Many stakeholders and steps are involved in the life cycle of a prescription drug as it moves

from chemical synthesis and formulation through dispensing or administration to patients. The

specific steps involved in prescription drug supply chains often differ depending on the type of

drug, the channel of distribution, and the patient’s source of prescription drug coverage. The

authors describe the stakeholders involved in prescription drug supply chains and the flows of

products, payments, and information between stakeholders. Although we present a typical supply

chain for retail pharmacy drugs, we also highlight the important supply chain distinctions for

specific distribution channels and for specific types of drugs. This report is intended to be a

reference for those interested in the prescription drug industry and pharmaceutical policy and

do this by providing health care decisionmakers, practitioners, and consumers with actionable,

rigorous, objective evidence to support their most complex decisions. For more information, see

www.rand.org/health-care, or contact

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Patients, policymakers, researchers, reporters, and others often refer to prescription drugs

collectively. All prescription drugs dispensed in the United States are used to treat or prevent

disease and are regulated by the U.S. Food and Drug Administration (FDA). Beyond these

similarities, there are key differences in how specific drugs are manufactured, distributed,

dispensed to patients, and paid for. Relatedly, different stakeholders and economic incentives

come into play depending on the category of drug, the distribution channel, and the patient

population in question.

Understanding differences in supply chains across types of drugs and distribution channels is

increasingly important in ongoing policy discussion and debate around approaches to address

stakeholders and flows of information, product, and payment between stakeholders, and then

detailing deviations from the typical case for different categories of drugs and distribution

channels. We intend for the report to be a reference for those interested in the prescription drug

industry and pharmaceutical policy and economics.

We collected information via a literature review, a stakeholder-focused environmental scan,

and eight phone conversations with stakeholders of different types. We conducted a total of eight

phone conversations with representatives from groups representing drug manufacturers,

distributors, group purchasing organizations (GPOs), hospitals, pharmacies, and pharmacy

benefit managers (PBMs).

We found that the typical stakeholders, relationships, and financial incentives involved in

prescription drug supply chains vary depending on the characteristics of a drug and how it

See Figure S.1 for an illustration of a typical supply chain for brand-name drugs dispensed

via retail pharmacies. In brief, a market authorization holder has FDA approval to sell a given

prescription drug. Key steps in manufacturing, including formulation, packaging, and labeling,

can be either in house or under contract. These steps rely on many different inputs, including

active pharmaceutical ingredients and glass vials, which are often sourced globally and

sometimes have applications outside pharmaceutical manufacturing. Finished drug products

often reach pharmacies and other points of dispensing via a handful of national distributors, but

there are many other distribution models. In general, payers and their PBMs seek more direct

negotiate prices and other contractual terms on behalf of providers.

approach; otherwise, the risk of unanticipated consequences is substantial.

Our analysis excluded supply chains for several categories of drugs, including vaccines, that

warrant separate consideration and analysis. Our analysis also excluded narrow but important

distribution channels, such as home health and long-term care facilities, that could also be the

target of future study. Furthermore, we recommend further analysis on margins for different

stakeholders (including study of variation in margins across products and firms), in-depth

analysis of drug shortages related to supply chain issues, and the effects of horizontal and

vertical integration on supply chains. Finally, given the pace of change in the prescription drug

industry, including new arrangements and adaptations in response to the COVID-19 pandemic,

we expect the need to revisit this overview of prescription drug supply chains in the future.

About This Report .......................................................................................................................... iii!

Summary ........................................................................................................................................ iv!

Figures.......................................................................................................................................... viii!

Abbreviations ................................................................................................................................. ix!

1. Introduction and Approach ......................................................................................................... 1!

Figure S.1. Typical Supply Chain for Brand-Name Drugs Dispensed Through Retail

Pharmacies ............................................................................................................................. vi!

Figure 2.1. Typical Supply Chain for Brand-Name Drugs Dispensed Through Retail

Pharmacies .............................................................................................................................. 4!

Figure 2.2. Manufacturing Outsourcing Scenarios ......................................................................... 9!

Figure 2.3. Additional Distribution Scenarios .............................................................................. 11!

Figure 3.1. Typical Supply Chain for Drugs Dispensed in Outpatient Facility Settings .............. 22!

Figure 3.2. Typical Supply Chain for Drugs Dispensed During Inpatient Hospital Stays ........... 27!

to other firms. We refer to this company as the market authorization holder.

In our model supply chain, the market authorization holder purchases ingredients necessary

to manufacture the drug from other companies and then performs all other manufacturing steps

internally. In this case, the market authorization holder could also be described as the

manufacturer of the drug. In other cases, a company other than the market authorization holder

actually manufactures the drug. We discuss several common manufacturing outsourcing

scenarios below.

APIs are parts of any drug that produce the intended effect. Prescription drugs are often

outside the United States—and in particular from China and India.

input is manufactured in a foreign country, an importer is responsible for meeting FDA

requirements for entry into the country. An importer is registered and listed with each

manufacturing facility that they import from, and multiple importers can be listed with one

facility. Importers can be the input manufacturer, the market authorization holder, or a third

party.

Other inactive bulk chemicals, including binders, coatings, flavorings, and colorants, are also

needed to manufacture drug products. Both APIs and other bulk chemicals tend to be purchased

by drug manufacturers in large batches that are then used over relatively long periods of time

(e.g., six months or longer). Batches of bulk chemicals are typically shipped by sea or air and

when reviewing new drug applications.

know that FDA has a complete DMF on record for the API but could not review the DMF unless

it was provided by the API manufacturer. Although DMFs are not required, having one can help

manufacturers of inputs in drug manufacturing describe their products to potential buyers (such

All APIs and other chemical ingredients of drugs must be manufactured, processed, packed,

and held in accordance with current good manufacturing practices (CGMPs).

CGMPs, manufacturers of APIs and other bulk chemicals are required to test their products to

manufacturers offering broad catalogues of products. Suppliers typically sell on a per-batch

Manufacturers of finished dosage forms formulate—or combine—API and other chemical

ingredients into a drug product, such as a pill or liquid. The processes, equipment, and

manufacturing facilities necessary for formulation vary depending on the form of the drug (e.g.,

oral solid tablets or capsules versus liquids). Drug manufacturers often have facilities that

specialize in the formulation and packaging of a single product category, such as sterile

(e.g., oncology).

CGMPs similarly govern the manufacture, processing, packing, and holding of drug products

and require a manufacturing system that ensures the identity, strength, quality, and purity of the

drug product. Specifically, CGMPs set forth requirements for the facilities and equipment used,

as well as for production, testing, packing, labeling, warehousing, and distribution procedures

and conditions.

they can be distributed for sale as drug products. Packaging involves several steps, including

packaged drug products are labeled. In the United States, under the Drug Supply Chain Security

Act, FDA requires serialization of labeling such that serial numbers on individual final drug

products (e.g., vials) match serial numbers on cartons and boxes of the product for tracking

purposes (FDA, 2018b). Packaged and labeled drug products are stored at market authorization

holder or third-party storage and distribution centers until they are shipped to pharmacies,

hospitals, or other purchasers.

decide to transfer ownership of their facilities while continuing to source products from them.

The development and implementation of contract manufacturing relationships—from initial

contact to the actual transfer of product manufacturing—usually takes up to two years and can

take even longer. A significant share of this time is spent establishing processes to ensure

manufacturing quality (e.g., testing the drug product for stability and producing commercial-

scale batches called validation batches to validate manufacturing processes; Contract Pharma,

2012). Depending on the customer agreement, CMOs might be responsible for sourcing all of the

necessary ingredients for manufacturing a finished drug product, including APIs, other bulk

the past, and, in some cases, market authorization holders can help finance a CMO’s expansion

into new manufacturing lines. However, market authorization holders and CMOs generally have

transactional relationships as opposed to partnerships. Some interviewees noted that CMOs

shoulder much of the risk in manufacturing for relatively slim profit margins compared with the

margins accrued to market authorization holders. Although the CMO market is generally

fragmented, with the largest five CMOs accounting for only 15 percent of the CMO market,

there has been increasing merger and acquisition activity among CMOs in recent years

(PricewaterhouseCoopers, 2019).

Market authorization holders (and, if applicable, contract manufacturers) might outsource

product to market authorization holder distribution centers, to a third-party logistics company

(such as UPS), or directly to distributors.

are important variations in this typical distribution model that apply to specific types of drugs

and buyers. For example, specialty drugs, including biologics and other typically high-cost

drugs, are sometimes distributed directly from manufacturers to the point of dispensing, which

could be hospitals or specialty pharmacies (Figure 2.3, Scenario 2).

There are three major health care distributors in the United States—AmerisourceBergen,

Cardinal Health, and McKesson—that together account for 92 percent of the overall market

(Deloitte, 2019). These large distributors all supply a full range of prescription drugs, over-the-

counter products, medical devices, and other goods. There are smaller distributors serving

often purchase broad portfolios of many generic products from a single generic manufacturer,

likely leading to lower acquisition prices compared with sourcing individual generic drugs from

different manufacturers.

Separately, distributors realize revenue from service fees paid by their drug manufacturer

suppliers in exchange for access to markets (i.e., stocking fees); from business intelligence data

sold to manufacturers, pharmacies, and data aggregators; and from services (e.g., logistics

management consulting) sold to their pharmacy customers and other customers.

Beyond managing the logistics of moving prescription drugs from manufacturers to points of

settings rather than through retail pharmacies. Repackaging and relabeling can also be done by

Most drugs are dispensed to patients via retail pharmacies, including large national and

regional pharmacy chains (e.g., CVS and Walgreens), pharmacies in grocery stores and “big

box” stores (e.g., Target and Walmart), and independent pharmacies. Pharmacies have

contractual relationships with typically one main distributor governing prices, payment terms,

delivery logistics, and financial incentives tied to meeting thresholds of distribution through the

distributor (e.g., 90 percent of generics dispensed must be purchased through the primary

distributor). Although chain pharmacies negotiate prices with distributors directly, most

independent pharmacies negotiate prices through buying groups that bid members’ distribution

when an initially prescribed drug is not on a preferred tier of a patient’s formulary and therefore

has high cost sharing (as discussed below). For most generic drugs, pharmacists are free to

substitute any of a set of drugs considered by FDA to be therapeutically equivalent to a reference

product.

pharmacies generally carry product from only one or a small number of generic manufacturers—

and, more specifically, they carry the generic manufactured by the company offering the lowest

price (and therefore highest margin) to the pharmacy’s distributor.

Pharmacies generally carry a relatively short-term inventory of prescription drugs and

acquire drugs from distributors with a larger distributor markup, albeit off of a typically smaller

in setting retail prices, which are prices paid by patients without coverage and by patients with

coverage buying a non-covered drug or choosing to pay cash for a covered drug.

realized by pharmacies for drugs covered by insurance is determined by contracts between PBMs

and retail pharmacies.

Scripts, CVS/Caremark, and OptumRx—cover 76 percent of national prescription claims (Fein,

2019).

exchange for an increase in prescription volume from the PBM’s patients. Pharmacy networks

often include a mix of chain and independent pharmacies. The largest three distributors facilitate

banner pharmacies (e.g., Good Neighbor Pharmacy and Health Mart) that can be included in

pharmacy networks. Independent pharmacies can be included in pharmacy networks in some

cases, individually or, more commonly, as a block through pharmacy services administrative

organizations (PSAOs), which represent independent pharmacies in negotiations with PBMs.

other key issues in pharmacy negotiation with PBMs typically include dispensing fees, which are

prescriptions filled with generics (National Community Pharmacists Association, undated).

If

pharmacies fail to meet the specified performance target, they must return a portion of payments

to the PBM, and if they exceed the target, they might receive a supplemental payment, although,

at least in Medicare Part D, payments from pharmacies are much larger in aggregate than

payments to pharmacies (Fein, 2020a). The following section discusses specific prices paid in

more detail.

Pharmacies and pharmacists provide other important health care services beyond dispensing

drugs. Pharmacists can educate and advise patients on their prescription drugs and increasingly

with clinics providing primary care and urgent care services that can serve as a driver of

prescription volume.

One strategy that PBMs use to manage pharmacy benefits is leveraging mail order pharmacy,

and most PBMs operate their own mail-order pharmacies (Danzon, 2015). Mail-order pharmacy

is often required or incentivized by prescription drug plan sponsors for refills of prescriptions

used to treat chronic conditions, such as diabetes, chronic heart disease, and HIV/AIDS

instead of 30-day quantities, and patient cost-sharing tends to be lower than through retail

of scale, at least to a point.

Third, PBMs generally operate their own mail-order pharmacies,

which can lower per-prescription costs relative to prescriptions filled via retail pharmacies,

depending on the costs involved in running the mail-order pharmacy versus retail dispensing fees

(Pharmaceutical Care Management Association, 2011; Visante, 2014). Despite these benefits, the

use of mail-order pharmacies reduces face-to-face interaction between patients and pharmacists

on side effects, adverse events, drug-drug interactions, and dosing (Khandelwal et al., 2011).

This interaction might be less important when patients fill an initial prescription in a retail

pharmacy and then receive refills via mail-order pharmacy.

This chapter describes the differences in drug supply chains when distribution occurs through

hospitals or physician offices rather than in retail pharmacies. Our description focuses on

differences in supply chains when drugs are dispensed in these other channels relative to the

model retail pharmacy supply chain illustrated in Figure 2.1. The figures in this chapter mirror

Figure 2.1 with differences emphasized in red.

Some oncology, rheumatology, and other drugs are administered to patients by physicians or

other practitioners in an outpatient facility setting like hospital outpatient departments (Figure

3.1). In Medicare, these drugs are covered by Medicare Part B rather than the Part D retail

pharmacy benefit. In commercial insurance, physician-administered drugs are often covered

systems and independent hospitals. Members sign agreements detailing access to negotiated

prices and terms as well as additional services (such as supply chain support) that they will

receive from the GPO. Although there typically is not a membership fee for access to negotiated

prices per se, members often purchase at least some services from GPOs. Most hospitals belong

to at least one GPO; some belong to several.

GPOs negotiate with both manufacturers and distributors to secure national contracts

detailing prices and other terms. The collective negotiation on the part of many (potentially

competing) hospitals is possible due to an anti-kickback “safe harbor” provision.

Although

therefore, is not incentivized to offer discounts (Burns and Briggs, 2018). Importantly,

Buyers pay distributors the GPO-negotiated price even though the distributor paid manufacturers

a flat WAC-based price. For example, the distributor might pay manufacturers $100 per unit of a

drug while a pharmacy buyer negotiates and pays distributors a lower price of $80 (Figure 2.3,

Scenario 3). In this case, the distributor bills the manufacturer for the difference (a “chargeback”;

$20 in this case). In contrast with rebates, which apply primarily for drugs dispensed through

retail pharmacies (where distributors are not aware of the net price negotiated between

manufacturers and PBMs), in the case of chargebacks, distributors are aware of the price

Although hospitals generally have flexibility to purchase drugs through GPOs or other

channels, some GPO membership agreements include financial incentives for hospitals to

purchase an amount of product that is above a threshold through preferred manufacturers. Some

large hospital or broader health care delivery systems might be able to negotiate prices directly

from manufacturers that are even lower than GPO-negotiated prices. These larger systems might

set up their own consolidated service centers (CSCs), which function as system-owned

distributors, buying directly from manufacturers and storing and distributing products to

hospitals and other components of the delivery system. Health care delivery systems operating

the largest margin or have the lowest cost. As a result, prescriber and patient decisionmaking is

found that hospitals are increasingly using relatively restricted formularies: Approximately 73

percent reported having “a limited, strict formulary with tight restrictions on nonformulary

medication use” (Pedersen et al., 2020). Pharmacists are generally involved in managing

medication therapies, which can include “writing medication orders, selecting doses, ordering

appropriate laboratory tests, and monitoring patient response to therapy” (Pedersen et al., 2020).

However, they are more likely to manage certain therapy types over others: For example, 97

percent of hospitals have pharmacists manage vancomycin therapy, and 77 percent of hospitals

have them manage anticoagulation therapy, while 8.3 percent of hospitals make pharmacists

sequestration

individual biosimilar products plus the margin calculated on the reference biologic. ASP rates are

lagged by two quarters but over time reflect the prices paid to manufacturers after rebates and

chargebacks. In general, providers might have an incentive to choose more-expensive Part B

drugs because the margin on a drug with a higher ASP is greater than the margin on a drug with

a lower ASP. Payments for new drugs, blood products, and vaccines are based on WAC and

AWP. Payment rates for other services are often based on Medicare’s physician fee schedule and

outpatient hospital prospective payment system, although payment approaches vary widely.

the purposes of the program) qualify either through their status under other programs and

designations (e.g., federally qualified health centers and critical access hospitals) or, for

hospitals, by meeting a threshold of care provided to Medicaid patients (called disproportionate

share hospitals).

The 340B program sets ceiling prices that are approximately equal to Medicaid Prescription

Drug Rebate Program prices. Participating covered entities can voluntarily purchase drugs

through the 340B prime vendor, which can negotiate additional discounts. Drugs are dispensed

either directly by the covered entity (typically a hospital or clinic) or, increasingly, through

community pharmacies under contract with the covered entities. Contract pharmacies must

negotiate favorable prices through GPOs or, for the largest buyers, on their own.

physician offices (such as dermatological drugs).

In terms of payment, the Medicare allowed amount for physician-administered drugs covered

under Medicare Part B is ASP plus a margin (typically 6 percent, although now 4.3 percent due

to sequestration) in most cases (with exceptions discussed above). Physicians are in some cases

administered during the stay.

Many commercial and other payers adapt some version of

hospital setting.

Prescription drug supply chains are continually evolving in response to changes in the mix of

drugs used by patients, use of new drug and insurance benefit design features, consolidation in

health care delivery systems, and shifting negotiating leverage between key stakeholders. This

report is intended as an update on prior efforts that are now dated (Kaiser Family Foundation,

2005), focusing on differences in stakeholders and incentives for different categories of drugs

and in different distribution channels. Because of the pace of change in the pharmaceutical

industry and in the U.S. health care system, we expect that an update to the current document

will be necessary in another decade.

We found that the typical stakeholders, relationships, and financial incentives involved in

four common core components of drug supply chains across all cases: manufacturing,

distribution, coverage and payment, and prescribing and demand.

Separate analysis of relationships is needed for specific categories of drugs that we did not

consider in our analysis and are often excluded in other research, including vaccines,

radiopharmaceuticals, and compounded drugs. These product categories have additional steps

and stakeholders involved. In addition, separate analysis of relationships is also needed for the

specific distribution channels we did not consider in our analysis, such as home health care,

long-term care facilities, nuclear medicine, and federal health systems.

More research is also needed to understand how the evolving industrial organization of

stakeholders in prescription drug supply chains—particularly vertical and horizontal

prescription drugs are sourced from China and other countries. Although there were at least some

disruptions in prescription drug supply attributed to the pandemic (Rowland and Slater, 2020),

most of these appear to be due to buyers aggressively stocking drugs used to treat patients with

COVID-19 rather than to disruptions in manufacturing or supply.

The ability of policymakers to identify, assess, and respond to shortages and other

disruptions in supply chains, regardless of the cause, is hampered by incomplete data. FDA does

maintain databases listing the facilities and companies registered to manufacture and import

APIs and finished drug products. FDA does not, however, have the regulatory authority to

impose additional burden, richer data would allow for a more accurate assessment of drug supply

how they will likely respond is necessary to assess unanticipated consequences of these

proposals. In particular, the need to test, manufacture, and distribute millions of doses of

COVID-19–specific therapies and vaccines will be a major undertaking that will utilize the

supply chain components described in this report but likely in new ways and configurations.

This appendix includes definitions of several pricing terms referenced throughout the report.

The terms are listed in alphabetical order. An asterisk preceding the term indicates that the prices

are publicly available, although in some cases a payment is required to access the data.

340B ceiling price: The 340B program determines a maximum (ceiling) price using reductions

off of AMP, like the Medicaid drug rebate program. The 340B prime vendor can negotiate

additional 340B discounts beneath this ceiling price.

The average manufacturer price (AMP) is the average price paid to the manufacturer by

rather than ASP in the relatively rare case where AMP is lower (U.S. Department of Health and

Human Services, Office of Inspector General, 2018).

* The average sales price (ASP) is the average net price paid across all purchasers (not just

retail purchasers, as in AMP) after accounting for most discounts, rebates, and other price

concessions. 340B prices and rebates under the Medicaid drug rebate program do not contribute

to ASP. ASP is defined at 42 CFR § 414.904 and is used by Medicare as the basis of payment for

most Medicare Part B drugs. Medicare payments for non-biosimilar Part B drugs are a fixed

amount (typically 6 percent, now 4.3 percent due to sequestration) above ASP per billing unit of

a drug. Payment for biosimilars is based on the biosimilar ASP plus the markup calculated using

brand drug relative to a benchmark, such as AWP. BERs apply over a period of time.

Differences between BER and actual rates might result in reconciliation between and pharmacies

and PBMs.

The cash price is the price charged by pharmacies, for example, to those without prescription

drug coverage.

* Federal supply schedule (FSS) price: The Department of Veterans Affairs, on behalf of the

The generic effective rate (GER) is a rate describing the amount received by a pharmacy for a

therapeutically equivalent versions of a drug—for example, to a brand-name drug and

therapeutically equivalent generics.

The Medicaid best price is the lowest net price paid by any non-federal buyer or Medicare Part

D plan sponsors for a drug (42 CFR § 447.505). State Medicaid programs are guaranteed access

to this price if it is lower than the rebates that would otherwise apply under the Medicaid drug

rebate program (42 CFR § 447.509).

https://www.fda.gov/about-fda/center-biologics-evaluation-and-research-cber/

what-are-biologics-questions-and-answers

U.S. Food and Drug Administration, Product Identifier Requirements Under the Drug Supply

Chain Security Act—Compliance Policy: Guidance for Industry, September 2018b. As of

October 23, 2020:

https://www.fda.gov/media/106198/download

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U.S. House of Representatives, Committee on Veterans Affairs, Establishment of Limits on

Prices of Drugs Procured by the Department of Veterans Affairs (to accompany H.R. 2890),

Visante, Mail-Service and Specialty Pharmacies to Save $1.8 Billion for California Consumers,

Association, June 2014. As of August 16, 2021:

visante-pcma-ca-mail-specialty-savings.pdf

Vogenberg, F. Randy, and Judith Gomes, “The Changing Roles of P&T Committees: A Look

Back at the Last Decade and a Look Forward to 2020,” P & T: A Peer-Reviewed Journal for

Yu, Nancy L., Preston Atteberry, and Peter B. Bach, “Spending on Prescription Drugs in the

U.S.: Where Does All the Money Go?” Health Affairs Blog, 2018. As of October 23, 2020:

https://www.healthaffairs.org/do/10.1377/hblog20180726.670593/full/

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