Caterpillar Breaks New Ground Managing the Prescription Drug Supply Chain

AJPB® Translating Evidence-Based Research Into Value-Based Decisions®April 2010
Volume 2
Issue 2

By eliminating waste in the prescription drug supply chain, Caterpillar lowered total drug costs while copayment tiers remained unchanged.

It’s no secret that pharmaceutical costs are rising at an alarming rate, and Caterpillar is not immune to these increases. For example, our prescription drug expenditures rose an average of 14% annually between 1996 and 2004. Since 2004, we have seen branded prescription drug prices double. To address the continuing cost pressures, in 2004 we began to actively manage drug spending in the areas of generic utilization, formulary management, and supply chain management. We’ve made outstanding progress in all 3 areas. In fact, since 2004 we’ve achieved the following:

  • Compared with 2004, total 2009 drug costs are 6.8%lower and per-member per-year costs are 13.8% lower.
  • Employee and retiree copayment tiers are generally unchanged since 2002, and lower in some cases.

Our most visible achievements are in the area of prescription drug supply chain management, which we’ll take a closer look at in this commentary.


Our accomplishments in supply chain management are not surprising when you consider that our initial analysis estimated that there was 10% to 25% waste in the system, some of which we believed was driven by conflicts of interest in the system. For example, some of the same consulting firms that plan sponsors pay to help them choose their pharmacy benefit manager (PBM) often receive “broker fees” from the selected PBM. As we evaluated the supply chain, we knew eliminating conflicts of interest would be an area of focus.

As plan sponsors and payers, we have what everyone else wants—money. But in the healthcare space, we sometimes feel we have no leverage and are at the mercy of a confusing system. We wanted to challenge the system.

One of our first steps was to identify who is part of the prescription drug supply chain. That helped us better understand the complexity and inefficiency of the supply chain and identify the waste. To be clear, we define waste as money spent that does not contribute to our plan participants’ health. By applying the same principles to our pharmaceutical costs that we do to other expenditures at Caterpillar, we eliminated waste in the prescription drug supply chain. That, in turn, promoted the sustainability of our healthcare benefits.


One of the first things we wanted to promote and incorporate into our prescription plans was transparency. We worked diligently with the HR Policy Association (HRPA) pharmaceutical coalition to develop and implement transparency standards that are in place today for HRPA-certified PBMs. But transparency alone does nothing; it simply enables improvement. The transparency committed to by HRPA-certified PBMs gave us the opportunity to evaluate each component of the services they provide based on cost and value. The assumption was that because our PBM was not profiting (by taking spread) on the pricing of our prescription drugs, they would not mind if Caterpillar directly negotiated a better deal on its own.

We set out to accomplish 4 major goals:

  • Identify at least 1 major pharmacy that would bewilling to partner in a direct contracting relationship (bypassing the normal PBM pricing process).
  • Ensure nonexclusivity.
  • Develop a new pricing methodology to eliminatethe use of average wholesale price (AWP)methodology.
  • Ensure transparency in price.

Our agreements with Walmart and Walgreens allow us to achieve all 4 goals. Here’s how:

Exchange Volume for Margin

In the current system, pharmacies do not have an effective way to increase their market share outside of building additional stores. By negotiating directly with pharmacies, we enabled them to find another way to increase their market share by exchanging volume for margin. In our agreements, increasing Caterpillar’s volume benefits both Caterpillar and the pharmacies—so it’s a win—win for both companies.

Drive Competition

Although this model also would work in an exclusive arrangement, we believe in healthy competition. So a key deliverable was to ensure that neither party would be locked into an exclusive arrangement. It also allows for continued competition as this ethodology takes hold in the industry.

Implement a New Pricing Methodology

Caterpillar believes the AWP methodology is flawed and only produces more waste. So we worked with our pharmacy partners to develop what we call a “cost-plus” methodology. The components are simple:

  • A “real” invoice price, which represents the actual net cost to purchase the drug by the pharmacy. It’s not a transfer price. It also includes all net items/revenue streams that are generated now or in the future by the purchase of such drugs.
  • Overhead.
  • Margin.

For this model to be sustainable, pharmacies need to realize a profit. Therefore, the final cost is real invoice price + overhead + margin for each drug. Think of it as a giant maximum allowable cost list. It allows pharmacies to optimize/compete on 3 fronts in addition to customer service—buying, efficiency, and margin—to make them a more attractive partner to payers and win more of their business.

Establish Audit Rights

We understand that the net price a company pays its supplier often is a confidential matter. However, to ensure that this new methodology does not become corrupt like those before it, validation is necessary. Our arrangement gives us the right to engage a third-party auditor to ensure that the pricing methodology is properly applied. The audit keeps critical pharmacy information confidential while allowing us to validate we are paying the price that was agreed to in the contract.


With 2-year contracts in place with both Walgreens and Walmart effective January 1, 2010, their combined footprint ensures reasonable geographic access nationwide to more than 90% of our participants. Broad access to both pharmacies led us to develop a preferred pharmacy network consisting primarily of Walgreens and Walmart. In locations where participants didn’t have reasonable access to a preferred network pharmacy, we added a local, independent pharmacy to the preferred network. With a preferred network in place, we chose to incentivize our plan participants to purchase their prescriptions at a preferred network pharmacy by maintaining current prescription copayments at those pharmacies. Plan participants continue to have the option of using a pharmacy in our broader PBM network; however, they now will have higher copayments (or coinsurance) at those pharmacies.

Over the course of the 2-year contracts, we expect our savings to be well into 8 figures.


Our model is based on a simple premise: find a way to manage pharmaceutical costs so we continue to provide a sustainable, valuable prescription benefit to our healthcare participants.

Although some pharmacies have lost Caterpillar business, we believe we have created a way for them to compete in the future. Our model allows pharmacies to take control by setting their own prices and exchanging better pricing for volume, thereby eliminating the squeeze from PBMs we often hear about. We believe this is better for pharmacies than the alternative: losing an increasing number of payers who are forcing prescription volume to mail order (largely owned by PBMs) to lower their costs.

At the same time, we expect our preferred pharmacy network will drive competition among pharmacies and encourage them to differentiate themselves with price and service. Ideally, other pharmacies will take heed and realize elements other than geography can drive prescription market share. That would create competition for Caterpillar’s business, provide choice for our participants, and allow our PBM, Restat, to add value where we need it. In fact, Restat’s partnership has been invaluable in determining how to best implement this new process.

One thing is certain: the current market dynamic is creating a bloated supply chain and, ultimately, exposing plan sponsors to additional costs.

During the past year, we’ve had many inquiries from companies that also are looking for ways to save money. It’s no secret that it has been difficult to initiate and implement this process. Developing the solution has required a significant investment of time from Team Caterpillar and our consultants and vendors, but we think this model is an improvement over the way most payers purchase prescription drugs today, and other payers could easily adopt it.

Within the next several months we intend to host a meeting of like-minded companies that are interested in implementing a solution such as ours. Our intent is to help facilitate the development of a consistent process for payers. Hopefully, this process will help remove some of the confusion and complexity from the current prescription drug supply chain and assist others in achieving their sustainability goals. Finally, we commend Restat, Walgreens, and Walmart for their progressiveness and vision in helping drive innovation and change in the marketplace.

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