Pharmaceutical Wholesalers 2010

IBISWorld Industry Report February 10 2010 Prescription Drug Wholesaling in the US: 42221 DISCLAIMER This product has been supplied by IBISWorld Inc. ('IBISWorld') solely for use by its authorized licenses strictly in accordance with their license agreements with IBISWorld. IBISWorld makes no representation to any person with regard to the completeness or accuracy of the data or information contained herein, and it accepts no responsibility and disclaims all liability (save for liability which cannot be lawfully disclaimed) for loss or damage whatsoever suffered or incurred by any other person resulting from the use of, or reliance upon, the data or information contained herein. Copyright in this publication is owned by IBISWorld Inc. The publication is sold on the basis that the purchaser agrees not to copy the material contained within it for other than the purchasers own purposes. In the event that the purchaser uses or quotes from the material in this publication - in papers, reports, or opinions prepared for any other person - it is agreed that it will be sourced to: IBISWorld Inc.

Contents Industry Definition................................................................................................................................................. 3

ACTIVITIES (PRODUCTS AND SERVICES) ......................................................................................................................................3 SIMILAR INDUSTRIES ........................................................................................................................................................................3 DEMAND & SUPPLY INDUSTRIES ....................................................................................................................................................3

Key Statistics ........................................................................................................................................................ 5 INFLATION ADJUSTED (CONSTANT) PRICES.................................................................................................................................5 REAL GROWTH...................................................................................................................................................................................5 RATIO TABLE......................................................................................................................................................................................5 GRAPHS ..............................................................................................................................................................................................6

Segmentation ....................................................................................................................................................... 7 PRODUCTS AND SERVICE SEGMENTATION..................................................................................................................................7 MAJOR MARKET SEGMENTS............................................................................................................................................................8 INDUSTRY CONCENTRATION...........................................................................................................................................................9 GEOGRAPHIC SPREAD ...................................................................................................................................................................10

Market Characteristics........................................................................................................................................ 12 MARKET SIZE ...................................................................................................................................................................................12 LINKAGES .........................................................................................................................................................................................12 DEMAND DETERMINANTS ..............................................................................................................................................................13 DOMESTIC AND INTERNATIONAL MARKETS................................................................................................................................14 BASIS OF COMPETITION.................................................................................................................................................................14 LIFE CYCLE.......................................................................................................................................................................................15

Industry Conditions............................................................................................................................................. 17 BARRIERS TO ENTRY......................................................................................................................................................................17 TAXATION .........................................................................................................................................................................................17 INDUSTRY ASSISTANCE .................................................................................................................................................................18 REGULATION AND DEREGULATION..............................................................................................................................................18 COST STRUCTURE ..........................................................................................................................................................................19 CAPITAL AND LABOR INTENSITY...................................................................................................................................................20 TECHNOLOGY AND SYSTEMS .......................................................................................................................................................21 INDUSTRY VOLATILITY....................................................................................................................................................................22 GLOBALIZATION...............................................................................................................................................................................22

Key Factors ........................................................................................................................................................ 24 KEY SENSITIVITIES..........................................................................................................................................................................24 KEY SUCCESS FACTORS................................................................................................................................................................24

Key Competitors ................................................................................................................................................. 26 MAJOR PLAYERS .............................................................................................................................................................................26 PLAYER PERFORMANCE ................................................................................................................................................................26 OTHER PLAYERS .............................................................................................................................................................................34

Industry Performance ......................................................................................................................................... 36 CURRENT PERFORMANCE.............................................................................................................................................................36 HISTORICAL PERFORMANCE.........................................................................................................................................................41

Outlook ............................................................................................................................................................... 44

INDUSTRY DEFINITION Prescription Drug Wholesaling in the US

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© Copyright 2010, IBISWorld Inc. 3

Industry Definition Prescription drug wholesalers sell biological and medical products, botanical drugs and herbs, and pharmaceutical products, to hospitals and private medical practices, department stores, supermarkets and mass merchandisers, cosmetics retailers and retail pharmacies. Products include medical and pharmaceutical drugs, veterinary supplies, first-aid supplies, and personal care goods.

ACTIVITIES (PRODUCTS AND SERVICES) The primary activities of this industry are: • Antiseptics wholesaling • Beauty preparations and supplies wholesaling including cosmetics, personal care items and colognes • Diagnostic reagents wholesaling • First-aid supplies wholesaling • Nonprescription drugs wholesaling • Plasmas, blood, wholesaling • Prescription drugs wholesaling • Razors (except electric), blades and shaving preparations wholesaling • Veterinarians' medicines wholesaling • Vitamins wholesaling The major products and services in this industry are: • Prescription drugs • Non-prescription pharmaceuticals • Cosmetics and beauty supplies • Vitamins and nutritional supplements • Health aids and first aid supplies • Perfumes • Medical, hospital and surgical supplies

SIMILAR INDUSTRIES Industry: 42145 - Medical Supplies Wholesaling in the US Description: Companies primarily engaged in wholesaling surgical, dental, and hospital equipment.

DEMAND & SUPPLY INDUSTRIES 32541 - Pharmaceutical & Medicine Manufacturing in the US 32561 - Soap & Cleaning Compound Manufacturing in the US 32562 - Cosmetic & Beauty Products Manufacturing in the US 33911a - Medical Instrument & Supply Manufacturing in the US 33911b - Ophthalmic Lens Manufacturing in the US 44512 - Convenience Stores in the US 44611 - Pharmacies & Drug Stores in the US 44612 - Beauty, Cosmetics & Fragrance Stores in the US 44619 - Health Stores in the US 45211 - Department Stores in the US 62111a - General Practitioner Family Doctors in the US

INDUSTRY DEFINITION Prescription Drug Wholesaling in the US

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62111b - Specialist Doctors in the US 62211 - Hospitals in the US

KEY STATISTICS Prescription Drug Wholesaling in the US

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Key Statistics INFLATION ADJUSTED (CONSTANT) PRICES 2006 2007 2008 2009 2010 Industry Revenue *377,400 *378,000 *397,000 *409,625 *421,700 $Mil Industry Gross Product *52,500 *50,300 *50,650 *51,400 *52,225 $Mil Number of Establishments *10,725 *10,600 *10,450 *10,275 *10,250 Units Number of Enterprises *9,255 *9,150 *9,050 *8,900 *8,885 Units Employment *260,500 *262,225 *261,500 *260,000 *259,500 Units Exports -- -- -- -- -- Imports -- -- -- -- -- Total Wages *21,700 *22,100 *22,000 *21,750 *21,500 $Mil Domestic Demand NC NC NC NC NC $Mil Prescriptions filled *3,495 *3,520 *3,550 *3,570 *3,585 Million

REAL GROWTH 2006 2007 2008 2009 2010 Industry Revenue *2.1 *0.2 *5.0 *3.2 *2.9 % Industry Gross Product *7.4 *-4.2 *0.7 *1.5 *1.6 % Number of Establishments *-1.8 *-1.2 *-1.4 *-1.7 *-0.2 % Number of Enterprises *-2.7 *-1.1 *-1.1 *-1.7 *-0.2 % Employment *-1.7 *0.7 *-0.3 *-0.6 *-0.2 % Exports NC NC NC NC NC % Imports NC NC NC NC NC % Total Wages *1.6 *1.8 *-0.5 *-1.1 *-1.1 % Domestic Demand NC NC NC NC NC %

RATIO TABLE 2006 2007 2008 2009 2010 Imports share of Domestic Demand NC NC NC NC NC % Exports Share of Revenue NC NC NC NC NC % Average Revenue per Employee *1.45 *1.44 *1.52 *1.58 *1.63 $Mil Wages and Salaries Share of Revenue *5.75 *5.85 *5.54 *5.31 *5.1 %

KEY STATISTICS Prescription Drug Wholesaling in the US

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GRAPHS Revenue

Revenue Growth Rate

Employment

Note: Unless specified, an asterisk (*) associated with a number in a table indicates an IBISWorld estimate and references to dollars are to US dollars.

SEGMENTATION Prescription Drug Wholesaling in the US

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Segmentation PRODUCTS AND SERVICE SEGMENTATION

Product/Services Share

Prescription drugs 75.0%

Non-prescription pharmaceuticals 9.0%

Cosmetics and beauty supplies 6.0%

Vitamins and nutritional supplements 4.0%

Health aids and first aid supplies 3.0%

Perfumes 2.0%

Medical, hospital and surgical supplies 1.0%

Pharmaceutical and medical products account for the largest share of industry revenue, amounting to approximately 84% of Prescription Drug Wholesaling sales.

In the pharmaceutical and medical product segment, IBISWorld estimates that prescription drugs account for 75% of revenue, non prescription pharmaceuticals generate 9% of revenue, and vitamins and nutritional supplements 4%.

Medical and first-aid supplies account for 1% of revenue. This proportion remains relatively consistent as the demand for these goods is not sensitive to changes in economic conditions. Medical, hospital and surgical goods include surgical and medical products, orthopedic and prosthetic appliances and supplies.

In contrast, cosmetics, beauty supplies and perfumes which are thought to account for roughly 8% of revenue tend to be more sensitive to fluctuations in economic conditions and thus their relative importance will change in line with changes in discretionary consumer expenditure patterns.

IBISWorld believes that product varieties with different features are associated with different levels of technological sophistication, different suppliers and different distribution channels within the industry. These factors account for the large number of distribution channels and product varieties.

Products sold through this wholesale industry have performance differences. Performance differences include such aspects as prescription, tablet versus oral forms as well as other features that are related to technology (R&D) and design.


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National health expenditure by item Industry item

Billion Dollars 2004



Health services and supplies 1733.1 2089.7 2181.3 Personal health care expenses 1550.2 1878.3 1952.3 Prescription drugs 188.8 226.8 234.1 Other goods 32.7 37.4 39.0 Source: Centers for Medicare & Medicaid Services

MAJOR MARKET SEGMENTS

Market Segment Share

Retail pharmacies 60.0%

Supermarkets and mass merchandisers 20.0%

Department stores 8.0%

Hospitals and private medical practices 7.0%

Cosmetic retailers 5.0%

Roughly 80% of all human use ethical pharmaceutical products produced by upstream manufacturers are currently distributed via primary wholesalers.

Wholesalers then distribute the relevant products to various downstream health care users including hospitals, clinics, HMOs, retail pharmacies etc as well as to the likes of chain stores and mail order companies. According to data produced by IMS Health, retail pharmacies (including chain stores and independents) accounted for 48% of all dispensed prescription sales in terms of sales in 2008, compared with 16% for mail-order pharmacies, 12% for clinics, 10% for non-federal hospitals 5% for long-term care pharmacies and 7% for food stores.

However in some instances, manufacturers may bypass the wholesaler and deal directly with downstream end users including pharmacies, health food chain stores, mail order companies etc. One development of note has been the adoption of direct to pharmacy distribution models by manufacturers keen to extend their control over the supply chain.

On a total product basis, retail pharmacies still constitute by far the largest market segment. In recent years pharmacies and drug stores have been increasing the range of front of store products they stock. These establishments have also been increasing their range of pharmaceuticals and over-the-counter medicines in an attempt to increase market share.


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In comparison, supermarkets account for 20% of market demand. Supermarkets and mass merchandisers are also serviced by a variety of industry participants including pharmaceutical wholesalers who stock over-the-counter (OTC) products, as well as by those who supply detergents, soaps, cosmetics and toiletries products.

Over the current performance period, pharmaceutical wholesalers have lost an increasing proportion of OTC pharmaceuticals, medical supplies (e.g. band aids, bandages), cosmetics and toiletry sales to external competitors and to the distribution operations of supermarkets, mass merchandisers and health and beauty chains.

At the consumer level, seniors are the dominant users of medical care. They make up about 13% of the population, but they account for more than 35% of all health care expenditures, 34% of all prescriptions dispensed, and over 40% of prescription drug expenditures.

Average annual expenditure on drugs, 2007 Age

Dollars Expenditure on drugs*

Under 25 103 25 to 34 203 35 to 44 303 45 to 54 498 55 to 64 674 65 to 74 935 75 years and older 777 Source: Bureau of Labor Statistics Note: * Prescription and non-prescription

INDUSTRY CONCENTRATION Concentration in this industry is medium

The Prescription Drug Wholesaling Industry is deemed to have a medium level of concentration with the top four participants accounting for just over 60% of industry revenue.

This has gradually increased in recent years as the industry has undergone a process of consolidation.


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GEOGRAPHIC SPREAD Year: 2009 Establishments

Region Units

Mid-Atlantic 1,809.0

West 1,697.0

Southeast 1,695.0

Southwest 755.0

Great Lakes 717.0

Plains 384.0

Rocky Mountains 318.0

New England 274.0

Note: "Far West" and "Mid East" have been changed to "West" and "Mid-Atlantic," respectively, in some parts of this report

Geographic analysis, by region, shows that business activity is concentrated in the Southeast region (22% of establishment numbers in 2007), the Mid-Atlantic (24% of establishments), and the Far West (22% of establishments) regions of the U.S. Geographic analysis, by state, shows that California (1,311 establishments in 2007), New York (843 establishments), Texas (515 establishments), New Jersey (575 establishments), and Florida (729 establishments) account for a greater number of establishments, employment, and sales receipts in the industry.

These same proportions are expected

to hold today.

This in turn reflects in part the nation's population distribution. In 2005 California was the most populous state (accounting for 12% of the total U.S. population with 36.1 million people) followed by Texas (22.9 million) and New York (19.3 million). These three states also have 10% of their population aged 65% and older. Other key states with a high proportion of seniors include Florida (17% of population), West Virginia (15%) and Pennsylvania (15%).

Thus a number of wholesalers are thought to maintain a close proximity to these particular markets with the older populations playing a role in supporting downstream industries such as pharmacies and drug stores.

Participants in the Prescription Drug Wholesaling industry also locate themselves in areas well supported by infrastructure and close to downstream markets for convenience. Other factors affecting location include proximity to medical supply and pharmaceutical manufacturers, which themselves are thought to be concentrated in the Mid-Atlantic and Southeast regions.


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Average consumer expenditure on health care, 2007 Region

Dollars Total health care

Percentage Health insurance

Percentage Medical services

Percentage Drugs and medical

Northeast 2084 50.1 26.4 23.4 Mid-west 2292 49.1 24.9 26.0 South 2194 49.5 24.1 26.3 West 2129 45.3 40.6 23.5 Source: U.S. Census Bureau

MARKET CHARACTERISTICS Prescription Drug Wholesaling in the US

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Market Characteristics MARKET SIZE

The Prescription Drug Wholesaling industry derives most of its revenue from distributing pharmaceuticals, medical supplies and personal-care goods to retail pharmacies, as well as to other retailers such as supermarkets, mass merchandisers and department stores. The aging population has been an important factor driving long-term growth in the industry, with the elderly generally requiring more medical care and drugs. In 2008, roughly 3.8 billion prescriptions were filled in the downstream retail-drug sector, up from 3.5 billion in 2007. For the 12 months that ended October 2009, drug sales through retail pharmacies were in the order of $215 billion.

With growth rates having moderated in recent years, the industry is expected to generate an estimated revenue figure of $421.7 billion in 2010, up from $369.5 billion five years earlier. At 2010 year end, the industry is expected to consist of 10,250 establishments. These firms are expected to employ around 260,000 staff, and pay approximately $21.5 billion in wages and salaries. Nearly half of all firms operating in this industry generate revenue of between $1 million and $5 million per year. These firms also account for the majority of employment in the industry (roughly 65%). Following a considerable spate of consolidation, the industry is currently dominated by three major players: AmerisourceBergen, Cardinal Health and McKesson.

LINKAGES Demand Linkages

44512 - Convenience Stores in the US Supermarkets and convenience stores demand products supplied by Drugs and Druggist Sundry Wholesalers.

44611 - Pharmacies & Drug Stores in the US Retailers such as these sell a wide range of medications, medicinal supplies, cosmetics, and toiletry products.

44612 - Beauty, Cosmetics & Fragrance Stores in the US Retailers such as these sell a wide range of cosmetics, hair preparations and toiletry products.

44619 - Health Stores in the US Retailers such as these sell a wide range of vitamin supplements, as well as natural cosmetic and toiletry products.

45211 - Department Stores in the US Industry participants supply a variety of products to department stores including cosmetics, perfumes, soaps and toiletries products.

62111a - General Practitioner Family Doctors in the US Demand medical products from this industry.

62111b - Specialist Doctors in the US Demand medical products from this industry.

62211 - Hospitals in the US Hospitals demand medical supplies as well as endocrine substances and blood plasma from this industry.


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Supply Linkages 32541 - Pharmaceutical & Medicine Manufacturing in the US

Participants in this industry supply pharmaceutical products to this industry.

32561 - Soap & Cleaning Compound Manufacturing in the US Participants in this industry supply soaps and toothpastes to this industry.

32562 - Cosmetic & Beauty Products Manufacturing in the US Participants in this industry supply perfumes, cosmetics, hair preparations, face and body creams, and shaving preparations to this industry.

33911a - Medical Instrument & Supply Manufacturing in the US Participants in this industry supply first-aid and other medical products to this industry.

33911b - Ophthalmic Lens Manufacturing in the US Participants in this industry supply first-aid and other medical products to this industry.

DEMAND DETERMINANTS

Demand is directly related to expenditure patterns in the Health Care and Social Assistance sector. Industries in the sector include: Physicians, Dentists, Optometrists, Mental Health and Substance Abuse Centers, Medical and Diagnostic Laboratories, Ambulance Services, General and Surgical Hospitals, Nursing and Residential Care facilities. For example doctors and specialists operating in these industries prescribe drugs and diagnostic tests; surgeons and other specialists select procedures, prostheses and devices while hospitals purchase diagnostic and surgical equipment.

Thus factors affecting demand for the above industries include Government health programs and related expenditure. In recent years programs such as Medicare and Medicaid, along with private healthcare insurance and managed care plans, have attempted to control costs by limiting the amount of reimbursement they will pay for a particular drug, procedure or treatment. Effectively this has led to an increased level of price sensitivity among customers for products distributed by this industry.

Similarly changes in domestic and international regulations such as more vigorous compliance and enforcement activities carried out by government agencies may delay or prevent the approval of certain products thereby impacting sales at the wholesale level.

At the same time there have been a number of other variables which have served to impact upon the product portfolio carried by drug wholesalers.

For example the aging American population and the trend towards more consumer-oriented health care products and devices is increasing the demand for the pharmaceutical industry as well as the medical equipment and supply industry to develop technologies and products that enable patients to take a more active role in their own health care.

In addition with conditions such as heart disease, cancer, AIDS, and hepatitis on the increase, the demand for specialized drugs, instrumentation and consumables has also increased. This demand is derived from the health of population and the methods employed by medical professionals to treat disease, illness and injury.


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Product development by manufacturers as well as their marketing practices may also influence demand. Manufacturers are spending ever increasing sums on developing and marketing new products in an attempt to increase demand and product scope in an otherwise mature and saturated marketplace.

DOMESTIC AND INTERNATIONAL MARKETS Domestic and International Markets Exports Exports in this industry are low Exports in this industry are steady Domestic and International Markets Imports Imports in this industry are low Imports in this industry are steady Domestic and International Markets Analysis

The U.S. Prescription Drug Wholesaling Industry is oriented towards the domestic market. Indeed IBISWorld estimates that less than 5% of sales revenue in the Prescription Drug Wholesaling industry is generated from export sales.

However of note is the fact that many of the products distributed by this industry are sourced from overseas suppliers although international trade in the Prescription Drug Wholesaling industry is accounted for under the relevant upstream NAICS manufacturing classes: 32541 - Pharmaceutical and Medicine Manufacturing; 33911 - Medical Equipment and Supply Manufacturing; 32561 - Soap and Cleaning Compound Manufacturing; and 32562 - Toilet Preparation Manufacturing.

BASIS OF COMPETITION Competition in this industry is high Competition in this industry is increasing

The Prescription Drug Wholesaling Industry is characterized by a high level of competition which has tended to intensify in recent years. According to Cardinal Health, there are three national wholesale distributors operating within the pharmaceutical supply chain (Cardinal Health, McKesson Corporation and AmerisourceBergen Corporation) as well as a number of smaller regional wholesale distributors, direct selling manufacturers, specialty distributors and third party logistics companies and self-warehousing chains. These participants compete on the basis of a value proposition which includes pricing, breadth of product lines, service offerings and support services. According to the company, a participant's earnings will depend on its ability to: compete effectively on the basis of price; distribute a large volume and variety of products; provide quality support services; maintain low cost sourcing arrangements with generic pharmaceutical manufacturers and effectively manage inventory and other working capital items.

Thus competition within this industry is primarily based upon a number of factors including service range, product mix and price.

In the case of service range, this can include a range of value added services, such as the provision of buying, marketing, management and training and merchandising services to downstream drug stores and other retail outlets. Recent years


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have seen the level of services provided being extended to include manufacturing, packaging, contract sales and drug testing. Downstream markets are also being extended to include mail order and direct distribution to patients.

Product mix includes the ratio of prescription products to over-the-counter products and other medicinal items relevant to this class, as well as the ratio of generic to branded products. For example existing and established companies that offer a wide range of quality or branded products gain greater market presence and product acceptance. In the immediate to near term future, biologics will gradually start to play a more important role.

In the case of price based competition, this is particularly fierce within the over-the-counter (OTC) pharmaceuticals segment and related medical areas as supermarkets actively expand this area of their business. Price competition is also growing in the face of scheduling status changes as an increasing number of products are now being granted unscheduled status and as such can now be sold without a prescription and/or outside of pharmacies.

Relationships with drug stores and other downstream retail outlets also play a role in influencing the competitive nature of the industry. Given the increasingly competitive nature of the industry at both the distribution and the retail level, this variable has continued to increase in importance in recent years.

Similarly, relationships with upstream manufacturers have also increased in relative importance. Another development of note in recent years has been the move towards more collaborative relationships with upstream manufacturers as wholesalers seek to take on a greater role within the pharmaceutical supply chain. This has seen the adoption of new business models including fee-for-service arrangements as well as fee-for-performance arrangements.

In analyzing the competitive basis of the industry it is important to note that pharmaceutical wholesale distribution operations tend to have narrow profit margins so an industry participant's earnings depend significantly on its ability to distribute a large volume and variety of products efficiently and to provide quality support services to external customers. These lower than average profit margins are indicative of an industry that operates on the basis of high volumes and lower margins.

Competition is also a function of product life cycle. Products in the introduction phase compete mainly on the basis of performance. As products begin to advance in the life cycle, and substitute products come into existence, the basis of competition begins to shift to price, and brand loyalty.

With regards to competition, it is interesting to note that wholesalers are also increasingly having to compete with manufacturers adopting new direct-to-pharmacy models as they seek to have greater control over the supply chain.

LIFE CYCLE Life Cycle Stage The life cycle stage is mature Life Cycle Reasons • Value added is growing slightly below that of the general economy • A number of players have left the industry in line with a phase of consolidation • The industry is benefiting from an aging population and the introduction of higher priced innovative pharmaceuticals Life Cycle Analysis


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The Prescription Drug Wholesaling industry is deemed to be mature, with industry value added increasing at an average rate of just 1.3% per annum over the five years to 2010, below that of the general economy.

At the same time a number of players have left the industry in line with the consolidation process currently occurring within the industry. By year end 2010, the number of industry enterprises is expected to have fallen by roughly 7% over the five year period.

The mature nature of some product segments such as cosmetics and toiletries where the market is nearing saturation despite constant efforts by manufacturers to reintroduce or reinvent products is also serving to restrain industry growth though this is being partially offset by the introduction of new products within the pharmaceutical product segment including higher priced bio-pharmaceuticals.

An aging population has also served to stimulate some growth in recent years and will continue to do so over the outlook period.

INDUSTRY CONDITIONS Prescription Drug Wholesaling in the US

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Industry Conditions BARRIERS TO ENTRY Barriers to entry in this industry are medium These barriers are steady

As with most wholesale industries, potential new entrants require capital investment in buildings and other structures as well as IT systems to establish a warehouse and distribution system and to survive alongside large and existing participants that have efficient systems in place.

The existence of well established vertically integrated operators who also operate at the manufacturing and/or retail level of the supply chain can act as a significant entry barrier. For example, Cardinal Health Inc, one of the largest U.S. pharmaceutical distributors, also operates the Medicine Shoppe International retail pharmacy franchise and it is also involved in the manufacture of medical and surgical products.

Some firms in the industry, particularly established firms, are in a better position to escalate their advertising outlays when new entrants enter the industry. As a result, advertising while increasing unit costs for established firms can also raise barriers for new entrants.

In most segments, customers are much more aware of the brand name of key components. To a certain extent, this gives manufacturers greater bargaining power in selling to firms that target more experienced buyers.

In the majority of instances, wholesale operators in this industry are required to obtain licenses and accreditation from state and federal agencies. For example, licenses are required to operate as a wholesaler in the state of California.

TAXATION

The Prescription Drug Wholesaling industry is subject to sales tax which then varies according to each U.S. state.

In general terms, the sales and use tax is applicable to some products purchased within the Prescription Drug Wholesaling industry. However prescription and non prescription drugs are exempt from any taxes around the nation, except in the state of Illinois, which carries a 1% tax.


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INDUSTRY ASSISTANCE The level of Industry Assistance is low The trend of Industry Assistance is steady

There are no specific tariffs for this industry

Tariffs do not apply to this industry. Instead they are accounted for at the manufacturing level.

However participants do receive some assistance (albeit limited) via industry bodies, providing them with industry exposure opportunities, such as trade shows and conferences, and allowing players to develop links with suppliers and customers.

REGULATION AND DEREGULATION The level of Regulation is medium The trend of Regulation is steady

Regulations relevant to the wholesaling industry are generally covered by each American state. In California, the state with the largest representation of drug and druggist wholesalers, the following applies to manufacturers and wholesalers (effective January 1, 2006):

A person may not act as a wholesaler of any dangerous drug or dangerous device unless he or she has obtained a license from the board (Board of Pharmacy). Upon approval by the board and the payment of the required fee, the board shall issue a license to the applicant. A separate license shall be required for each place of business owned or operated by a wholesaler. Each license shall be renewed annually and shall not be transferable.

The board shall not issue or renew a wholesaler license until the wholesaler identifies a designated representative-in-charge and notifies the board in writing of the identity and license number of that designated representative. The designated representative-in-charge shall be responsible for the wholesaler's compliance with state and federal laws governing wholesalers. A wholesaler shall identify and notify the board of a new designated representative-in-charge within 30 days of the date that the prior designated representative-in-charge ceases to be the designated representative-in-charge. A pharmacist may be identified as the designated representative-in-charge.

A drug manufacturer licensed by the Food and Drug Administration or licensed pursuant to Section 111615 of the Health and Safety Code that only distributes dangerous drugs and dangerous devices of its own manufacture is exempt from this section and Section 4161. The board may issue a temporary license, upon conditions and for periods of time as the board determines to be in the public interest. A temporary license fee shall be fixed by the board at an amount not to exceed the annual fee for renewal of a license to conduct business as a wholesaler.

Firms operating outside of California

A person located outside this state that ships, mails, or delivers dangerous drugs or dangerous devices into this state shall be considered a nonresident wholesaler. A nonresident wholesaler shall be licensed by the board prior to shipping, mailing, or delivering dangerous drugs or dangerous devices to a site located in this state.


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A separate license shall be required for each place of business owned or operated by a nonresident wholesaler from or through which dangerous drugs or dangerous devices are shipped, mailed, or delivered to a site located in this state. A nonresident wholesaler shall maintain records of dangerous drugs and dangerous devices sold, traded, or transferred to persons in this state, so that the records are in a readily retrievable form.

A nonresident wholesaler shall at all times maintain a valid, unexpired license, permit, or registration to conduct the business of the wholesaler in compliance with the laws of the state in which it is a resident. An application for a nonresident wholesaler license in this state shall include a license verification from the licensing authority in the applicant's state of residence. The board may not issue or renew a nonresident wholesaler license until the nonresident wholesaler identifies a designated representative-in-charge and notifies the board in writing of the identity and license number of the designated representative-in-charge.

The designated representative-in-charge shall be responsible for the nonresident wholesaler's compliance with state and federal laws governing wholesalers. A nonresident wholesaler shall identify and notify the board of a new designated representative-in-charge within 30 days of the date that the prior designated representative-in-charge ceases to be the designated representative-in-charge.

COST STRUCTURE

Year: 2010

Item Cost %

Purchases 85.0%*

Wages 3.0%*

Advertising 2.0%*

Rent 2.0%*

Depreciation 1.0%*

Other 5.5%*

Profit 1.5%*

IBISWorld estimates that as is typical of the wholesaling industry, purchases are the largest expense for the Prescription Drugs Wholesaling Industry. IBISWorld estimates that purchases will account for approximately 85% of industry revenue in 2010.

Note that purchase costs have increased in recent years in line with new product introductions and the increased consumer use of medications. However this trend has been partially offset by the increased demand for generic products that are relatively cheap compared with brand name pharmaceuticals.

The larger vertically and horizontally integrated businesses enjoy lower purchasing costs and are better able to move their stock of inventory from areas of weak market and product demand to areas with higher market and product demand.


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Note that wage and salary costs fluctuate with sales revenue and employment levels. The majority of wage and salary costs are incurred in the sales and sales support areas. More than 50% of employees are engaged in sales support. In comparison roughly 30% of employees are sales people. In general terms wages are thought to represent 3% of sales.

Some factors of production, such as managerial expertise and skilled labor are relatively expensive in this industry, but because of the possibility of increased efficiency with such inputs, they can lead to a decrease in the average cost of production and selling.

Other expenses include general office expenses as well as advertising and promotional costs. Advertising expense amounts to 2% of net sales revenue. Most participants incur minimal marketing expenses, instead relying heavily on existing arrangements with suppliers and customers to sell and distribute products. Advertising expenses are higher at the retail level.

Given the small amounts of capital expenditure, depreciation expense for the industry accounts for a small proportion of revenue. Cash generated from operations and selected borrowings provide the major sources of funds for the growth of the industry.

According to Cardinal Health, a participant's earnings will depend on its ability to: compete effectively on the basis of price; distribute a large volume and variety of products; provide quality support services; maintain low cost sourcing arrangements with generic pharmaceutical manufacturers and effectively manage inventory and other working capital items. It also makes the point that the five primary factors influencing the gross margin for pharmaceutical products are customer discounts, manufacturer cash discounts, distribution service agreement, fees, pharmaceutical price appreciation and manufacturer rebates and incentives.

In 2008/2009 net profit margins for the larger players operating within the pharmaceutical product segment were a meager 0.7% for AmerisourceBergen, 0.8% for McKesson and 1.2% for Cardinal Health.

Firms can lower their cost structure as a result of the superior scale of firms (greater spread of fixed costs), from having lower factor costs (for example, the integration of manufacturers and distributors), and from superior product capabilities (product scope).

CAPITAL AND LABOR INTENSITY The level of Capital Intensity is medium

• The labor component of the industry is mainly focused on providing sales services • There is an increasing reliance on automated systems

The capital intensity of the Prescription Drug Wholesaling Industry is determined by the ratio of labor costs (wages) to capital (depreciation). IBISWorld estimates that labor expenses are approximately 3.0% of industry revenue while capital expenditures are 1%. This gives a labor to capital ration of 3.0:1, meaning that for every dollar invested in capital, $3.00 is spent on labor. IBISWorld classifies this as a medium level of capital intensity.


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Wholesalers are increasingly dependent on the provision of superior service as a means of distinguishing themselves from manufacturers or large retail giants such as the supermarkets. Such developments are likely to continue to reduce the level of labor intensity in the industry over the outlook period.

Capital expenditure includes expenditure on warehousing and logistics, and computerized inventory systems. Often service and product quality sets firms apart, neither of which have a high capital component. Businesses capital expansion aims are related to economies of scale: lower cost of products from volume purchasing, new product lines, and financial, administrative and technical support.

An analysis of industry participants indicates that, as a percentage of net revenue, major players within the industry spend approximately 1% to 2% on property, plant and equipment each financial year.

In terms of capital expenditure firms across the industry maintain their financial condition and their ability to generate adequate amounts of cash while continuing to make significant investments in inventory, warehouse facilities, delivery equipment and computers to better meet the needs of their customers.

In terms of the labor component of the industry, around half of the staff in the industry are engaged in various sales support functions (office, clerical, warehousing and customer service). Sales staff account for a further 30% of employment and have relatively higher wage levels. The industry is reliant on a large number of people with skills in marketing, selling, packaging, as well as those people involved in the actual distribution of the products.

TECHNOLOGY AND SYSTEMS The level of Technology Change is medium

Recent years have seen businesses in this industry continue to evolve, with the most successful firms have added a broader range of services to manufacturers and end-users. This evolution has resulted from changing trends in the wholesale sector as well as among end-users.

Within the wholesaling industry, the main types of capital improvement have also converged upon the introduction and/or upgrading of communications technology. Some of this technology includes: online services which allow customers to search inventory lists, check pricing, and place and print-out orders, and be billed using their e-mail.

Developments in information technology systems have offered the possibility for firms to revolutionize procurement by changing ordering procedures and facilitating better supply chain management practice (to both suppliers and customer markets).

IBISWorld believes that the main technological developments have been electronic ordering systems such as Supply Management On-Line, which allows drugs and druggists' sundries products to be ordered over the internet. Programs such as Optipak are developed for wholesalers to allow customers to customize their ordering of supplies.

The internet has a great influence on the cost efficiency of the wholesale distribution process, by providing an alternative method for wholesalers to provide services to customers. This technology can also be used by manufacturers to bypass the wholesale function.

The growing acceptance and use of the internet, as well as other electronic commerce systems, in recent years has, and will continue to have, far-reaching implications for the Prescription Drug Wholesaling industry. In fact, it is expected that


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information technology will continue to redefine the relationship between distributor, retailer and customer in the immediate future. Many of the major players in this industry have employed electronic ordering systems for internet use.

By ordering over the internet orders can be stored automatically in the company computer system reducing manual entering errors, speeding the ordering process and providing a more efficient system.

Other effects of the internet on industry performance include the sale of pharmacy items such as OTC drugs and prescription medications via the internet. This phenomenon is already widespread in the U.S.A and is expected to continue over the coming years.

There have also been significant technological developments in the wholesaling industry in general, including the computerized automation of inventory control, which are of relevance to this industry. These allow inventory to be stored on a national or international basis, requiring fewer regional distribution centers and allowing more efficient distribution.

It is important for players to keep up to date with any changes in products sold by this industry. Although the level of technological change in products offered by this industry is medium to low wholesalers must be made aware of any new launches or product developments in order to provide current customers with state of the art products and win new business.

INDUSTRY VOLATILITY The level of volatility is low

The low level of volatility tends to reflect the essential nature of many of the products carried by the industry. Public health, and therefore industry demand, is not sensitive to short term changes in the economic environment. However, some items of a discretionary nature, such as fragrances and cosmetics, will be affected by changes in economic activity.

GLOBALIZATION The level of Globalization is medium The trend of Globalization is increasing

The U.S. Prescription Drug Wholesaling Industry is deemed to have a medium level of globalization in line with the increasingly global nature of the overall pharmaceutical industry. Indeed in recent years, the trend towards globalization has become more pronounced throughout the entire pharmaceutical supply chain, including at the distribution level.

At the manufacturing level, the international pharmaceutical product manufacturing industry is one of the world's largest manufacturing industries and is characterized by a broad geographical distribution of final production and marketing operations, high levels of foreign penetration in national markets and extensive intra-firm trade. A number of factors help to explain the highly globalized nature of the industry including minimal technical barriers in final drug formulation; the need to meet variations in the evaluation process and government regulations for admission of drugs onto the local market; and the highly segmented nature of individual markets as a result of national health and price regulations.

Within the U.S. Prescription Drug Wholesaling Industry, a number of participants (including the likes of Cardinal Health and McKesson Corporation) have operations overseas and it is expected that participants in this industry will continue to expand their global operations in the future.


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Aiding this development will be the growth of online/Internet sales as consumers throughout the world seek out better value purchases. The move by upstream manufacturers to outsource their manufacturing operations to contract manufacturing organizations (CMOs) located in lower cost Asian countries (including India and China) will also aid this development as a greater degree of domestic demand is then met by imported product.

KEY FACTORS Prescription Drug Wholesaling in the US

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Key Factors KEY SENSITIVITIES The key sensitivities affecting the performance of the Prescription Drug Wholesaling industry include: Average Age of Population Description: The age distribution of the population. Due to improved medical treatment, Americans are living longer on average. The aging population increases the demand for products from this industry such as prescription and non-prescription medications. Health - Number of Hospital Visits The number of visits to doctors affects the number of prescriptions written and therefore increases the demand for products supplied by this industry. Per Capita Disposable Income Description: The level of and/or movements in real per capita disposable income. The higher the level of disposable income, the greater the capacity to pay for higher price medical treatment and non-essential items such as fragrances and cosmetics. Private Health Insurance Membership Description: The number of Americans covered by private health insurance. Private health insurance membership allows for more access to medical care and therefore increases the number of doctor visits and number of prescriptions. As a result, demand for drugs and druggists sundries supplies tends to increase when private health insurance membership rises.

KEY SUCCESS FACTORS The key success factors in the Prescription Drug Wholesaling industry are:

• Guaranteed supply of key inputs Access to or contracts with, reliable manufacturers or importers.

• Having an extensive distribution/collection network Efficient warehouse and distribution systems.

• Having contacts within key markets Established links with a number of customers. It is preferable that wholesalers deal with a variety of customers and do not have one or two which account for the majority of their business.

• Provision of superior after sales service Exceptional customer service to retain key clientÃ¨le.

KEY FACTORS Prescription Drug Wholesaling in the US

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• Having a good technical knowledge of the product Staff-knowledgeable staff are required to liaise with clients and provide sound product advice.

• Ability to control stock on hand Stock control - computerized stock controls allow for up-to-date monitoring and analysis of inventory. They can be of use to service clients by advising them of stock levels and expected delivery schedules.

• Production of goods currently favored by the market Value for money - the products stocked should be perceived as offering value for money (unless the operator has an exclusive up market positioning).

KEY COMPETITORS Prescription Drug Wholesaling in the US

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Key Competitors MAJOR PLAYERS Market Share

Major Player Market Share Range

McKesson Corporation 22.0% (2010)

Cardinal Health, Incorporated 20.0% (2010)

AmeriSource Bergen Corporation 17.0% (2010)

Other 41.0% (2010)

PLAYER PERFORMANCE McKesson Corporation Market Share: 22.0%

The largest pharmaceuticals distributor within the U.S., McKesson Corporation is involved in the distribution of pharmaceuticals, beauty and health care products and medical supplies to retail and institutional pharmacies and to alternate health care sites (including doctors' offices, surgery centers and long term care facilities) within the U.S. and Canada. Following a recent restructure, it now operates just two segments; McKesson Distribution Solutions (which combines its former Pharmaceutical Solutions and Medical-Surgical Solutions and which accounted for 97% of revenue for the year ended March 2009) and McKesson Technology Solutions (its previous Provider Technologies segment). In the year ended March 2009 McKesson generated revenue of $106.6 billion, up from $36.7 billion in the year ended March 2000. Of this, its U.S. operations accounted for 93%. Employee numbers as at March 2009 stood at 32,500, up from 31,800 in 2007 and 21,000 in 2000 but down from 32,900 in 2008.

Of interest to this report is its Distribution Solutions segment which is involved in the distribution of ethical and proprietary drugs, medical-surgical supplies and equipment and health and beauty care products throughout North America. The segment is also involved in the provision of specialty pharmaceuticals solutions for biotech and pharmaceutical manufacturers, the sale of pharmacy software and the provision of consulting, outsourcing and other services. It also includes a 49% interest in Nadro, S.A. de CV, the leading pharmaceutical distributor in Mexico and a 39% interest in Parata Systems, LLC which sells automated pharmaceutical dispensing systems to retail pharmacies. Businesses within this segment include McKesson U.S. Pharmaceutical, McKesson Canada, Medical-Surgical Distribution, McKesson Pharmacy Systems & Automation, and McKesson Specialty Care Solutions.

Of note is McKesson's U.S. Pharmaceutical Distribution operations which supplies pharmaceuticals and other health care related products to more than 40,000 customers in three primary customer segments: national and regional retail chains (including drug/food combinations, mail order pharmacies and mass merchandisers), institutional health care providers (including hospitals, health systems, clinics and other acute-care facilities and long term care providers), and retail independent pharmacies. This operation serves over 30,000 locations through a network of 29 distribution centers, as well as a master distribution center, a strategic redistribution center and a repackaging facility, serving in all states of the U.S.


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Also of interest is its Medical-Surgical Solutions segment which provides medical-surgical supply distribution, equipment, logistics and other services to health care providers including physicians' offices, surgery centers, extended care facilities etc as well as alternate-site health care facilities through a network of 29 distribution centers within the U.S.

In the year ended March 2009 McKesson's Distribution Solutions segment generated revenue of $103.6 billion, up from $98.7 billion in 2008, $90.7 billion in 2007 and $85.1 billion in 2006. In comparison its Technology Solutions segment generated revenue of $3.0 billion. Of note is the fact that a significant portion of its revenue growth has been with a limited number of large customers; in 2009 sales to its ten largest customers (including pharmacy benefits manager Caremark RX, Inc and Wal-Mart) accounted for just over half of its total consolidated revenue with the top two customers (CVS Caremark and Rite Aid) counting for 26%.

In recent years McKesson's Distribution segment has benefited from an increasing sales mix of higher margin drugs including generics as well as the introduction of its fee-for-service contracts. These measures have helped to slowly boost margins. McKesson claims to be the largest pharmaceutical distributor within North America, distributing one third of the medicines consumed each day and supplying over 40,000 U.S. pharmacies.

Financial performance

In the year ended March 2009 McKesson generated sales of $106.6 billion, up 5% on the previous year ($101.7 billion). This compares with a growth rate of 9% in the previous year. Driving this growth in recent years has been its Distribution Solutions segment (which accounted for 97% of consolidated revenue in both years) which reflected market growth rates (including higher drug utilization and price increases), and new and expanded business. Recent acquisitions have also boosted sales including those of McQueary Brothers Drug Company (a regional distributor of pharmaceutical, health and beauty products to independent and regional chain pharmacies in the Midwestern region) in May 2008, Oncology Therapeutics Network (a U.S. distributor of specialty pharmaceuticals) in October 2007 and Per-Se Technologies, Inc in January 2007.

These variables also underlie the growth in U.S. pharmaceutical direct distribution and service revenue which totaled $66.88 billion in 2009, up from $60.44 billion in 2008 and $54.13 billion in 2007. However sales to customer warehouses were marginally lower in 2009 at $25.81 billion (compared with $27.67 billion in 2008 and $27.55 billion in 2007) reflecting the loss of a large customer, plus revenue lost as a result of the consolidation of certain customers. A shift to direct store delivery also impacted on revenue derived from these particular operations. In 2009 sales to customers warehouses accounted for 29% of U.S. pharmaceutical distribution sales (down from 33% and 35% in the previous years) compared with 32% for direct sales to institutions, 26% for direct sales to retail chains and 13% for direct sales to independents.

In the year ended March 2007 McKesson had posted sales growth of 7%, with revenue for the year amounting to $93.0 billion, up from $88.5 billion in the previous year. Again this growth was predominantly derived from its Pharmaceutical Solutions segment (which accounted for 95% of consolidated revenue) which had benefited from market growth rates as well as the earlier acquisition of D&K Healthcare Resources Inc in the second quarter of 2006. Within its U.S. pharmaceutical distribution operations, direct distribution and service revenue was higher relative to the previous year despite the loss of a large customer as were sales to customer warehouses primarily as a result of new and expanded agreements with customers.

In 2006 sales growth was in the order of 9.4%, down from 15.8% in the previous year and 21.6% in 2004. Growth for the year had been attributable to existing customer sales growth and the acquisition of D&K Healthcare Resources, Inc. Chain stores accounted for 22% of sales, up from 20% to the previous year. Institutions accounted for 32% of sales, declining by 2% as a share of total sales. The remaining 12% of sales were to independent retailers. Overall, strong performance was due to increasing drug utilization and price gains, partly offset by increased demand for low-priced generic drugs.


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For the 12 months ended March 2005, McKesson Corporation had reported sales revenue of $80.51 billion, up from $69.5 billion in the previous year. Driving sales revenue during the year was a 9% increase in revenue from the Pharmaceutical Solutions business as well as a 7.8% increase in sales revenue from the Medical-Surgical Solutions business. U.S. Healthcare pharmaceutical direct distribution and services revenue increased during the period due to new pharmaceutical distribution agreements, the acquisition of D&K Healthcare Resources, expanded agreements with existing customers and continued, although slowed market growth among existing customers. There was a net loss of $156.7 million due to Securities Litigation charges and competitive price pressures.

In the first quarter of 2009 McKesson acquired McQueary Brothers Drug Company, a regional distributor of pharmaceutical, health and beauty products to independent and regional chain pharmacies in the midwestern U.S.

In the six months ended September 30 sales derived from its U.S. pharmaceutical distribution & services operations amounted to $46.44 billion, essentially unchanged on the previous corresponding period ($46.0 billion).

McKesson Corporation - financial performance Year*

Million Dollars Revenue

% Growth Growth

Million Dollars Net Income

% Growth Growth

Employees

2004-05 80514.6 15.8 -156.7 N/C 25200 2005-06 88050.0 9.4 751.0 N/C 26400 2006-07 92997.0 5.6 913.0 21.6 31800 2007-08 101703.0 9.4 990.0 8.4 32900 2008-09 106632.0 4.8 823.0 -16.9 32500 Source: Annual Report Note: * Year end March Cardinal Health, Incorporated Market Share: 20.0%

The second largest player within the industry, Cardinal Health is a leading distributor of pharmaceuticals and medical products. Indeed the company claims to distribute approximately one third of all pharmaceutical products distributed within the U.S. The company's customers include hospitals, clinics, other medical offices and retailers. According to the company, its depth and breadth of products is unique within the industry and as such provides it with a competitive advantage. As at June 2009, the company had 29,600 employees within the U.S. with a further 16,900 employed outside of the U.S. Following the spin off of its clinical and medical products business (CareFusion Corporation) in September 2009, Cardinal Health is now operating just two business segments: Pharmaceutical and Medical. However, in fiscal 2009 it had three reportable segments; Healthcare Supply Chain Services, Clinical and Medical Products and All Other. Of these, its Healthcare Supply Chain Services division accounted for 94% of fiscal 2009 sales and 64% of company profits.

Of interest to this report is its Healthcare Supply Chain Services - Pharmaceuticals Supply Chain business under which it distributes a broad line of branded and generic pharmaceutical products, OTC health care products and consumer products. Operating as a full service wholesale distributor, the segment also provides a number of customer support services including online procurement, fulfillment and information via cardinal.com, computerized order entry and order confirmation systems, generic sourcing programs, product movement, inventory and management reports and consultation on store operations and merchandising. In addition, the segment operates a pharmaceutical repackaging and distribution for chain and independent drug store customers. Customers serviced include chain and independent drug stores, pharmacy departments of supermarkets and mass merchandisers, hospitals and alternate care providers including mail order pharmacies. Key customers include the likes of CVS Corporation and Walgreen Co with these two customers accounting for roughly 44% of fiscal 2009 revenue. In the same year its top five customers accounted for 54% of all sales.


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In comparison its top five suppliers accounted for approximately 22% of company revenue. Support services are also provided to branded pharmaceutical manufacturers and can include inventory management services, data/reporting services, new product launch support and contract and chargeback administration services.

Of note is the fact that the segment differentiates between bulk and non bulk customers with the former including customers' centralized warehouse operations and customers' mail order businesses while non bulk customers include retail stores, pharmacies, hospitals and alternate care sites. Bulk customers are thought to generate significantly lower segment profits as a percentage of revenue although non bulk customers require more complex servicing.

During fiscal 2005 and fiscal 2006 Cardinal implemented a new fee-for-service arrangement system which relies on written distribution service agreements. Relative to previous business models, the new system is less dependent on manufacturers pricing practices and is more reflective of the level of service provided.

Cardinal Health operates manufacturing and distribution facilities in 45 U.S. states and Puerto Rico; it also has manufacturing facilities outside the United States. These include manufacturing, distribution and research facilities in Australia, Canada, the Dominican Republic, France, Germany, Italy, Ireland, Malaysia, Malta, Mexico, Thailand, and the UK. With regards to its Healthcare Supply Chain Services - Pharmaceutical segment it has 24 pharmaceutical distribution facilities and four specialty distribution facilities within the U.S. as well as 167 nuclear pharmacy laboratory, manufacturing and distribution facilities and 50 medical-surgical distribution and assembly facilities.

Acquisitions

Much of the growth enjoyed by Cardinal Health over the past two decades can be attributed to its acquisitive path; since 1980 it has made more than 50 acquisitions. Purchases made in the 1990s include Ohio Valley-Clarksburg (1990, the Mid-Atlantic), Chapman Drug Co. (1991, Tennessee), PRN Services (1993, Michigan), Solomons Co. (1993, Georgia), Humiston-Keeling (1994, Illinois), and Behrens (1994, Texas). In 1994 it acquired the number six drug wholesaler Whitmire distribution which served to propel Cardinal into the number three slot. In the following year it made its biggest purchase yet ($348 million in stock), that of Medicine Shoppe International, the countries largest franchisor of independent retail pharmacies. Attempts to acquire rival Bergen Brunswig in 1998 were blocked by the Federal Trade Commission

Since 2003 it has made a number of further acquisitions including The Intercare Group, Plc (the UK) for $570 million in 2003, ALARIS Medical Systems, Inc for $2,080 million, Medicap and Snowden Pencer Holdings, Inc in 2004, Geodax Technology, Inc in fiscal 5005 and ParMed Pharmaceutical, Inc and Denver Biomedical, Inc in fiscal 2006. Fiscal 2007 saw the purchase of medical equipment manufacturer Viasys Healthcare Inc, data miner MedMined, Care Fusion and SpecialtyScripts LLC.

At the same time it has made a number of divestments including the international and non core domestic businesses of Syncor International Corporation and a significant portion of its specialty distribution business (which had been involved in the trading of excess inventories on the secondary drug market). In fiscal 2007 it sold its Pharmaceutical Technologies and Services business to the Blackstone Group for $3.3 billion as well as its health care marketing services business and its UK based Intercare pharmaceutical distribution business. In fiscal 2009 it then sold its Tecomet (orthopedic implants and instruments) and MedSystems business. In September 2009 it completed the spin off of its CareFusion business.

Financial performance

Following on from revenue growth of 5% in fiscal 2008, the company posted sales growth of 9% in fiscal 2009 with sales totaling $99.5 1 billion, compared with $90.97 billion in fiscal 2008 and $86.75 billion in fiscal 2007. Growth was driven by the combination of pharmaceutical price appreciation, increased volume from existing customers, the addition of new


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customers (which was partially offset by the loss of some existing customers) and the benefits derived from recent acquisitions. The Healthcare Supply Chain Services division generated sales of $95.72 billion (representing 10% growth), up from $87.11 billion and $83.85 billion in the previous two years. Divisional profits were also marginally higher at $1.34 billion, compared with $1.33 billion in the previous year though down from $1.52 billion in fiscal 2007. This reflected higher gross margins (which in turn were the result of increased distribution agreement service fees, increased manufacturer cash discounts and pharmaceutical price appreciation) which were then partially offset by higher SG&A expenses (higher bad debt expenses).

In fiscal 2008, $79.3 billion had been derived from its Healthcare Supply Chain Services-Pharmaceutical segment which represented a 4% rise on the previous year ($76.57 billion). However segment profits were 14% lower at $1.1 billion, reflecting customer re-pricings, and direct-store-door customer losses the effects of which were only partially offset by branded pharmaceutical price increases and greater profit from distribution service agreement fees.

In fiscal 2006 the company had posted sales growth of 8.6% (down from 15.2% in the previous year) with the distribution segment again leading the growth. During the year, transition to a fee-for-service business model for general pharmaceuticals was completed. Under the new model, Cardinal Health is compensated for the provision of data relating to sales and distribution trends to manufactures that assist them with market and demand forecasting. In addition, the company receives fee-based compensation for distributing services, and is therefore less dependent on manufacturer's pricing practices.

In recent times, the company's pharmaceutical segment has been challenged by "a comparatively tougher environment for its generics business, repricing of large contracts, increased surveillance costs at federally regulated facilities and some unfavorable pricing in the radiopharmaceutical market". It has also been adversely impacted by license suspensions that have prevented it from distributing controlled substances from three out of its 24 distribution centers.

Following the spin off of its CareFusion business in September 2009 the company now hopes to benefit from "enhanced management focus and sharper strategic vision".

Cardinal Health - financial performance Year*


% Growth Growth

Million Dollars Net Income

% Growth Growth

Employees

2004-05 74910.7 15.2 1050.7 -28.7 55000 2005-06 81363.6 8.6 1000.1 -4.8 55000 2006-07 86852.0 6.7 1931.1 93.1 43500 2007-08 91091.4 4.9 1300.6 -32.6 47600 2008-09 99512.4 9.2 1151.6 -11.5 29600 Source: hoovers.com Note: * Year end September AmeriSource Bergen Corporation Market Share: 17.0%

The third largest player within the industry, AmerisourceBergen distributes pharmaceuticals and health care products throughout the U.S. and Canada, as well as operates a number of packaging facilities. The company, initially known as Alco Health went public as AmeriSource Health in 1995 and subsequently bought competitor Bergen Brunswig in 2001. The company serves a variety of clients which include hospitals, managed care facilities, drugstores, nursing homes, clinics, supermarkets, and mass merchandisers across the U.S. In the year ended September 2009 it generated revenue of $71.76 billion, up from $16 billion in 2001. Employee numbers as at year end September 2009 numbered 10,300


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compared with 13,700 in 2001. The company is currently describing itself as one of the world's largest pharmaceutical service companies, serving the U.S., Canada and selected global markets with a focus on the pharmaceutical supply chain.

The Company's operating segments have been aggregated into two reportable segments: Pharmaceutical Distribution (96% of fiscal 2008 sales) and Other (which includes its PharMerica operations). The former segment includes the operations of AmerisourceBergen Drug Corporation (ABDC), AmerisourceBergen Specialty Group (ABSG), Bellco Health and AmerisourceBergen Packaging Group (ABPG).

The first of these (ABDC) includes the company's full service wholesale pharmaceutical distribution facilities and other health care related businesses in both the U.S. and in Canada. According to the company, ABDC "distributes a comprehensive offering of brand name and generic pharmaceuticals, over-the-counter health care products, home health care supplies and equipment, and related services to a wide variety of health care providers, including acute care hospitals and health systems, independent and chain retail pharmacies, mail order pharmacies, medical clinics, alternate site facilities and other customers. ABDC also provides pharmacy management, consulting services and scalable automated pharmacy dispensing equipment, medication and supply dispensing cabinets, and supply management software to a variety of retail and institutional health care providers."

ABSG in comparison is involved in the provision of distribution of specialty pharmaceutical products (including vaccines, other injectables, plasma and other blood products) and other value added services to physicians, clinics, patients and other providers in the oncology, nephrology, plasma and vaccines sectors, as well as an array of services for manufacturers. This business also provides commercialization services, third party logistics, reimbursement consulting services, physician education consulting and other services to biotech and other pharmaceutical manufacturers. In 2008 the specialty pharmaceuticals business generated operating revenue in the order of $14.6 billion with the company believing that it commands a significant presence within this rapidly growing part of the pharmaceutical supply chain. It also believes that the business posses a well developed platform for growth.

ABPG comprises American Health Packaging (whose operations are closely aligned with those of ABDC), Anderson Packaging (a leading provider of contract packaging services for pharmaceutical manufacturers) and Brecon Pharmaceutical Ltd which operates in

the UK.

In the year ended September 2007 its Pharmaceutical Distribution segment generated revenue of $60.9 billion compared with $55.9 billion in 2006 and $49.3 billion in 2005. In fiscal 2008 this figure was higher again at $67.5 billion.

In fiscal 2009, the company's largest customer (Medco Health Solutions, Inc) accounted for 17% of total company revenue, and 90% of bulk deliveries to customer warehouses, with its second largest customer accounting for a further 8% of operating revenue. Its top ten customers for the year accounted for 41% of total revenue. In the same year institutional customers accounted for 68% of total revenue while retail customers accounted for 32%.

In recent years AmerisourceBergen has sought to increase its operating efficiencies. To this end it initiated its Optimiz program in fiscal 2001 which has seen it reduce its distribution network within the U.S. from 51 facilities to 26 full service facilities as of September 2007; 31 facilities were closed during this period while six new facilities were opened. It is thought that these measures were successful in reducing operating costs and working capital giving it one of the lowest cost operating structures within the industry. It also outsourced a considerable portion of its information technology activities. At the same time it implemented new warehouse automation technology as well as adopted "best practices" in its warehousing activities. The remaining facilities are located in Alabama, Arizona, California, Colorado, Florida, Georgia,


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Hawaii, Illinois, Kentucky, Massachusetts, Michigan, Missouri, Minnesota, New York, New Jersey, North Carolina, Ohio, Pennsylvania, Texas, Utah, Virginia and Washington. ABDC also has 11 distribution facilities within Canada. In addition, the Specialty group has significant operations located in Alabama, Kentucky, Nevada, North Carolina and Ohio.

Strategy

The company's business strategy solely revolves around the pharmaceutical supply chain and the provision of value added distribution and service solutions to various health care providers including pharmacies, health systems and physicians and pharmaceutical manufacturers. It believes that it is well positioned in size and market breadth to continue to grow its distribution business. It also believes that it has one of the lowest cost operating structures in pharmaceutical distribution among its major competitors. Of note is its focus on generic pharmaceuticals in line with their rapid growth within the U.S. market and in recent years it has sought to enhance its position within the generic marketplace. At the same time it has also sought to expand its product/service offering within the general pharmaceutical supply channel, offering various value added services and solutions. Also of note is its use of acquisitions in order to supplement its organic growth and boost its strategic growth plans.

In 2008 the company announced a new initiative (by the name of cE2) designed to further improve customer efficiency and cost effectiveness. It also introduced a more streamlined organizational structure.

Acquisitions

In recent years the company has made a number of acquisitions, expanding into areas including inventory management technology, drugstore pharmaceutical supplies, and disease-management services for pharmacies. In 1997 AmeriSource made its largest purchase of Walker Drug for $140 million, adding 1,500 drugstores in the Southeast to its customer list. Also, during the year, the company signed a five-year deal to become the exclusive pharmaceutical supplier to Sutter Health, a not-for-profit organization. During 1999 the company acquired pharmaceutical distributor C.D. Smith Healthcare and in 2000 the company initiated an online health products marketplace called NewHealthExchange.com, with McKesson, Cardinal Health, Fisher Scientific and Owens & Minor. In 2002 the company bought a maker of automated pharmacy dispensing equipment, AutoMed Technologies. In fiscal 2006 it acquired three businesses (Trent Drugs Wholesale Ltd, Asenda Pharmaceutical Supplies Ltd and Rep-Pharm Inc) to expand its distribution and service businesses into Canada with these acquisitions making it the second largest pharmaceutical distributor within the Canadian market. It also acquired Access MD Inc to complement the distribution services offered by AmerisourceBergen Canada Corporation. 2006 also saw the purchase of Health Advocates, Inc, a leading provider of Medicare set-aside cost containment services to insurance payors operating within the workers' compensation industry, as well as of ICG of America, inc, a specialty pharmacy and infusion services business specializing in the blood derivative intravenous immunoglobulin in line with its strategy of building its specialty pharmaceutical services to manufacturers.

2007 saw the purchase of Xcenda LLC with the purchase intended to enhance its consulting business within its existing pharmaceutical and specialty services businesses. Its latest acquisition made in October 2007 was that of Bellco Health, a privately held New York distributor of branded and generic pharmaceuticals. Generating sales of $2.1 billion in its fiscal year ended June 2007 the business was acquired for $181 million in cash and will expand AmerisourceBergen's presence in the Metro New York community pharmacy market. The year also saw the sale of its Long Term Care business which had previously been included within the Other business segment. Prior to its sale, Long Term Care had been a leading national dispense of pharmaceutical products and services to patients in long term care and alternate site settings. In October 2008 it sold PMSI, its workers compensation business which had generated revenue of roughly $400 million in fiscal 2008. It was sold for $34 million.


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In fiscal 2009 it acquired Canadian specialty pharmaceutical services company Innomar Strategies Ltd for $13.4 million in a move designed to increase its specialty distribution and services presence in Canada.

Financial summary

In fiscal 2009 AmeriSourceBergen generated total revenue of $71.76 billion, up just 2% on fiscal 2008 results. The year saw ABSG post 7% sales growth while ABDC posted growth of just 1.8% following the loss of a national retail drug chain customer. Growth in operating income was a higher 7% giving rise to an operating profit margin of 1.23% up 5 basis pts on the prior year.

In fiscal 2008, total revenue for AmerisourceBergen amounted to $70.2 billion, up 7% on the previous year ($66.07 billion) driven by growth within its Pharmaceutical distribution segment which in turn partially reflected its recent Bellco acquisition (3%) as well as revenue growth within ABDC (5%). Operating income for the company totaled $828 million, up 5% on the previous year. In the case of the pharmaceutical distribution segment operating income was 15% higher at $107 million which saw it increase its operating income as a percentage of total revenue by 7 basis points. At the same time operating income was adversely impacted by the costs of facility consolidation and employee severance. Customer mix for the year saw a slightly lower focus on retail sales (32% as opposed to 36% in the previous year) with the bulk of the revenue derived from sales to institutional customers (68%) following the decision not to renew a contract with a large retail customer.

Growth had also been a relatively strong 8% in fiscal 2007. This was predominantly attributable to increases in revenue for both its ABDC and ABSG operating segments with the former reporting a 6% increase in operating revenue while ABSG recorded a 23% increase in operating revenue. Overall Pharmaceutical Distribution operating revenues totaled $60.9 billion, up 9% on the previous year. During the year 62% of segment revenue came from sales to institutional customers following strong growth in its specialty pharmaceutical business compared with 38% for sales to retail customers. Operating income for the segment was 14% higher at $733 million reflecting improved operating expense margins. Revenue derived from bulk deliveries totaled $4.4 billion, down 3% on the previous year.

For the year ended September 2006, the company achieved revenue growth of 12.1%, to reach $61.2 billion. Net income increased by 51.4% to $467.7 million. Contributing to a major portion of industry revenue, the Pharmaceutical Distribution business generated $55.9 billion in revenue, 90% of the total, while the PharMerica business accounted for 3%, at $1.67 billion. During the year, two new drug distribution centers began operation in Kansas City, MO, and Bethlehem, PA. The establishment of these centers, into which the company began investing in 2001, contributed to the increase in capacity and lower costs. The company also made three acquisition of drug distribution business in Canada, making AmerisourceBergen the second largest player in that country.

For the fiscal year ended September 2005 AmerisourceBergen reported operating revenue of $54.58 billion, an increase of 2.6% from the previous financial year. While consolidated sales revenue increased by 2.7%, financial reports indicate that sales revenue in the Pharmaceutical Distribution business increased by 2.5% or $1.206 billion to $49.319 billion. AmerisourceBergen reported that the Pharmaceutical Distribution business' growth largely reflected U.S. pharmaceutical industry conditions, including increases in prescription drug utilization and higher pharmaceutical prices offset by the increased use of lower priced generics. The revenue in the Pharmaceutical Distribution business has also been affected by industry competition and changes in customer mix.

At this point in time total revenue growth for fiscal 2010 for ABDC and ABSG is expected to be in the order of 5 to 7% reflecting current conditions within the U.S. pharmaceutical industry as well as heightened competition and changes in customer mix.


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AmerisourceBergen Corporation - financial performance Year*


% Growth Growth

Million Dollars Operating Income

% Growth Growth

Employees

2004-05 54577.3 2.6 264.6 -43.5 13400 2005-06 61203.1 12.1 467.7 76.8 14700 2006-07 66074.3 8.0 469.2 0.3 11300 2007-08 70189.7 6.2 250.6 -46.6 10900 2008-09 71759.9 2.2 N/A N/C 10300 Source: Annual Report Note: * Year end September

OTHER PLAYERS

Kinray Inc.

Estimated market share: 1.0%

Kinray is the U.S.'s largest privately-held distributor of pharmaceutical, generic and health & beauty care products with annual revenue in excess of $4 billion. Operating as a full line, full service wholesale distributor within a niche market, Kinray distributes drugs, health and beauty products, medical equipment, vitamins and herbals, and diabetes-care products as well as 800 private label pharmacy products under the Preferred Plus Pharmacy brand. In recent years it has tended to focus on higher margin generic drugs and private label home health care products; it currently carries over 8,000 generic products. The company services over 4,000 independent pharmacies in eight states (New York, New Jersey, Connecticut, Pennsylvania, Rhode Island, Massachusetts & Delaware). Operating out of one 400,000 sq ft facility, employee numbers currently total 1,000, up from 400 in 2000. The company was first founded in 1944.

Claiming to be the fourth largest wholesaler in the country, Kinray generated revenue of $4.8 billion in the year ended December 2007, up from $2.5 billion in 2002. The company claims that it has enjoyed "unparalleled" growth in recent years. For 2008 it was listed as number 73 in Forbes Magazine's top privately held companies in America.

Having experienced average growth rates of 20% per year for the past five years, sales are now thought to be approaching the $5 billion mark.

Quality King Distributors Inc

Estimated market share: 0.7%

A privately owned company, Quality King distributes groceries and hair, health, and beauty care products to pharmacy and grocery chains throughout the U.S. The company's QK Healthcare subsidiary is involved in the distribution of pharmaceuticals. Quality King Distributors' business practice is to buy U.S. name-brand products that have been exported to overseas markets, then re-import them and reintroduce them to the U.S. market below market price. Annual revenue is thought to exceed $2 billion with revenue of $2.5 billion in 2007, up from $1.9 billion in 1999. As at October 2007, it had 875 employees, down from 1,400 in 2002.

Kinray Inc. - financial performance


February 10 2010


Year


% Growth Growth

Employees

2004 3510 20.6 1000 2005 4000 14.0 800 2006 4400 10.0 1000 2007 4800 9.1 1000 Source: hoovers.com

INDUSTRY PERFORMANCE Prescription Drug Wholesaling in the US

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Industry Performance CURRENT PERFORMANCE

Over the five years to 2010, the Prescription Drug Wholesaling industry enjoyed moderate growth, fueled by rising demand levels and higher drug prices. By year-end 2010, revenue levels are expected to reach $421.7 billion, up from an estimated $369.5 billion (in constant 2010 prices) in 2005, representing an average increase of 2.7% per annum. In contrast, employment levels tended to fall over the same time period. By year end 2010, employment levels are expected to be in the order of 259,500, compared with an estimated 265,000 in 2005, representing an overall fall of 2.0% as various players sought to consolidate the number of distribution facilities used. In a number of years the benefits of an increase in drug utilization and higher pharmaceutical prices was then partially offset by the increased use of lower priced generics. Across the industry, these types of competitive issues impacted on industry competition and affected the industry's profitability as changes in customer mix to lower priced generic products impacted the margins generated within the industry.

Moderate revenue growth.

Having experienced strong growth in 2005 with revenue rising by an estimated 8.2%, growth rates then dropped away to 2.1% in real terms (though a marginally higher 5.4% in current terms) in 2006. The main feature of the year was the boost in sales volumes arising from the January 2006 launch of the new Medicare Part D outpatient prescription drug plan (part of the Medicare Prescription Drug Improvement and Modernization Act of 2003); indeed according to IMS Health, the program expanded the market by nearly 1.0% in 2006 with the total number of dispensed prescription volumes increasing by nearly 5.0% while prescription sales increased by 8.0%. During the year, the number two player in the industry, Cardinal Health, increased its industry share by switching to a fee-for-service business model for the distribution of generic pharmaceuticals, whereby it generates additional income for data provided to manufacturers on the sales patterns of their products.

In 2007, the Prescription Drug Wholesaling industry is estimated to have generated sales of $378.0 billion, essentially unchanged on the previous year. Once again the performance of the industry was influenced by volume and drug pricing trends associated with the Medicare Part D program as well as the effects of generic substitution rates. However, total dispensed prescription growth for the year was considerably lower at 2.8% while overall sales growth in the prescription product segment were also considerably lower with growth rates just under half of 2006 levels. The year also witnessed fewer new product launches as well as further safety concerns with a number of black box warnings and product withdrawals; indeed according to IMS Health the year was thought to have seen the smallest number of new product launches in nearly three decades.

In 2008, the industry had to contend with a leveling off of growth arising from the Medicare Part D program, combined with increased cost containment pressures from third party payers which contributed to a slowdown in growth in retail pharmaceutical dollar sales; total prescription sales increased by just over 1.0% while dispensed prescription volume growth was less than 1.0%. Curbed expenditure patterns in view of the global financial crisis and marked deterioration in the local economy and increased demand for less expensive generic drugs also served to restrain growth during the year. At the same time higher drug prices (up 2.5%) were also a feature of the industry. In view of the above revenue growth was an estimated 5.0%.

In 2009, the industry had to face the continued challenges of lower consumer discretionary expenditure, which impacted upon the demand for cosmetics and personal care items and intensifying generics competition. Moves by pharmacy chains to tighten inventory levels also impacted on industry performance along with increased volatility in purchasing


February 10 2010


patterns. At the same time it was expected to benefit from increased Medicare and Medicaid expenditure which was expected to offset lower private prescription drug expenditure. In 2010, revenue growth rates are also expected to be relatively subdued (3.0% as opposed to 3.2% in 2009) with price increases being one of the key growth drivers. The year may also witness fundamental changes to the U.S. health care system, the implications of which have yet to be fully determined.

Rising domestic demand.

The Prescription Drug Wholesaling industry is involved in the distribution of a range of products including medical and pharmaceutical products (including prescription and over the counter drugs), medical and first aid supplies as well as personal care goods. The demand for such industry products is determined by a number of factors including the age structure of the population, general levels of disease rates, government health policies and economic conditions.

In recent years there has been a steady rate of growth in the number of pharmaceutical products consumed within the United States, reflecting in part the effects of increasing life expectancies and an aging population which has served to increase the demand for drugs, particularly for degenerative diseases such as cardiovascular, cardiopulmonary, cancers and arthritis.

The development of new and more sophisticated diagnostic processes and drugs, including the new biotech drugs as well as changes in practitioner's prescribing habits and less restrictive health-insurance products has also stimulated demand levels as has a greater emphasis on prevention and a healthy lifestyle resulting in increasing demand for an expanding range of OTC pharmaceuticals and other health-related products.

In view of the above, one good indication of the level of domestic demand within the industry is given by consumption expenditure levels on both drug preparations and sundries and on toilet articles and preparations.

Pharmaceutical expenditure.

Recent years have seen a continued rise in both the total national health expenditure bill for the United States, as well as the pharmaceutical expenditure bill; indeed the United States is the largest spender on pharmaceuticals in the OECD/world. In 2007, prescription medicines accounted for 10% of the total U.S. health care bill. At the same time however, growth rates in pharmaceutical expenditure have been more restrained as managed care organizations (as well as various government programs) sought to curb their escalating health-care expenditure levels. Of particular importance has been the cost-containment strategies employed by MCOs (including health maintenance organizations, medical insurance programs, hospital/physician alliances and preferred provider organizations), many of which have merged into even larger entities. With a significant proportion of the U.S. population participating in some form of managed care program, the downward pricing pressure exerted by MCOs (who have significant purchasing power) has had a substantial impact on the revenue earned by various industry participants. A number of the cost containment strategies employed by MCOs have focused on the use of co-payments and generic substitution (i.e. a brand name drug is replaced with a cheaper generic copy).

In 2005, prescription drug expenditure increased by 5.8%, down from a growth rate of 8.4% in the previous year. A significant deceleration in Medicaid drug spending and a lower number of new product introductions combined with an increasing reliance on tiered co-payment benefit plans and usage of generic drugs are believed to have contributed to this apparent slowdown. Then in 2006, drug expenditure increased by 8.5% (boosted by the Medicare Part D prescription benefit program) before slowing back down to 4.9% in 2007 in view of slower prescription drug price growth, an increase in the generic dispensing rate and growing safety concerns.


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Growth rates were expected to have fallen further in 2008 (down to an estimated 3.5%) reflecting the effects of the global financial crisis as consumer either cut back on prescription drugs or increase their use of lower cost generic drugs. However, in 2009 a slight rebound was expected (4.0%) as a result of higher Medicare/Medicaid expenditure.

It is interesting to note that in 2008 the average brand name prescription price was $137.90 (up 14% on the previous year) while the average generic price was $35.22 (up 9%) giving an average prescription price of $71.69 compared with $64.86 in 2005. However of this average cost wholesalers received just $2.51 or 3.5%.

Changes in the regulatory backdrop.

Of initial concern to the industry, given the ramifications of pricing pressure, was the Medicare Prescription Drug Improvement and Modernization Act of 2003, which was enacted in December 2003. The Act provided for a voluntary discount card for Medicare beneficiaries from June 2004 onward and added prescription drug coverage to Medicare from 2006 onward. By expanding population coverage, it is thought that this new Part D program has increased the use of pharmaceuticals within this supply channel to the benefit of pharmaceutical distributors. By year end 2007 prescriptions dispensed through the Medicare Part D program accounted for 19% of retail prescriptions. The part D program was then later modified by the Medicare Improvements for Patients and Providers Act of 2008.

Also of note is the Deficit Reduction Act of 2005 which included provisions changing the prescription drug reimbursement formula for generic pharmaceuticals under Medicaid to one based on the lowest average manufacturers' price (AMP) in an attempt to reduce net Medicaid and Medicare expenditure by roughly $11 billion over five years program. With the final rules released by the Centers for Medicare and Medicaid Services (CMS) in July 2007, major changes to the reimbursement formula were initially to become effective in the second and third quarters of fiscal 2008. However, the Medicaid Improvements for Patients and Providers Act of 2008 (MIPPA) which was enacted by Congress in July 2008 delayed the adoption of the July 2007 rule and prevented CMS from publishing AMP data until October 1, 2009.

Regulations have also been introduced in a number of states seeking to monitor the pharmaceutical distribution system in view of safety concerns with regards to counterfeit, adulterated or mislabeled pharmaceuticals. For example, regulations requiring pedigree tracking and/or chain of custody tracking in certain circumstances became effective on December 1, 2006 under the federal Prescription Drug Marketing Act, although these regulations have already been challenged in a case brought by secondary distributors. Should they be enforced, such regulations will add to the regulatory burden and costs associated with the distribution of pharmaceuticals.

In the immediate future, the industry may also have to contend with health-care reforms under the new Obama led government; for example in May 2009 the Government secured a historic agreement with doctors, hospitals, insurers and the pharmaceutical industry whereby the major lobby groups agreed to trim the growth in health-care costs by 1.5 percentage points per year for the next ten years. Reform of the health insurance system also appears to be on the cards. A number of Medicare and Medicaid policy reforms were included.

Changing product mix.

The product portfolio of a number of industry participants underwent some fundamental changes over the performance period in line with the changing industry backdrop. The continued introduction of new (and more expensive) drugs initiated a number of changes, as did the continued rise in the use of generic products. Recent years have also seen industry participants expand their product portfolio to include both the newly emerging range of biotech drugs in line with technological advancements as well as a growing range of complementary or alternative medicines in view of the growing focus by an increasing number of U.S. consumers on a more holistic approach to their general health and well-being.


February 10 2010


Moves by manufacturers to either bypass the traditional wholesaler or to seek greater control over the amount of product available in the supply chain also prompted changes in both the product mix and in the business model pursued; prior to this a number of industry participants had engaged in secondary trading although in several situations accusations of wrongdoing had arisen forcing many to moderate/cease this particular practice.

Increasing importance of generics.

The performance period saw further growth in the relative importance of generic products as key innovator products began to lose patent protection. Generic drugs are now thought to command roughly 72% of the market (by volume), up from 60% in 2004. According to Cardinal Health, branded pharmaceuticals with industry wide sales volumes of $22 billion came off patent protection in fiscal 2007 with a similar level expected to come off patent protection during fiscal 2008 although IMS Health puts the relevant figures at a slightly lower $17 billion and $13 billion respectively. Another factor contributing to the increased importance of generics revolves around practices by MCOs which favor generic substitution

Such developments have had a significant impact upon the operations of industry participants since generic pharmaceuticals are offered at considerably lower prices than branded pharmaceuticals.

Pharmaceutical sales via all retail channels Retail channel



Million Dollars 2008

Drug stores (chain) 86.7 96.0 104.1 Drug stores (independent) 44.2 46.7 43.8 Mass merchandisers 16.7 21.6 25.7 Supermarkets 26.4 28.1 28.5 Mail order 42.7 50.9 53.1 Total 216.7 243.3 253.6 Source: National Association of Chain Drug Stores


February 10 2010


Per capita consumption levels Year

Million Dollars Prescription and non-prescription drugs

% Growth Growth

Million Dollars Personal care items

% Growth Growth

2004 480 2.8 581 10.2 2005 521 8.5 541 -6.9 2006 514 -1.3 585 8.1 2007 481 -6.4 588 0.5 Source: Bureau of Labor Statistics


February 10 2010


Prescription drug expenditure Year

Billion Dollars Total

% Growth Growth

Dollars Per capita

% Growth Growth

2004 188.8 N/C 642 N/C 2005 199.7 5.8 673 4.8 2006 216.7 8.5 723 7.4 2007 227.4 4.9 766 5.9 2008 234.1 2.9 772 0.8 2009* 244.8 4.6 796 3.1 2010* 255.9 4.5 825 3.6 2012* 288.8 12.9 915 10.9 2014* 329.8 14.2 1027 12.2 Source: Centers for Medicare & Medicaid Services Note: * Estimate

HISTORICAL PERFORMANCE

On a historical basis, the main factors influencing the performance of the Prescription Drug Wholesaling industry have been the health and age of the population; advances in pharmaceutical preparations; new cosmetic and toiletry product developments; and changes in economic conditions.

The demand for more sophisticated health-care items attributed to most of industry growth during the period. Advances in pharmacological technology have allowed for the development of new and sophisticated medications, which are then demanded by consumers. The demand for products at the retail level ultimately impacts demand at the wholesale level.

In addition, many new products were developed in response to increasing consumer awareness of the importance of skin care. Products such as moisturizers with added sunscreen and foundation tints became very popular. These new products boosted industry revenue at the wholesale level.

IBISWorld estimates that the Prescription Drug Wholesaling Industry grew by 1% per annum in constant prices over the five-year period to 1998, with industry revenue reaching $164.4 billion in 1998. The industry then enjoyed a strong period of growth with revenue rising from an estimated $195.23 billion in 1999 to $325.27 billion in 2003, representing an overall increase of 67%. This saw a corresponding rise in both industry value added and employment levels.

In 2003, the industry is estimated to have posted sales growth of 9.0% compared to 2002. The year saw private consumption expenditure levels on prescription drugs increase by 11% relative to the previous year although growth in private consumption expenditure on sales of non-prescription drugs was considerably slower at 2%. The year also saw a decline in the amount of federal funding provided to operators in customer industries.

One reason for this strong growth lies in the increase in the nation's pharmaceutical expenditure bill. This in turn reflected the combination of an increased usage of pharmaceuticals in line with changing doctor's prescribing patterns and increased consumer acceptance; changes in the mix of pharmaceuticals and medicinal products used, aided in part by a steady increase of new, innovative products and product formulations and price increases. As an example of these rising pharmaceutical costs, pharmaceutical expenditure as a proportion of total health expenditure for the U.S. increased from 8.5% in 1994 to 12.4% in 2005.

Revenue (constant prices)


February 10 2010


Revenue $ Million Growth % 1998 164,400.0 N/A 1999 195,225.0 18.8 2000 222,750.0 14.1 2001 260,035.0 16.7 2002 298,500.0 14.8 2003 325,275.0 9.0 2004 341,500.0 5.0 2005 369,500.0 8.2 2006 377,400.0 2.1 2007 378,000.0 0.2 2008 397,000.0 5.0 2009 409,625.0 3.2 2010 421,700.0 2.9 Revenue

Revenue Growth Rate

Gross Product (constant prices) Gross Product $ Million Growth % 1998 23,575.0 N/A 1999 27,785.0 17.9 2000 31,700.0 14.1 2001 36,935.0 16.5 2002 41,775.0 13.1 2003 44,500.0 6.5 2004 46,150.0 3.7 2005 48,900.0 6.0 2006 52,500.0 7.4


February 10 2010


2007 50,300.0 -4.2 2008 50,650.0 0.7 2009 51,400.0 1.5 2010 52,225.0 1.6 Gross Product

Gross Product Growth Rate

OUTLOOK Prescription Drug Wholesaling in the US

February 10 2010


Outlook Revenue (constant prices) Revenue $ Million Growth % 2011 435,500.0 3.3 2012 451,000.0 3.6 2013 468,000.0 3.8 2014 485,750.0 3.8 2015 502,750.0 3.5 2016 520,300.0 3.5 Revenue

Revenue Growth Rate

Gross Product (constant prices) Gross Product $ Million Growth % 2011 52,750.0 1.0 2012 54,500.0 3.3 2013 56,500.0 3.7 2014 58,500.0 3.5 2015 60,500.0 3.4 2016 62,500.0 3.3


February 10 2010


Gross Product

Gross Product Growth Rate

Over the outlook period, the U.S. Prescription Drug Wholesaling Industry is expected to enjoy moderate growth with industry revenue forecast to increase from an estimated $421.7 billion in 2010 to $502.75 billion in 2015, representing an average growth rate of 3.6% per annum. It is anticipated that initial weak growth will be offset by stronger growth from 2011 onward.

An aging population, changing community attitudes to health care and continued product development and innovation (including the "lifestyle" drug phenomena, the growth of personalized drugs as well as biotechnology innovations) are expected to underpin the continued growth of the industry, as is direct to consumer advertising and growth in the private health-insurance sector. The development of new products in various therapeutic areas including oncology, Alzheimer's disease and hypertension will also fuel growth as will the growth of new specialist driven products. At the same time, the industry will have to contend with the effects of patent expirations on blockbuster drugs, the continued increase in generic utilization, increasing safety and regulatory issues, health care reforms and growing price pressures from MCOs. The industry may also have to contend with the fall out effects associated with the next wave of merger and acquisition activity currently occurring amongst upstream pharmaceutical manufacturers.

As in the previous five years, the industry will have to continue to evolve over the outlook period in order to adapt to its changing environment. Most businesses within this wholesale industry will continue to face rising costs and lower returns. In this environment, IBISWorld forecasts that competitive success will come from economies of scale, and firms' ability to access leading pharmaceutical and health-care brands. While growing price competition will pressure margins, cost reduction strategies and the strength of the over-the-counter segment of the market will offset this. In the short term, competition is likely to intensify as businesses focus on cost and collaborative value added services as a means to differentiate themselves from one another and to discourage wholesale bypass. The outlook period is expected to see the increasing adoption of new business models including fee-for-service arrangements as well as fee-for-performance arrangements with upstream manufacturers. There may also be a greater focus on serving specialty pharmacies in line with their gradual increase in relative importance.

In the immediate future, a number of industry participants may continue to undertake various cost cutting exercises in view of the recent economic downturn. These include the likes of Cardinal Health who implemented cost control measures


February 10 2010


across all of its businesses over the course of 2009. As at September 2009 it had also just completed the spin off its $4 billion clinical and medical product businesses under the name of CareFusion Corporation.

Prescription drug expenditure and policies.

The level of expenditure on prescription drugs will continue to rise, though possibly not at the same pace as earlier in the decade. While to the benefit of pharmaceutical wholesalers, this anticipated drug expenditure increase will also have flow-on effects for health-care policies adopted by state governments and managed health-care plan providers. Indeed the continued implementation of new cost containment policies is expected to increasingly impact upon the industry, thereby offsetting some of the anticipated volume growth. It is interesting to note that even the health-insurance strategies (which also contain a cost containment element) of some of the nation's largest employers (such as Walmart) may impact on the industry.

Also to impact on the industry will be the Deficit Reduction Act (DRA) of 2005 which became effective January 1, 2007. While yet to become full effective with regards to the use of the lowest average manufacturers' price (AMP), eventual full implementation or any further changes to reimbursement formula may adversely indirectly affect drug wholesalers as may any other changes to Medicare/Medcaid drug payment policy.

Indeed a number of proposed changes to Medicare and Medicaid were included within President Obama's proposed fiscal year 2010 budget which included a 10 year, $634 billion reserve fund to finance comprehensive health reform It remains to be seen what the implications of this are for pharmaceutical wholesalers; in the latest development in late December 2009 the Senate passed its health care reform legislation, the Patient Protection and Affordable Care Act. It now remains for the Senate and the House of Representatives to reconcile their respective bills in order to produce the final compromise legislation. Also of note will be any legislation seeking to legalize the importation of drugs from Canada; as at March 2009 legislation legalizing the importation of FDA approved medicines from Canada, Europe, Australia, New Zealand and Japan was being supported by a bipartisan group of U.S. lawmakers. As at late 2009 the Senate was proposing an amendment to the Patient Protection and Affordable Care Act which would allow personal drug importation.

Continued growth of generics .

In the immediate future, a number of key innovator drugs are expected to lose their patent protection which will have a number of implications for the industry; over the period 2008 to 2012 patents for roughly 150 products with combined annual sales of $60 billion are expected to expire with dramatic consequences for the profile of the general pharmaceutical industry.

This growth will also be boosted in part by Government/managed care institutions' policies designed to change prescription patterns in favor of the bio-equivalent, cheaper, generic drugs. For example, the enactment of the Medicare Prescription Drug Improvement and Modernization Act of 2003 has increased drug benefits for Medicare recipients, which in turn translates into a growing reliance on low cost generic drugs; generics are already thought to account for nearly 70% of all scripts filled under the scheme.

Non-prescription products .

The continued trend toward switching products from prescription to over-the-counter (OTC) status will be another important driver influencing the profile of this industry over the outlook period. While the U.S. market is currently thought to lag its Canadian and European counterparts with regards to its acceptance of Rx-to-OTC switches, it is interesting to note that the FDA has recently announced that it hopes to increase the number of switches by 50% over the next few years. Another factor influencing the product segment profile of this industry will be the growth in the relative importance of


February 10 2010


herbal/botanical or complementary medicines which in turn will create a number of new niche segments. As the acceptance of such products continues to increase, this product segment is also expected to grow in relative importance. Any moves to introduce a "behind the counter" status will also serve to change the profile of the industry.

Aging population.

Much has already been made of the potential impact of America's aging population, particularly as its baby boomers begin to gray; in 2005 the first of the baby boomers cohort turned 59 while the number of people aged 55 to 64 exceeded 30 million with another 32 million aged 65 to 84. As the baby boomers reach their 70s and 80s, their importance as a demographic cohort will continue to increase; by 2014 seniors are expected to account for roughly 14% of the population and 20% of the U.S. population by 2030. Over the five years to 2014, the number of people in the 65 and over age cohort is forecast grow at an average annual rate of 2.6%, compared to forecast annual growth in the total population of around 1.0%. Over the years, better medical technology has meant that people are living longer, with the current life expectancy being 77 years. This compares to a figure of only 73.5 years, a quarter of a century ago. This will have a number of implications on the demand for pharmaceutical products as a whole; note that the 65 plus age cohort utilizes health-care services at around four times the rate of the remainder of the population in the United States. As this age cohort continues to expand, it will tend to increase revenue over the outlook period. Lifestyle trends and the subsequent development of lifestyle diseases (such as obesity, depression and ulcers) will also serve to dictate drug development and consumption patterns.

Other factors, which will also help to gradually change the profile of the industry over the outlook period, include sustained developments in technology, including the increasing use of the internet and e-commerce (particularly for the dissemination of information on major branded pharmaceuticals, as well as for e-marketing), as well as continued falls in exclusivity times combined with an increased roll out of second and third generation products as a result of technological advancements. Heightened regulatory control over the entire pharmaceutical supply chain, whether it be with regards to drug safety, allowable marketing practices or with regards to tracking requirements in an attempt to quell the rising threat of counterfeit and/or illegal drugs will also impact on the industry.

Combined, these variables will serve to slowly influence the development of the U.S. Prescription Drug Wholesaling industry in the short to medium term.

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Pharmaceutical Wholesalers 2010