Intermountain, Generics, and Bold Intentions

Last week, non-profit health system Intermountain Healthcare announced that they, along with three other health systems, would be establishing a collaborative consortium to manufacture generic pharmaceuticals.

In an era of business where the lines around industries seem to be getting increasingly blurry, it’s surprising that health systems are getting into the pharmaceutical game, but doesn’t seem foolhardy. The real question lies in how big of a splash Intermountain and company want to make in the pharmaceutical world.

Information beyond their announcement is scant at this point, but in understanding the generics business, the opportunity at hand, and by scrutinizing some interesting choices for the advisory board, we can get a better idea of where this is all headed.

Why Health Systems Can Do This

Examining the issue from a business perspective, it’s interesting to explore the systemic conditions that enable this consortium to relatively easily slide into the business of selling generic pharmaceuticals.

Generics are, by definition, commodities. Once patent protections on pharmaceutical molecules expire, it’s simply a question of which generic manufacturers will decide to gear up a manufacturing effort to produce it. Aside from the non-active ingredients in the medication, the composition of the generic drug must be the same as the original branded version. Generics companies mostly don’t compete on product quality or differentiation - they’re essentially pure commodity players. (Some generic companies are getting into the world of ‘branded generics’ where they add to formulations to sell drugs at a premium, but the consortium seems to be focused on basic generics at this point.)

New entrants to the space simply need to bring an ability to manufacture medications and a compelling reason that customers (health systems and pharmacies via distributors) will buy from them instead of the existing competitors. For some this means pursuing areas of the market not already served. Typically, it comes down to price and availability.

In addition to the numbers, there is a sentimental opportunity. Generic pharma, usually a sleepy corner of healthcare well outside of the spotlight of public scrutiny, has become a focal point of late. As national and individual healthcare expenditures continue to balloon, generics companies have come under fire for rising drug prices. Innovative branded companies can hide behind their massive R&D expenditures when explaining the sticker price of a drug, but rising prices at generics firms are generally seen for what they are: brazen market opportunism. Highlighted by a few really bad actors like Turing and Mylan, the shady practices of the generics sector have started to come to the broad attention of Americans. (Turing Pharmaceuticals, led by all-around slimy individual Martin Shkreli, bought the marketing rights to Daraprim - a drug that’s existed since 1953 and is the only drug in its category - and raised the price 55x overnight. Mylan, maker of the EpiPen, got caught with their hand in the cookie jar when people stared to notice they’d raised the price of their life-saving epinephrine auto injectors multiple times over.)

One man’s crisis is another man’s opportunity.

In their announcement, Intermountain and their partners were sure to stress that their new drug-making consortium would ensure a steady supply of affordable generic drugs. Not only can these health systems lower their cost basis on medications, they can ensure they and their patients won’t be held hostage by opportunistic pharmaceutical companies seeking to sell drugs at 1,000%+ margins simply by virtue of being the only ones who make it. As the American healthcare system is inevitably remade in the coming years, having public opinion on their side will only help health systems like Intermountain.

A Strong Strategic Advantage

As I mentioned above, competition in the commodified generic pharmaceutical space is almost entirely around price. Cost of goods in all of pharma is, generally speaking, minimal. Thus, a generic pharma company’s pricing determination is the lowest price they can achieve while covering their administrative and operating costs, servicing any debt, and providing a return to their investors. According to one report, this means most generic pharma companies are operating at around a 15% net margin.

We know from their announcement that the Intermountain-led consortium will be operating as a non-profit. Right from the start, the consortium could have the exact same operating costs and afford to sell goods at a 15% discount. But given that the consortium can likely do away with any of the marketing and business development activities of a typical generics company, they’ll run at a lower operating cost as well.

Another important consideration for the ultimate drug selling price will be scale. Even just selling to the founding health systems would be enough scale to turn this into a serious enterprise, but it’s the inclusion of the VA system in the announcement that’s a major signal of just how big of an exercise this could become. The VA has serious purchasing power, and while they’re simply supporting this effort from the sidelines at the moment, their inclusion in the announcement should be taken as a signal that they could be big customers for this consortium in the future.

This consortium, in short order, will have a strong competitive advantage through pricing, access to customers, and access to further capital if need be. There’s no reason they couldn’t gobble up serious market share in the generics space. Current generics companies haven’t really responded to the announcement, but that could change once it’s revealed which drugs this consortium will be adding to its initial roster.

Bold Intentions

So, what sort of story is this?

You could see this as the story of a bunch of health systems deciding to leverage their means to solve the problem of an unpredictable group of suppliers. They’ll take their consortium, add new drugs at a reasonable pace, and do their part to bring down the overall cost of healthcare in America.

I’m not sure that’s it.

The biggest clue to the ultimate goal of this new consortium lies in an interesting member of its advisory board. In addition to the government folks who will help them navigate the FDA and HHS and some ex-Amgen officers to sort out the operational side of making drugs, there’s Clay Christensen. Christensen literally wrote the book on disruptive innovation. He’s the professor and consultant who has made a career of understanding how companies disrupt established industries. While his focus is largely on tech, he applied his disruptive thinking to healthcare in his book The Innovator’s Prescription, where he argues that disruption of the pharmaceutical industry would occur via supply chain disruption.

Regardless of what we can divine of Christensen’s healthcare thinking from a book he wrote nearly a decade ago, his inclusion on the advisory board is a signal to the pharmaceutical world that this consortium is looking to make waves. I can’t imagine Christensen would sign on to advise a sleepy generics manufacturer. There are probably some interesting plans being developed around how a well-funded and non-profit pharmaceutical manufacturer can upset the status quo of the pharmaceutical industry.

If I were running a generics company, I’d keep a close watch.