Medco and Its Peers Brace for a Flank Attack

The embattled pharmacy benefit management industry could soon face competition from its own customers.

For years, major employers have simply trusted PBMs such as Medco (MHS Quote), Caremark (CMX Quote) and Express Scripts (ESRX Quote) to hold prescription costs down. But some big companies have grown frustrated by the industry's lack of transparency and have come to doubt that the professed savings are real. Thus, dozens of companies -- including big names like IBM (IBM Quote) -- have joined forces in an effort to directly negotiate with drug manufacturers for discounts on their own.

The HR Policy Association, which formulated the idea, calls the group "the largest private-sector drug purchasing coalition ever assembled." Meanwhile, a number of states -- some seeking to regulate the industry -- have launched a similar effort.

The potential group buyers have surfaced at a time when drug costs are soaring and PBMs face intense government scrutiny for their pricing and business practices. Despite the strong negotiating power enjoyed by PBMs -- which provide about 80% of the drug coverage in the U.S. -- prescription drug costs actually doubled between 1995 and 2000 and have continued to rise since then. Critics blame PBMs for allegedly charging far more for drugs than they actually pay to manufacturers. They insist that PBMs engage in secret deals that allow them to pocket much of the savings that they are supposed to pass on to their clients.

But the loosely regulated industry -- monopolized by the three big for-profit companies -- staunchly defends itself. It points to government reports that say that PBMs slash billions of dollars from prescription drug costs annually. And it argues that some of the savings would evaporate if regulators forced PBMs to disclose trade secrets that enable them to reduce costs for their customers.

There is no dispute, however, about the industry's growing profitability. Medco, the nation's largest PBM, recently posted a 21% jump in net income even after losing some major contracts. Caremark, which won some of that business, reported "record" second-quarter results -- with cash flow tripling -- following a big merger that further reduced competition within the industry. And Express Scripts, the No. 3 PBM, saw its own cash flow more than double in the same period.