CVS-Aetna deal will save money by cutting supply chain negotiations

CVS’s $69 billion acquisition of Aetna continues to lurch toward closure — the deal doesn’t yet have the full green light — marking one of the health care industry’s largest transactions to date. CVS has promised consumers an improved experience and lower costs.

This deal has ramifications far beyond the current customers of CVS and Aetna. It should pave the way for a new kind of health care by addressing major inefficiencies in our overly complex health care system. If everything goes as planned, the deal will cut spending in the pharmaceutical supply chain — and possibly the entire health care supply chain — likely leading to lower markups and costs for consumers. It could also usher in a round of similar pharmacy-insurance mergers that could radically change health care in the U.S.

One of the major drivers of the CVS-Aetna deal is the current landscape of health care in this country. Industry players have faced both public and private pressure to lower costs as Americans feel the squeeze of increasing health care expenses, from insurance premiums to prescription drugs. Yet many of these players are stuck in the middle, expected to provide high-quality care at a low-quality cost. Advances in medicine have led to more expensive treatment options that consumers want and expect access to. “Outsiders” like Amazon are entering the health care industry, introducing a new level of competition. Further complicating the picture, Americans are living longer and consuming more drugs and health care services than previous generations.

With pressure mounting from the outside, the industry was left with no choice but to look within to reduce costs. Although the pricing scheme of pharmacy drugs and services is a closely guarded secret, we’ve learned that the complexity of the industry is what’s likely driving up costs. Insurance companies, pharmacy benefit managers, retail pharmacies, manufacturers, and wholesalers are all involved in the process to provide Americans with services and prescription drugs. For example, a brand-name drug is made by a manufacturer, then purchased and distributed by a wholesaler, who sells it to the pharmacy. Meanwhile, pharmacy benefit managers reimburse the pharmacy for the drug, and insurance companies reimburse the pharmacy benefit managers. With so many players involved in a single drug, it is clear to see the multiple points of pricing negotiations that take place.

To reduce costs, industry giants like CVS have been working to simplify this complex supply chain. In 2007, CVS and Caremark merged, combining a retail pharmacy chain and a pharmacy benefit manager. CVS’s acquisition of Aetna pulled an insurance company under its umbrella.

What does all of this mean for consumers?

Consolidations of complex supply chains improve efficiency and lower costs. Why? Because they reduce redundancies. If each entity in a drug supply chain operates independently, costs increase because each company needs to take a cut in order to make a profit. Markups at each stage result in higher-than-necessary costs. With fewer entities in the chain, there would presumably be fewer markups and lower costs.

In addition, supply-chain consolidation reduces the need for negotiations between each of the players, yielding further savings.

CVS has promised to fundamentally change the health care experience. It may take years, but with the power of an insurer, a pharmacy benefit manager, and a pharmacy, the company controls enough of the supply chain to actually deliver on its promise.

The CVS-Aetna deal is just the beginning of a major industry shift. Think about it strategically: Why would the nations’ third-largest insurance company agree to be acquired by one of the largest pharmacy chains? Neither company is struggling to survive; both are doing fine on their own. If revenues aren’t driving this deal, then costs must be.

In light of outside pressures from the public and lawmakers, as well as the overly complex drug supply chain, consolidation makes perfect sense. Which is why CVS and Aetna aren’t the only companies in the game. I would expect to see other pharmacy-insurance mergers and acquisitions on the horizon, just as we saw consolidation among pharmacies and pharmacy benefit managers over the last decade. We already are observing insurer-pharmacy benefit manager consolidation with the proposed acquisition of Express Scripts by Cigna. After that, who knows what’s next — perhaps manufacturers and wholesalers will get in on the trend?

My take-home lesson from the CVS-Aetna deal is that this move was made to reduce redundancy and complexity in the pharmaceutical (and possibly health care) supply chain. It has the potential to reduce costs. Some critics have claimed that none of the savings will actually be passed on to consumers, but I disagree. Realistically, consumers can expect to see most of the savings: Imagine the uproar if they didn’t. What’s more, the insurance industry is highly regulated, ensuring that a specific percent of funds goes toward claim payments.

Consumers aren’t happy with the current health care climate, and the industry must change in response. More mergers will follow and consumers will see cost savings without a hit to quality, which is really a win-win for all.

Kathleen Iacocca, Ph.D., an assistant professor of management at the Villanova University School of Business, is an expert in health care policy and health care supply chains.