This is part 1 of an ongoing series seeking to describe and decode the prescription drug market for policymakers and interested members of the public, to understand the price we pay at the pharmacy. In this part, we offer a basic review of the economic role played by each component of the prescription drug market. This will form the basis for understanding in how these market players (and the roles they play) determine the price you pay.

The prescription drug market can feel overwhelmingly complicated. There are multiple players with sometimes unfamiliar names. The impact each has on the price we pay at the pharmacy is not always clear. Moreover, in the news and in policy discussions, the prescription drug market is most often discussed one piece at a time rather than as a whole – the manufacturing industry or the insurance industry, for instance – which can make it difficult to understand the market as a whole and how it determines prices at the pharmacy.

Understanding those prices begins with a basic understanding of the industry players that make up the market, and the economic roles they play. Those players include:

1. Manufacturers
2. Distributors
3. Pharmacies
4. Insurers
5. Pharmacy Benefit Managers (PBMs)
6. Other Players

Manufacturers

If economics is about supply and demand, the prescription drug manufacturing industry is where the supply side of the market begins. Manufacturers use disease research to develop new drug treatments and generic drugs and vaccines, usually through collaborative partnerships between nonprofit (e.g., university-based) and for-profit (pharmaceutical companies) organizations. New and generic drug development and manufacturing is overseen by federal government rules and regulations.

When drug manufacturers believe they have a new drug to treat a disease or condition, they must then undergo a four-phase series of human tests to prove safety and effectiveness. If the drug is proven safe and effective, the manufacturers will be able to sell the drug in the prescription drug market.

Under federal law, drug manufacturers have a certain number of years to sell a new drug without competition from generic drug manufacturers (typically 12-20 years, depending on how long it takes to get a new drug through testing and ready to sell in the market). This is to allow drug manufacturers to recoup research and development costs, which can be extensive. Once this initial period expires, generic drug manufacturers can develop and receive approval to sell generic versions of new drugs.

Distributors

Once a new drug is developed and federally approved for sale in the market, the distribution industry makes wholesale bulk purchases of the new drug from manufacturers, temporarily stores them, and contracts with pharmacies and hospitals to supply the new drug to them, based on demand. Because some drugs have specific storage and transportation requirements (e.g., they must be stored and transported below a certain temperature), distributors play the important role of making sure a drug remains safe and effective between when it is manufactured and when it is purchased by a patient.

Pharmacies

Pharmacies contract with distributors to stock prescription drugs, then sell them to patients based on demand. The role they play is similar to that of the grocery store in the food industry: they are the point-of-sale for patients needing to purchase prescription drugs. But unlike at a grocery store, the price paid by the end consumer at a pharmacy (the patient co-pay, deductible and/or cash payment) does not cover most of the cost of a prescription drug.

Health Plans/Insurers

The insurance industry is made up of hundreds of private and government health plans, and it pays the largest share of the cost of drugs prescribed to patients. As the entity that pays the lion’s share – using revenues from insurance premiums (private plans) or taxpayer dollars (government plans) – health plans naturally want to control prescription drug costs.

Insurers attempt to control costs using mechanisms such as patient co-pays and deductibles in prescription drug coverage – giving patients financial incentive to purchase less expensive options. They also use what is called a formulary – a tiered list of prescription drugs covered by the health plan. The formulary helps control costs by changing the patient’s price at the pharmacy depending on what tier the drug falls into. Formularies have been shown to influence whether a patient in the health plan is willing to purchase a drug.

Pharmacy Benefit Managers (PBMs)

A PBM represents health plans in negotiations with drug manufacturers and pharmacies regarding most matters impacting the cost of prescription drugs. PBMs manage many of the details of a health plan’s prescription drug coverage, including where specific drugs land on the health plan’s formulary. PBMs negotiate rebates for health plans from manufacturers on the price of a drug, using formulary placement as part of those negotiations. PBMs also contract with pharmacies regarding the dispensing of drugs to patients and health plan payments for drugs sold to patients in the plan.

Other Players

Some important prescription drug market players do not fit neatly into one of the above categories. These include digital marketplace disruptors, such as GoodRx, and value evaluators such as the Institute for Clinical and Economic Review (ICER).

GoodRx (and companies offering similar services) uses its app to let patients know where they can get the best price for the prescription they need – a digital marketplace of sorts for prescription drugs. GoodRx also negotiates for discount coupons on prescription drugs that it offers to patients. In this way, it plays a role similar to PBMs, but negotiating on behalf of patients rather than health plans. The main role GoodRx and similar companies play is to increase competition for PBMs and pharmacies.

ICER is a nonprofit that uses a particular methodology to compare the manufacturer’s price for a new drug to an estimated dollar value of the extended or improved life offered by a new drug. For example, when the FDA gave anti-viral drug remdesivir an emergency-use authorization as a treatment for COVID-19, ICER released a report with a recommended price range for health plan payments for the drug treatment, based on its methodology. ICER reports are used by an increasing number of health plans to determine coverage levels for new drugs. ICER’s methodology borrows from a similar approach used by a government entity in the United Kingdom’s nationalized health system, and has subsequently met with some controversy about its likely impacts on vulnerable populations.

These various players/groups make up the basic parts of the prescription drug market and their primary economic roles. In our next installment, we will describe how each of these players can impact exactly what a patient pays at the pharmacy for a prescription.

Prescription Drugs 101: Follow the money

Prescription Drugs 101: The 6 things that determine the price we pay

Prescription Drugs 101: One visual to rule them all