergren, who received compensation in 2007 worth more than $22 million after presiding over the company’s record profits that year.

Imagine, too, that the distributor is powerful enough to slap new price stickers on cartons of drugs around the country, not just at your corner bodega, so you can’t simply elect to shop elsewhere to protest the new prices. Neither can you just stop consuming needed medicines the way you can snack chips.

Herrera’s federal civil suit probably has escaped media attention due to its esoteric nature (not to mention a potential conflict of interest at the San Francisco Chronicle, but we’ll get to that in a minute). It charges that McKesson Corp., along with a tiny drug data publisher based in San Bruno called First DataBank, conspired in an "elaborate scheme" to unfairly mark up the price on more than 400 name-brand prescription drugs. The conspiracy allegedly resulted in the San Francisco Health Plan being forced to make thousands or even millions of dollars in excess payments to cover the cost of such medications.

The SF Health Plan is not the same as Healthy San Francisco, the city’s historic 2006 bid to grant universal health care to the 82,000 adults here who live without insurance. The SF Health Plan extends mental, medical, and dental health coverage to about 50,000 people, including approximately 28,000 children in the city, and offers in-home support workers to the disabled and elderly. The plan is funded through a combination of federal and state dollars known in California as Medi-Cal and elsewhere as Medicaid.

The programs help low-income residents get health care, but its public subsidies are being endangered by a massive state budget deficit. So making sure the SF Health Plan is paying the appropriate price for prescription drugs, a $200 billion industry in the United States, is more important than ever.

McKesson and First DataBank, the lawsuit alleges, placed new stickers on drug packages so that everyone — from private insurers to Medi-Cal to consumers without insurance who simply walk up to a pharmacy window and cover their drug treatments with cash — paid far more than they should have, based on an industry calculation that’s similar to the suggested retail price printed on our analogy of a bag of chips. Herrera says he took on the suit because San Francisco is not alone in overpaying for pharmaceuticals and he saw a chance to force greater reforms in the system.

"We make our decisions based on the facts and the law, and we do our best to protect consumers, taxpayers, and businesses alike," Herrera told the Guardian. "This impacts a lot of things. It’s about protecting consumers from having high drug costs passed on to them. It’s about protecting taxpayer dollars since this is the San Francisco Health Plan, and it’s something that emanates out of a city program. But it’s also about protecting businesses, because a lot of businesses and health plans are the ones footing the bill for increased drug costs."

First DataBank is not listed as a defendant in Herrera’s suit but is described as "an unnamed co-conspirator." The company is a little-known subsidiary of the private, New York–based media conglomerate Hearst Corp., which owns dozens of major publications including the San Francisco Chronicle, the Seattle Post-Intelligencer, Esquire, and The Oprah Magazine. Spokespersons for McKesson and First DataBank refused to comment for this story.

As far as revenue is concerned, First DataBank is a bit player in the world of pharmaceuticals. Court records in a related 2006 suit describe its annual pretax income as just $19 million, barely enough to cover the McKesson CEO’s compensation last year.

But the company is nonetheless important to people who rely on prescription drugs. It’s one of the few major companies in the United States that maintains a sophisticated electronic database of information on tens of thousands of prescription drugs. Plus, First DataBank possesses a virtual monopoly on the market because the company merged with its only real competitor, Medi-Span, in 1998. Its database includes numbers, for instance, on what a drug manufacturer like Aventis might charge distributor McKesson for the allergy medicine Allegra, a figure known as the "wholesale acquisition cost."

Because it’s almost impossible to track every transaction between McKesson and retail chain pharmacies that McKesson distributes bulk drugs to, like Rite Aid and CVS Caremark McKesson, it’s First DataBank’s job to survey the distributors and come up with an "average wholesale price."

After you obtain a bottle of Allegra with a co-pay to take care of your stuffy nose, your insurance provider, say, Blue Cross or Kaiser Permanente or the SF Health Plan, refers to First DataBank’s massive catalog of drugs — for which they’ve paid a hefty subscription fee — to make sure the price they’re paying for your allergy medicine is the one properly set by the market.

First DataBank claimed for years that it was surveying multiple drug wholesalers like McKesson to come up with its average published prices and that it was increasing the number of surveys it conducted. But there aren’t that many wholesalers to actually survey because so many of them have merged with one another in recent years. Also, two out of the nation’s three top wholesalers apparently declined to participate in the surveys as a matter of policy.

Troy Kirkpatrick, a spokesperson for Cardinal Health, one of McKesson’s few competitors, said his company doesn’t give out proprietary information to anyone, let alone First DataBank.

"We have a long-standing policy of not providing confidential pricing information to external sources," Kirkpatrick said. "So if we get asked to share that type of information, we decline."

By 2001 it appeared that First Databank wasn’t really surveying several wholesalers or even the two major companies that compete directly with McKesson, according to court records. First DataBank allegedly conspired with McKesson to establish an artificial baseline markup on hundreds of drugs that didn’t accurately represent their true suggested retail price


But if the bodega, or in this case, the retail pharmacy, is benefiting from the new stickers, then what’s in it for McKesson?

Herrera’s suit contends that if pharmacies like CVS and Rite Aid saw McKesson pressing the scales for them, they’d return to McKesson with their business instead of its two other major American wholesale competitors, Cardinal Health and AmerisourceBergen.

The three companies aggressively compete with one another for business just like they’re supposed to in good ol’ free-market America. But now it appears that McKesson has found a way to game the system and edge ahead of its two rivals. Indeed, McKesson is narrowly beating them in total revenue according to the Fortune 500 list.

Profit margins from drugstore chains were sagging at the time the alleged scheme between McKesson and First DataBank took off, and chain pharmacies had been pressing manufacturers to help them earn higher profit margins. According to the lawsuit, distributor McKesson came to the rescue.

So the final question, then, is whether the drug stores were enriched by all this.

Longs Drugs last year made more than $5 billion in revenue. About 20 percent of that, or $1 billion, came from the government-subsidized health care programs Medicare and Medicaid, according to company records.

In its most recent annual report to the Securities and Exchange Commission, Longs admits that if insurers began using a different benchmark than the prices published by First DataBank, such as a pricing guide that more accurately reflected market prices, there could be a "material adverse effect on our financial performance."