The Business Of

Healthcare | CVS Health | What Do They Do?

Morning All!

Hope you had a great weekend! Last week, in the first part of our The Business Of Healthcare series, we explored the business model of AbbVie. And looked at how the drug manufacturer first developed, and then protected, their prized asset, Humira.

This week we’re moving away from drug manufacturers. And shifting our focus to another important part of the healthcare value chain - pharmacies (and pharmacy benefit managers). And where else to go - but the largest pharmacy chain out there. It’s the US giant, CVS Health!

Now, I’m uncertain how many readers will have actually heard of CVS Health. Especially those outside of the US - which is most you! But there are only 9 companies in the world that make more revenue than CVS Health!

In fact, listen to this. CVS Health made more revenue in 2022 ($330bn) than Microsoft ($207bn) and Facebook ($117bn) combined! That is ridiculous. And today, we’re going to set the scene of how they go about doing that…

Recap: The Flow of Drugs

So, first thing’s first. Let’s have a little reminder of the pharmaceutical supply chain. We saw last week how the flow of drugs worked. Drug manufacturers like AbbVie will discover and make the drugs. They then sell the drugs to wholesalers like McKesson. Who then sell them on to pharmacies like CVS.

CVS is the largest pharmacy chain in the world. With over 9,500 locations across the US. Interestingly, the biggest pharmacy chain in the UK (Boots) is actually owned by CVS’s biggest competitor - Walgreens!

Anyway, this week we’re going to be diving into how CVS makes money through their pharmacies. And the costs involved in these operations. But we’re also going to be looking at the flow of money! Because CVS aren’t just a pharmacy chain - they’re also a pharmacy benefit manager (PBM) - called CVS Caremark. And this is where it gets very interesting…

The Benefit of the Pharmacy Benefit Manager

… interesting and confusing! Because this pharmacy benefit manager stuff is incredibly complicated. So I’ll try my best to keep it as simple as possible! And I think a good place to start is - what on Earth is a pharmacy benefit manager?! Well, let’s spend the rest of today figuring out the answer!

So, let’s use our example of a person in America who has Crohn’s disease. And the first question is - what do they want? Well, that person wants health insurance. Because as we saw last week, without insurance, the individual with Crohn’s would have to cough up $77k a year for their Humira treatment! However, with insurance, the individual would only have to pay monthly premiums to their health insurer. And in the US, the average premium amount is ~$650/month. Slightly cheaper than $77k!

Now, what does the health insurer want? Well, the health insurer receives these monthly premiums from individuals. Which is great. But they now have the burden of paying for these expensive treatments! So what health insurers want is for drug manufacturers to give them good prices for the drugs. Like Humira.

And finally, what does the drug manufacturer want from all of this? Well, the drug manufacturer wants to make as much money as possible! They’ve spent billions to discover and develop their drug. They now want to make as much money as possible by selling their drug. But the issue here is that if drug manufacturers charge too much for their drugs. It becomes very costly for health insurers to cover their members’ medical costs (e.g. Humira injections). And they’ll have to increase the premiums that individuals pay them. Which leads to people stopping insurance, despite the dangers.

And this is where pharmacy benefit managers come into play! PBMs basically help health insurers, and hence individuals, receive lower medical costs. By negotiating discounts in drug prices with drug manufacturers. And passing these discounts onto health insurers. So health insurers can buy drugs for cheaper! The graphic below shows us how this works.

But question - why do drug manufacturers listen to these PBMs and give them a discount? Well, it’s because these PBMs have developed a lot of power. PBMs are actually responsible for deciding which drugs are covered by health insurance plans. This is called the formulary list. And so if AbbVie didn’t want to give a discount to CVS Caremark. CVS Caremark could say - ‘okay, we won’t put you on the list of drugs that will be covered by all our health insurer partners’. Health insurers would then have to ask insured individuals to use an alternative to Humira for their Crohn’s. And AbbVie would lose a lot of sales as a result!

Now, that’s the logic for PBMs. And the supposed benefit of them. That they reduce costs for health insurers. And then ultimately individuals because they don’t have to pay as high premiums. However, there’s a lot more to it than that.

Because CVS Caremark makes a lot of money. Like a lot! This PBM division for CVS Health actually made a ridiculous $169bn in revenue last year. But where are they making all this money from if they’re just passing on the discount to health insurers? Well, this is something we’ll dive into tomorrow! But for those of you who want a really nice, simple YouTube video to help explain things - I recommend this!

3rd Jul 2023

Nigel Jacob CFA