Motive & Opportunity: The Convoluted Tale of Generic Price Inflation


Since early 2013, prices for generics sold in the US at retail have risen more than 40% on a sales weighted basis

Three-quarters of this inflation was driven by straightforward median reversion: a host of products with very low prices simply raised their prices to within range of the broader market’s median. Before pricing actions these products had a median price of $0.29 as compared to $0.77 for products whose prices did not inflate; after the pricing actions these products’ median price rose to $0.72

Other than their very low starting prices, there is nothing remarkable about the median-reverting products – there are just as many manufacturers per median-reverting product as there are for products whose prices did not inflate; and the median-reverting products were no more likely to have experienced supply disruptions

The remaining one-quarter of inflation was driven by very large price increases on products that had average prices to begin with, but that also had very low average sales per product, and fewer manufacturers per product, as compared to products whose prices did not inflate

We believe the surge of inflation occurred for two simple reasons: generic manufacturers, under pressure from stalling sales growth and stagnant ROA’s, very badly needed it; and, the generic manufacturers’ main customers – drug wholesalers – chose to go along

The generic companies’ sales growth is at its lowest level in 14 years; ROA’s have been below 3 percent since before the financial crisis and have stayed there, despite a recovery in SP500 ROA’s to nearly 5 percent

From drug wholesalers’ perspective, their margins expanded on the products whose prices median-reverted. On the subset of products where sufficient data are available (representing about 75% of the median reverting products’ sales) wholesalers’ costs grew 25% but their selling prices grew 39%

Growth in prices paid to generic manufacturers is likely to stall once the industry’s aggregate fundamentals improve. There’s already evidence this is occurring, as pricing gains have substantially expanded both gross and operating margins, pointing to a corresponding recovery in ROA’s. Major pending US generic launches (e.g. Nexium, Abilify) may accelerate a fundamental recovery

Wholesalers’ margin gains are likely to be fleeting, as excess buying margin is passed along to retail clients in the form of lower prices

The ongoing shift to National Average Drug Acquisition Cost (NADAC) is a wildcard – very low cost generics could be highly profitable to wholesalers under the outgoing Average Wholesale Price (AWP) benchmark; under NADAC very low priced generics are likely to be money losers. It follows that drug wholesalers may welcome continued price inflation of very low cost generics, regardless of whether generic manufacturers remain as desperately in need of price gains as they have been recently

For our full research notes, please visit our published research site

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