Drug Prices: Effects of Opening Federal Supply Schedule for
Pharmaceuticals Are Uncertain (Letter Report, 06/11/97, GAO/HEHS-97-60).

GAO reviewed the factors that can affect negotiations for schedule drug
prices and the potential effects of opening the pharmaceutical schedule
on schedule prices available to federal, state, and local government
purchasers. Although GAO reviewed economic and other assumptions used in
these assessments, GAO did not validate the supporting data, such as
drug prices and expenditures.

GAO noted that: (1) the effects of opening the federal supply schedule
for pharmaceuticals on schedule prices ultimately depend on the outcome
of negotiations between the Department of Veterans Affairs (VA) and drug
manufacturers; (2) although many factors would influence the
negotiations between VA and drug manufacturers, two primary ones are
VA's negotiating ability and manufacturers' pricing strategies; (3) both
of these factors would be influenced by the size of the market
represented by combined federal, state, and local purchasers that would
have access to schedule prices; (4) moreover, the size of this market
could affect the size of any resulting price changes; (5) the larger the
market, the greater the economic incentive would be for a manufacturer
to raise schedule prices to limit the impact of giving low prices to
more purchasers; (6) at present, federal purchases from the schedule
represent about 1.5 percent of the total dollar value of domestic
pharmaceutical sales; (7) if eligibility is not narrowed, VA,
Pharmaceutical Research and Manufacturers of America, drug
manufacturers, and the Public Hospital Pharmacy Coalition agree that the
size of the combined market could be significantly larger than the
current federal market; (8) although the Coalition estimates that
limiting eligibility as it suggests could keep state and local purchases
from the schedule at between 0.5 and 4.4. percent of domestic
pharmaceutical sales, this would result in a combined market about 33 to
300 percent larger than the federal market; (9) federal efforts to lower
Medicaid drug prices suggest how opening the pharmaceutical schedule
could put upward pressure on schedule prices; (10) in 1990, the Congress
required drug manufacturers to give state Medicaid programs rebates for
outpatient drugs based on the lowest prices they charged other
purchasers; (11) because of the size of the Medicaid market, however,
many drug manufacturers sought to minimize the impact of the rebates on
their business by raising outpatient drug prices to some private sector
purchasers; (12) if the pharmaceutical schedule were opened to state and
local governments and drug manufacturers succeeded in raising their
schedule prices in response, the impact on different government
purchasers would vary; and (13) VA, the Department of Defense, the
Public Health Service, and the Coast Guard would be somewhat protected *

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  HEHS-97-60
     TITLE:  Drug Prices: Effects of Opening Federal Supply Schedule for 
             Pharmaceuticals Are Uncertain
      DATE:  06/11/97
   SUBJECT:  Drugs
             Pharmaceutical industry
             Hospitals
             State governments
             Price regulation
             Local governments
             Health care programs
             Cooperative agreements
             State and local procurement
IDENTIFIER:  Medicaid Program
             Federal Supply Schedule
             GSA Cooperative Purchasing Program
             
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Cover
================================================================ COVER


Report to Congressional Committees and the Administrator of General
Services

June 1997

DRUG PRICES - EFFECTS OF OPENING
FEDERAL SUPPLY SCHEDULE FOR
PHARMACEUTICALS ARE UNCERTAIN

GAO/HEHS-97-60

Pharmaceutical FSS

(108294)


Abbreviations
=============================================================== ABBREV

  CBO - Congressional Budget Office
  DOD - Department of Defense
  FCP - federal ceiling price
  FSS - federal supply schedule
  GSA - General Services Administration
  HIGPA - Health Industry Group Purchasing Association
  PhRMA - Pharmaceutical Research and Manufacturers of America
  VA - Department of Veterans Affairs

Letter
=============================================================== LETTER


B-276585

June 11, 1997

The Honorable Fred Thompson, Chairman
The Honorable John Glenn
Ranking Minority Member
Committee on Governmental Affairs
United States Senate

The Honorable Strom Thurmond, Chairman
The Honorable Carl Levin
Ranking Minority Member
Committee on Armed Services
United States Senate

The Honorable Dan Burton, Chairman
The Honorable Henry A.  Waxman
Ranking Minority Member
Committee on Government Reform and Oversight
House of Representatives

The Honorable Floyd Spence, Chairman
The Honorable Ronald V.  Dellums
Ranking Minority Member
Committee on National Security
House of Representatives

The Honorable David J.  Barram
Administrator
General Services Administration

The federal government purchased almost $1.3 billion worth of
pharmaceuticals during fiscal year 1996 from a catalog of prices
referred to as a federal supply schedule.  Schedule prices, which are
often considerably lower than retail prices, are currently available
primarily to federal purchasers.  In 1994, the Congress sought to
extend these lower prices to other government purchasers by
authorizing the General Services Administration (GSA) to establish a
cooperative purchasing program that would allow state, local, and
Indian tribal governments and the Commonwealth of Puerto Rico to
purchase pharmaceuticals and other goods and services from federal
supply schedules.\1

In administering the program, GSA indicated that it did not plan to
open any schedule to nonfederal entities that could result in
increased prices for products on the schedule.\2

The Department of Veterans Affairs (VA), to which GSA has delegated
administration of the pharmaceutical schedule, raised concerns that
drug manufacturers would seek to increase schedule drug prices if a
larger group of purchasers was given access to those prices.  As a
result, GSA proposed that the pharmaceutical schedule be excluded
from the cooperative purchasing program because opening it would have
the unintended effect of increasing federal agencies' drug costs. 

Because of concerns about the potential effects of opening more than
140 federal supply schedules to state and local governments, the
Congress directed GSA to delay opening the schedules, including the
pharmaceutical schedule, pending completion of our assessment of the
possible impact.\3 This report focuses on the factors that can affect
negotiations for schedule drug prices and the potential effects of
opening the pharmaceutical schedule\4 on schedule prices available to
federal, state, and local government purchasers.\5

To address the report's objectives, we interviewed representatives of
federal agencies that purchase the most products from the
pharmaceutical schedule:  VA, the Department of Defense (DOD), and
the largest Public Health Service drug purchaser, the Indian Health
Service.  In addition, we interviewed representatives of the Public
Hospital Pharmacy Coalition,\6 the Health Industry Group Purchasing
Association (HIGPA),\7 and two group purchasing organizations that
represent public hospitals and clinics.\8 We also interviewed
representatives of the National Association of Chain Drug Stores, the
Pharmaceutical Research and Manufacturers of America (PhRMA), and
several drug manufacturers.\9 We analyzed pharmaceutical schedule
prices obtained from VA and reviewed assessments made by VA, HIGPA,
and the Public Hospital Pharmacy Coalition of how opening the
schedule could affect schedule and other drug prices.  Although we
reviewed economic and other assumptions used in these assessments, we
did not validate the supporting data, such as drug prices and
expenditures.  We also reviewed public comments on GSA's proposed
regulations and discussed the potential effects of opening the
federal supply schedule with officials of the Congressional Budget
Office (CBO). 

We did our work between October 1996 and April 1997 in accordance
with generally accepted government auditing standards. 


--------------------
\1 See the Federal Acquisition Streamlining Act of 1994, P.L. 
103-355, sec.  1555.  The Senate-passed version of a pending
appropriation bill would repeal sec.  1555.  The House version does
not contain the repeal.  As of June 2, 1997, the bill was in
conference. 

\2 See Cooperative Purchasing:  Effects Are Likely to Vary Among
Governments and Businesses (GAO/GGD-97-33, Feb.  10, 1997), pp. 
19-21. 

\3 See the National Defense Authorization Act for Fiscal Year 1996,
P.L.  104-106, sec.  4309 (1996), and accompanying conference report,
H.R.  Conf.  Rep.  No.  104-450, at 970 (1996).  The act requires
that we submit our report to the Administrator of General Services
and to the Congress. 

\4 The implications of opening other schedules are discussed in
GAO/GGD-97-33, Feb.  10, 1997. 

\5 For the purposes of this report, Indian tribal governments were
considered with federal purchasers because the pharmaceutical and
other federal supply schedules are available to them under separate
authority (see GAO/GGD-97-33, Feb.  10, 1997).  Potential effects on
the Commonwealth of Puerto Rico were considered with state and local
governments. 

\6 The Coalition represents 70 public hospitals that are owned or
controlled by state and local governments and serve a
disproportionate share of Medicaid and indigent patients. 

\7 HIGPA is a national trade association that represents 84
organizations and vendors that purchase pharmaceuticals and other
medical products. 

\8 Some group purchasing organizations represent hundreds of
hospitals and have been able to negotiate significant price discounts
for them. 

\9 The manufacturers we contacted were Eli Lilly and Company; Johnson
& Johnson; Merck & Co., Inc.; Pfizer Inc.; and SmithKline Beecham
Corporation. 


   RESULTS IN BRIEF
------------------------------------------------------------ Letter :1

The effects of opening the federal supply schedule for
pharmaceuticals on schedule prices ultimately depend on the outcome
of negotiations between VA and drug manufacturers.  Because of the
uncertainties related to these negotiations, it is not possible to
predict how schedule drug prices would change or what the ultimate
impact on federal, state, and local purchasers would be. 

Although many factors would influence the negotiations between VA and
drug manufacturers, two primary ones are VA's negotiating ability and
manufacturers' pricing strategies.  Both of these factors would be
influenced by the size of the market represented by combined federal,
state, and local purchasers that would have access to schedule
prices.  Moreover, the size of this market could affect the size of
any resulting price changes.  The larger the market, the greater the
economic incentive would be for a manufacturer to raise schedule
prices to limit the impact of giving low prices to more purchasers. 

At present, federal purchases from the schedule represent about 1.5
percent of the total dollar value of domestic pharmaceutical sales. 
Estimates of the size of a combined federal, state, and local market,
however, vary widely because of uncertainty about which state and
local entities would be eligible for schedule prices.  If eligibility
is not narrowed, VA, PhRMA, drug manufacturers, and the Public
Hospital Pharmacy Coalition agree that the size of the combined
market could be significantly larger than the current federal market. 
Although the Coalition estimates that limiting eligibility as it
suggests could keep state and local purchases from the schedule at
between 0.5 and 4.4 percent of domestic pharmaceutical sales, this
would result in a combined market about 33 to 300 percent larger than
the federal market. 

Federal efforts to lower Medicaid drug prices suggest how opening the
pharmaceutical schedule could put upward pressure on schedule prices. 
In 1990, the Congress required drug manufacturers to give state
Medicaid programs rebates for outpatient drugs based on the lowest
prices they charged other purchasers.  Because of the size of the
Medicaid market, however, many drug manufacturers sought to minimize
the impact of the rebates on their business by raising outpatient
drug prices to some private sector purchasers. 

If the pharmaceutical schedule were opened to state and local
governments and drug manufacturers succeeded in raising their
schedule prices in response, the impact on different government
purchasers would vary.  VA, DOD, the Public Health Service, and the
Coast Guard would be somewhat protected from price increases because
the Veterans Health Care Act of 1992 sets maximum prices for these
agencies for over one-quarter of the drugs on the schedule.  Other
federal purchasers would not have that protection.  State and local
government purchasers, meanwhile, would benefit to the extent that
schedule prices were lower than the prices they or their
representatives could negotiate with drug manufacturers. 


   BACKGROUND
------------------------------------------------------------ Letter :2

The federal supply schedule (FSS) for pharmaceuticals is a price
catalog currently containing almost 23,000 pharmaceutical products\10
available to federal agencies and institutions and several other
purchasers, such as the District of Columbia, U.S.  territorial
governments, and many Indian tribal governments.  VA, to which GSA
has given responsibility for administering the pharmaceutical
schedule, negotiates prices with drug manufacturers.  It is also the
largest purchaser from the schedule; in fiscal year 1996 it made
purchases of about $922 million--or about 71 percent of the
government's purchases from the pharmaceutical FSS. 

While the pharmaceutical FSS, like other supply schedules, is meant
to provide eligible entities an efficient and economical option for
purchasing, other options exist.  For example, although VA depends on
the FSS for most of its drug purchases, it has awarded several
national contracts on a competitive basis for specific drugs it
considered to be therapeutically interchangeable.  VA spent about
$1.2 billion on pharmaceuticals in fiscal year 1996 through both FSS
and national contract purchases. 

Under the Veterans Health Care Act, drug manufacturers must make
their brand-name drugs available through the FSS in order to receive
reimbursements for drugs covered by Medicaid.\11 The act also
requires drug manufacturers to sell drugs covered by the act to four
agencies--VA, DOD, the Public Health Service, and the Coast Guard--at
no more than 76 percent of the nonfederal average manufacturer's
price,\12 a level referred to as the federal ceiling price.  The FSS
price may be higher or lower than the ceiling.  If it is higher, the
protected purchasers pay no more than the ceiling price, while
purchasers not protected by the act--such as the Bureau of Prisons
and institutions in the District of Columbia like Howard University
and St.  Elizabeths Hospital--pay the full FSS price. 

Although state and local government entities have not had access to
FSS drug prices, they have been able to purchase drugs at
significantly discounted prices.  For example, the Veterans Health
Care Act gave certain hospitals that serve a disproportionate share
of Medicaid recipients and certain categories of federally funded
clinics access to discounted prices on outpatient drugs similar to
those given state Medicaid programs.\13 In addition, public hospitals
have obtained significant discounts off retail and wholesale prices
for both outpatient and inpatient drugs by using large group
purchasing organizations to negotiate with drug manufacturers. 

GSA published its proposed plan for implementing the Federal
Acquisition Streamlining Act as it related to opening the federal
supply schedules to state and local governments in the Federal
Register on April 7, 1995.  The plan proposed excluding from
cooperative purchasing the schedule for drugs and pharmaceutical
products\14 and one medical equipment and supplies schedule.\15

In the plan, GSA specified that unique statutory requirements in the
Veterans Health Care Act affect the pricing and availability of
products on both schedules and that when combined with the
cooperative purchasing provisions, would have the unintended effect
of increasing costs to federal users of the schedules.  The plan also
proposed that participation in the cooperative purchasing program be
optional for both sellers and purchasers of goods and services.  In
comments GSA received on the plan, PhRMA, VA, and about 30 drug
manufacturers supported GSA's proposal to keep the pharmaceutical FSS
closed to state and local governments, while the Public Hospital
Pharmacy Coalition and over 60 public hospitals supported opening the
schedule. 


--------------------
\10 The FSS may list the same drug in different dosage amounts and
package sizes.  Each listing is considered an individual item or
product in counting the total number of products on the FSS. 

\11 See P.L.  102-585, sec.  603.  The act covers innovator
multiple-source drugs, single-source drugs, insulin, and biological
products such as vaccines and antitoxins.  Innovator multiple-source
drugs are ones that were approved by the Food and Drug Administration
as original new drugs but that now have competing drugs, including
generic versions, that have the same combination of active
ingredients.  Conversely, single-source drugs are original drugs that
have a unique combination of active ingredients unavailable in other
drugs.  The act does not cover noninnovator multiple-source or
generic drugs. 

\12 The nonfederal average manufacturer price is the weighted average
price of each single form and dosage unit of a drug that is paid by
wholesalers in the United States to a manufacturer, taking into
account any cash discounts or similar price reductions.  Prices paid
by the federal government are excluded from this calculation. 

\13 See P.L.  102-585, sec.  602. 

\14 Federal Supply Classification Group 65, part I, sec.  B. 

\15 Federal Supply Classification Group 65, part VII.  The
implications of opening this schedule (in vitro diagnostic
substances, reagents, test kits, and sets) are covered in
GAO/GGD-97-33, Feb.  10, 1997. 


   IMPACT OF OPENING THE FSS
   DEPENDS LARGELY ON PRICE
   NEGOTIATIONS
------------------------------------------------------------ Letter :3

Price negotiations between VA and drug manufacturers would ultimately
determine the extent to which opening the pharmaceutical FSS affects
the schedule drug prices available to federal, state, and local
governments.  VA's negotiating ability and drug manufacturers'
pricing strategies are two primary factors that would influence the
outcome of those negotiations.  Moreover, the size of the market that
could gain access to FSS prices could affect the size of any
resulting price changes.  That is, the larger the market, the greater
the incentive would be for drug manufacturers to raise FSS prices to
limit the impact of giving low prices to more purchasers. 


      FSS NEGOTIATIONS AND
      MANUFACTURER PRICING
      STRATEGIES ARE DRIVING
      FORCES
---------------------------------------------------------- Letter :3.1

In its role as administrator of the pharmaceutical FSS, VA negotiates
prices for the nearly 23,000 drug products listed on the schedule. 
Under GSA procurement regulations, VA contract officers are required
to seek an FSS price that represents the same discount off a drug's
list price that the manufacturer offers its most-favored nonfederal
customer under comparable terms and conditions.\16 To help VA
determine the "most-favored customer" discount, manufacturers provide
VA information on price discounts and rebates offered different
domestic customers and on the terms and conditions involved, such as
length of contract periods and ordering and delivery practices. 

GSA regulations recognize, however, that the terms and conditions of
commercial sales vary and that there may be legitimate reasons why VA
does not always obtain the most-favored customer discount.  Hence,
the regulations also allow VA's contract officers to accept a less
favorable price if an officer determines that (1) the price offered
to the government is fair and reasonable, even though a comparable
discount was not negotiated, and (2) awarding the contract is
otherwise in the best interest of the government. 

Opening the pharmaceutical schedule to state and local purchasers
could change the dynamics of negotiating FSS prices for both VA and
drug manufacturers.  Up to now, VA has been able to obtain
significant discounts from drug manufacturers by seeking the
most-favored customer price.  Many FSS prices are more than 50
percent below nonfederal average manufacturer prices.\17

Representatives of several drug manufacturers explained that their
companies have been willing to give federal purchasers such low
prices because they consider the FSS to be a special, limited
category of pricing that affects no more than about 2 to 3 percent of
total dollars in domestic pharmaceutical sales.  Two representatives
also told us that their companies gave VA favorable FSS discounts to
help ensure that their drugs were widely used in VA hospitals where
many of the nation's physicians receive part of their training.  But
some drug manufacturers have indicated an unwillingness to offer the
same low prices to an expanded group of government purchasers as well
as an unwillingness to combine different types of purchasers that the
manufacturers are accustomed to treating as separate markets. 

Opening the pharmaceutical and other schedules is intended to help
government purchasers take advantage of the total volume represented
by federal, state, and local sales to negotiate lower prices with
sellers.  But while volume of sales is integral to pharmaceutical
price negotiations between purchasers and drug manufacturers, it is
not the only important consideration.  Drug manufacturers have
historically offered different prices for the same product to
different purchasers based largely on the purchasers' ability to
influence drug utilization (sometimes referred to as the ability to
move market share).\18 A common technique used by large-volume
purchasers to influence utilization is to establish a formulary.  A
formulary is a list of drugs that a health plan prefers its
physicians to prescribe for patients.  Drugs are included on a
formulary not only for their medical value but also for their
favorable prices.  Both inclusion of a drug on a formulary and its
cost can affect how much it is prescribed and purchased and,
therefore, can affect its market share.  Because formularies have the
potential to significantly affect the sales of drugs, large
purchasers that use them have greater leverage in negotiating
discounts or rebates with manufacturers that want their drugs listed
as preferred drugs.  But because the FSS is a catalog of prices, not
a formulary, VA lacks that kind of leverage.  Access to FSS prices by
state and local entities that use formularies, such as public
hospitals, would not change the status of the FSS as a catalog.\19

Therefore, although VA would be negotiating on behalf of a larger
market if FSS prices were made available to state and local
governments, the increased size of the market may not in and of
itself improve VA's leverage to negotiate lower prices. 

If drug manufacturers are unwilling to extend low FSS prices to state
and local purchasers, VA contract officials expect a "showdown" with
manufacturers over price increases that they have not experienced
before.  The potential for such a change in the dynamics of setting
FSS prices was emphasized by several manufacturers' representatives. 
For example, they told us they consider drug sales to public
hospitals a large enough market segment to influence current pricing
decisions, even without having to give them and other state and local
purchasers low FSS prices. 

Because of their unwillingness to give state and local purchasers FSS
prices, drug manufacturers could respond to the opening of the
schedule in several ways.  First, drug manufacturers could simply
refuse to offer their products to state and local purchasers at FSS
prices, an option that is permitted under GSA's current proposal. 
Representatives of several manufacturers told us, however, that they
do not consider this option realistic because some competing
manufacturers would be likely to offer FSS prices to state and local
purchasers, a market too important to their companies' sales to
ignore.  Second, drug manufacturers could try to increase FSS prices
by raising prices to most-favored customers to change the base on
which prices are negotiated with VA.  Several manufacturers have
acknowledged that depending on the size of the market represented by
all government purchasers, this could be an option.  Third, drug
manufacturers could attempt to negotiate higher FSS prices without
linking them to most-favored customer prices.  VA contract officials
believe that this strategy could result in lengthy and difficult
negotiations that they have not experienced before with
manufacturers.  Ultimately, VA officials could choose not to list
those drugs on the FSS for which they were unable to reach agreement
on price with manufacturers.  VA contract officials, however, believe
that incentives would exist for manufacturers to reach agreement with
VA on price because drugs covered by the Veterans Health Care Act
must be included on the pharmaceutical FSS for drug manufacturers to
receive reimbursement for drugs covered by Medicaid. 


--------------------
\16 See 48 C.F.R.  sec.  538.270. 

\17 Drugs covered by the Veterans Health Care Act that had FSS prices
below federal ceiling prices as of Sept.  30, 1996, were, on average,
52 percent below the nonfederal average manufacturer price. 

\18 See CBO Papers:  How the Medicaid Rebate on Prescription Drugs
Affects Pricing in the Pharmaceutical Industry (Washington, D.C.: 
CBO, Jan.  1996). 

\19 PhRMA contends that opening the pharmaceutical schedule would
actually negate the ability of state and local purchasers to
influence drug utilization and, therefore, to move market share
because they would be considered part of an FSS market in drug price
negotiations with manufacturers. 


      SIZE OF MARKET ELIGIBLE FOR
      FSS PRICES WOULD BE KEY
      FACTOR
---------------------------------------------------------- Letter :3.2

The size of the market eligible to buy drugs at FSS prices if the
schedule is opened to state and local governments would be a key
factor in determining what would happen to drug prices.  The size of
the market involved would affect both VA's ability to negotiate and
manufacturers' pricing strategies.  The larger the market, the
greater the incentive would be for manufacturers to raise FSS prices
to limit the impact on their business of giving low prices to more
purchasers. 

Representatives of VA, PhRMA, drug manufacturers, HIGPA, and the
Public Hospital Pharmacy Coalition agree that unless the definition
of which state and local entities are to have access to the schedule
is narrowed, the FSS market could expand significantly from its
current size of about 1.5 percent of domestic pharmaceutical
sales.\20

GSA's proposed implementation plan for opening the FSS would make any
state and any department, agency, or political subdivision of a
state, including local governments eligible to participate.\21
Because GSA proposed that each state verify participants'
eligibility, it is possible that states would interpret the
definition in different ways.  Both purchasers and sellers, including
retail pharmacies, believe that the proposed definition could allow a
large number of entities to qualify for FSS prices.  For example,
PhRMA and the Coalition note that if entities that do not actually
purchase and take possession of pharmaceuticals themselves, such as
home health agencies and board and care homes are eligible, the
number of organizations that could purchase drugs at FSS prices could
be substantial.\22

PhRMA, several drug manufacturers, and the National Association of
Chain Drug Stores expressed concern that a broad definition of
eligibility could also increase the potential for drugs purchased at
FSS prices to be diverted to individuals or groups not meant to
benefit from the program.\23 For example, they believe that if
eligibility is loosely defined, an organization that does not take
possession of drugs or purchase drugs for its own use could buy drugs
at FSS prices and attempt to resell them to individuals or groups
that may not be state or local entities.  In addition to being
concerned about diversion, retail pharmacies are also concerned that
opening the FSS would give state and local government entities access
to drug prices that could be considerably lower than those retail
pharmacies pay.  Since publishing its proposed implementation plan
for opening the FSS, GSA has considered several modifications.  These
include more specifically defining which entities would be eligible
to participate in cooperative purchasing, requiring GSA--rather than
states--to determine entities' eligibility, and prohibiting the
resale of products purchased off the schedule. 

The Public Hospital Pharmacy Coalition has suggested that GSA's
definition be narrowed to limit access to FSS prices to state and
local government entities that purchase drugs for their own use and
dispense drugs in their own facilities.  The Coalition estimated that
defining eligibility that way would result in a state and local FSS
market of about 4.4 percent of total dollars in domestic
pharmaceutical sales.\24 Figure 1 shows the potential composition of
the state and local market for FSS sales based on the Coalition's
proposal. 

   Figure 1:  Composition of the
   State and Local Market for FSS
   Sales Based on the Public
   Hospital Pharmacy Coalition's
   Proposal

   (See figure in printed
   edition.)

Note:  Percentage estimates are based almost exclusively on 1993 drug
expenditures for approximately 5,760 entities. 

Source:  The Public Hospital Pharmacy Coalition. 

But the market might actually be considerably smaller, according to
the Coalition, for two reasons.  First, some state and local
purchasers are subject to procurement laws or regulations that would
restrict their participation in the cooperative purchasing program. 
Second, eligible state and local purchasers that choose to
participate probably would not buy all their drugs through the
program because some FSS prices would be higher than the drug prices
they or their representatives could negotiate with manufacturers.  If
these two assumptions are considered, the Coalition estimated that
state and local FSS purchasers would represent about 0.5 percent of
the total drug market.  The Coalition's estimates mean that the total
FSS market would expand by between about 33 and 300 percent if state
and local governments are given access to FSS prices. 

As for the impact of procurement laws or regulations on state and
local participation, 27 of 50 respondents\25 reported in a September
1996 survey we conducted that current state competitive-bidding and
other laws would limit their use of federal supply schedules.\26 But
most state and local government purchasing officials we contacted
indicated that they want the option of purchasing items from the
schedules.  How many states and localities would change purchasing
laws and regulations so that they could participate in the
cooperative purchasing program is uncertain.  It is also uncertain
how many and to what extent eligible state and local entities would
choose to buy drugs through the FSS rather than rely on the prices
they negotiate themselves with manufacturers. 

Although the size of the combined federal, state, and local market
that could have access to FSS prices if the schedule is opened is
unclear, past federal efforts to lower drug prices for a significant
market segment caused many manufacturers to raise prices.  Before the
Medicaid rebate program was enacted in 1990, state Medicaid programs,
which represent about 11 percent of the domestic pharmaceutical
market,\27 paid close to retail prices for outpatient drugs.  Other
purchasers, such as hospitals and health maintenance organizations,
paid considerably less.  Under the program, the Congress required
drug manufacturers to give state Medicaid programs rebates for
outpatient drugs based on the lowest prices they charged other
purchasers. 

After the rebate program's enactment, the prices many large private
purchasers paid for outpatient drugs increased substantially.  In
particular, prices paid by health maintenance organizations rose, on
average, more than twice as fast as the year before the program.\28
Moreover, the lowest outpatient drug prices in the market increased
faster than the drugs' average prices\29 as drug manufacturers
significantly reduced the price discounts they offered private
purchasers.\30 On the basis of its analysis of these price changes
for outpatient drugs, the Congressional Budget Office concluded that
because of the size of the market represented by Medicaid,
"pharmaceutical manufacturers are much less willing to give large
private purchasers steep discounts off the wholesale price when they
also have to give Medicaid access to the same low price."\31


--------------------
\20 According to IMS America, a private vendor of pharmaceutical
information, in 1996 the U.S.  pharmaceutical market totaled about
$85.4 billion in sales, including sales to federal, state, and local
government entities.  FSS drug sales of about $1.3 billion for fiscal
year 1996 represent about 1.5 percent of U.S.  pharmaceutical sales. 

\21 See GSA's Federal Register notice, Apr.  7, 1995, and the Federal
Acquisition Streamlining Act of 1994, P.L.  103-355, sec.  1555. 

\22 Coalition estimates indicate that these types of facilities could
represent over 30 percent of about 7,900 potential eligible state and
local entities. 

\23 PhRMA noted that the Congress acknowledged the potential for
diversion of discounted products in the Veterans Health Care Act. 
Sec.  602 provided safeguards to ensure that entities receiving
discounted outpatient drugs under the program would not resell those
drugs to other entities. 

\24 See PRIME Institute, College of Pharmacy, University of
Minnesota, Section 1555 of the Federal Acquisition Streamlining Act: 
Impact of Cooperative Purchasing on the Pharmaceutical Market,
prepared for the Public Hospital Pharmacy Coalition (Washington,
D.C.:  Jan.  15, 1997). 

\25 Respondents represented 48 states and 2 territories. 

\26 See GAO/GGD-97-33, Feb.  10, 1997. 

\27 According to IMS America, in 1995 total sales for the U.S. 
pharmaceutical market were about $77.1 billion.  According to the
Health Care Financing Administration, Medicaid drug expenditures for
fiscal year 1995 totaled about $8.4 billion, including rebates. 

\28 See Medicaid:  Changes in Drug Prices Paid by HMOs and Hospitals
Since Enactment of Rebate Provisions (GAO/HRD-93-43, Jan.  15, 1993). 

\29 See Medicaid:  Changes in Best Price for Outpatient Drugs
Purchased by HMOs and Hospitals (GAO/HEHS-94-194FS, Aug.  5, 1994). 

\30 A study conducted for HIGPA contended that opening the
pharmaceutical FSS could result in similar reductions in drug price
discounts to private purchasers.  See Muse & Associates, The Federal
Acquisition Streamlining Act of 1994:  The Effect of Federal Supply
Schedule Expansion on Expenditures for Health Care Products
(Washington, D.C.:  Oct.  1996). 

\31 See CBO Papers:  How the Medicaid Rebate on Prescription Drugs
Affects Pricing in the Pharmaceutical Industry.  CBO also noted that
many FSS prices increased significantly, perhaps because FSS prices
were initially considered with private sector prices in calculating
rebates.  In 1992, in the Veterans Health Care Act the Congress
exempted all drug prices paid by federal entities from rebate
calculations.




   FSS PRICE CHANGES WOULD AFFECT
   GOVERNMENT PURCHASERS
   DIFFERENTLY
------------------------------------------------------------ Letter :4

How FSS prices would change if the pharmaceutical FSS is opened
cannot be predicted given the uncertainties about the outcome of
negotiations between VA and drug manufacturers.  The factors involved
in these negotiations and the subsequent outcomes could vary for
different drugs.  For example, the factors involved in negotiating
FSS prices for unique, single-source drugs may differ greatly from
those involved in negotiating FSS prices for drugs that have
competing, generic versions.  At a minimum, federal, state, and local
purchasers have options for the sources they can use to purchase
generics. 

If the pharmaceutical schedule is opened, however, the factors
involved in negotiations between VA and drug manufacturers could
produce, in general, an upward pressure on FSS prices.  As described
earlier in this report, such factors include a change in the dynamics
of negotiations between VA and drug manufacturers, continued
limitations on VA's leverage to negotiate, and uncertainties about
the size of the overall market that would be represented by sales to
federal, state, and local purchasers.  If FSS prices were to rise,
the impact on federal purchasers would vary between those that are
protected by ceiling prices for drugs covered by the Veterans Health
Care Act and other federal purchasers that are not.  The effects of
FSS price increases on state and local purchasers would depend on
whether FSS prices are lower than the prices they can negotiate
independently with drug manufacturers. 


      FOR FEDERAL PURCHASERS,
      IMPACT OF ANY FSS PRICE
      INCREASES WOULD VARY
---------------------------------------------------------- Letter :4.1

If FSS prices rise after the schedule is opened, all federal
purchasers could pay higher FSS prices for drugs not covered by the
Veterans Health Care Act.  As seen in figure 2, about 73 percent of
the roughly 22,800 drugs on the FSS are not covered by the act.\32
The noncovered drugs, however, are generally generic drugs, and
though they constitute most of the drugs on the FSS, they represent a
smaller portion of federal expenditures because of the lower prices
charged for generics.  A VA official estimated that about
three-quarters of VA's total drug expenditures are for covered
drugs.\33

   Figure 2:  FSS Price Relative
   to FCP for Schedule Drugs as of
   September 30, 1996

   (See figure in printed
   edition.)

Note:  Percentages are based on the number of FSS products, rather
than FSS expenditures. 

Source:  VA data. 

For drugs that the act covers, VA and the three other protected
federal agencies would not have to pay FSS prices that are higher
than the federal ceiling prices (FCP).  But as figure 2 shows, they
may have to pay more for the 8 percent of all FSS drugs that
currently have FSS prices below the ceiling prices if manufacturers
succeed in raising those prices to or above the ceilings.  The
increases could be substantial given that, on average, the FSS prices
for these drugs are about 28 percent below the ceiling price.  Hence,
VA and the other protected agencies could experience price increases
for almost 81 percent of all the drugs on the FSS. 

In February 1995, VA presented to GSA its analysis of the potential
effects of opening the pharmaceutical schedule on FSS prices and VA
drug costs taking into consideration the protection the Veterans
Health Care Act gives VA against drug price increases.  On the basis
of discussions with representatives of numerous drug manufacturers,
VA made two key assumptions in its analysis about the potential
effects of opening the pharmaceutical FSS:  (1) drug manufacturers
would eliminate FSS pricing for all drugs not covered by the Veterans
Health Care Act, forcing federal purchasers to buy these generic
drugs at higher wholesale prices, and (2) FSS prices for all drugs
covered by the act would rise to their ceiling prices.\34

VA applied those two assumptions to drug purchases it made during the
first 6 months of 1994.\35 According to VA, it spent about $37.8
million on 4,877 generic drugs not covered by the act.  If it had
purchased the same drugs at wholesale rather than FSS prices, VA
estimated that it would have paid over $79.7 million, about 111
percent more.  In the same period, VA spent about $118.3 million on
911 brand-name drugs that were covered by the act and that had FSS
prices below their federal ceiling prices.  Had the manufacturers of
those drugs raised the FSS prices to the ceilings, VA estimated that
it would have paid over $152.9 million, roughly 29 percent more. 
Thus, VA calculated that on an annualized basis, the impact of giving
state and local governments access to the FSS would have been a
$153.1 million increase in its own yearly drug expenditures because
it would have to pay about 49 percent more overall for the drugs
included in its analysis. 

Those federal purchasers that, unlike VA, have no protection from the
ceiling prices established by the Veterans Health Care Act would pay
full FSS prices on all drugs they buy from the schedule.\36
Currently, however, most manufacturers' FSS prices do not exceed the
ceiling prices.  In fact, as of November 1996, only 25 of 162 drug
manufacturers had FSS prices that were above the federal ceiling
prices.  But manufacturers can offer purchasers not protected by the
act prices above the ceilings.\37 Officials representing several drug
manufacturers told us manufacturers would consider this option
attractive if the pharmaceutical schedule is opened because they
could then offer these higher prices to state and local purchasers. 
The federal purchasers that are not protected by the ceiling prices
would then also pay the full price increases when purchasing from the
schedule. 

The potential impact of FSS price increases on different government
purchasers when purchasing from the pharmaceutical schedule is
summarized in table 1. 



                          Table 1
          
          Potential Effects of FSS Price Increases
              on FSS Prices Paid by Government
                         Purchasers


               Before FSS     After FSS
Purchaser      opened         opened         Implications
-------------  -------------  -------------  -------------
VA, DOD,       Lower of FSS   Lower of FSS   FSS price for
Public Health  or federal     or federal     8% of drugs
Service,       ceiling price  ceiling price  could
Coast Guard    for covered    for covered    increase up
               drugs; FSS     drugs; FSS     to federal
               for drugs not  for drugs not  ceiling
               covered        covered        price; FSS
                                             price could
                                             increase for
                                             many drugs
                                             not covered

Other federal  FSS            FSS            FSS prices
government                                   could
entities                                     increase for
                                             many covered
                                             and uncovered
                                             drugs

State and      Not            FSS            FSS prices,
local          applicable--                  even if they
government     negotiated                    increase,
entities       prices                        could be
                                             lower than
                                             prior
                                             negotiated
                                             prices; if
                                             they are not,
                                             purchasers
                                             could try to
                                             negotiate
                                             lower prices
----------------------------------------------------------
Note:  For the purpose of this table, federal purchasers are
considered to be dependent on purchasing many of their drugs from the
FSS rather than from alternative sources. 


--------------------
\32 As of Sept.  30, 1996, the FSS included 22,828 products--6,243
were covered drugs and 16,585 were not covered. 

\33 Expenditure data were not readily available for products on the
pharmaceutical FSS. 

\34 DOD and Indian Health Service officials agreed with VA's
assumptions about the potential effects of opening the schedule. 

\35 According to VA, calculations were based on actual contract
purchase prices from VA's prime vendor network from Jan.  1 through
June 30, 1994. 

\36 Any federal purchaser may contact drug manufacturers and attempt
to obtain FSS price reductions on specific products before placing
orders from the schedule.  Manufacturers are allowed to provide such
reductions without passing them on to other federal purchasers or
changing a product's listed FSS price.  According to a VA official,
however, drug manufacturers typically do not provide FSS price
reductions without providing them to all federal purchasers. 

\37 About 72 percent of the drugs with FSS prices above FCP as of
Sept.  30, 1996, had FSS prices that were less than 1 percent above
FCP.  According to a VA representative, many of these drugs' prices
probably would be at FCP if not for a minimal fee included in the
price that covers VA's administration of the FSS. 


      STATE AND LOCAL PURCHASERS
      COULD CHOOSE BETWEEN FSS OR
      OTHER DRUG PRICES
---------------------------------------------------------- Letter :4.2

Opening the pharmaceutical schedule would give state and local
purchasers the choice of buying drugs from the FSS or from other
sources.  If a drug's FSS price rises, public hospitals, for
instance, could choose to buy it at the FSS price or continue to use
group purchasing organizations, formularies, and other cost-control
tools to attempt to negotiate a better price with drug
manufacturers.\38 The incentive for a drug manufacturer to negotiate
a price below the FSS price would be limited, however, because the
negotiated price could become the most-favored customer price and,
thus, potentially affect the manufacturer's FSS price negotiations
with VA. 

The Public Hospital Pharmacy Coalition believes opening the schedule
will benefit state and local purchasers because FSS prices will
continue to represent a significant discount.  The Coalition contends
that drug manufacturers would have little incentive to raise FSS or
other drug prices if the pharmaceutical schedule is opened because

  a manufacturer's participation in the cooperative purchasing
     program is voluntary, thus allowing a company to opt out of the
     program if it anticipates any adverse economic consequences;

  if a manufacturer concludes that it must participate in the program
     for competitive reasons, the same competitive forces will keep
     prices from rising;

  the potential size of the state and local market will be small
     based on the Coalition's proposal for determining eligibility to
     access FSS drug prices; and

  market size is but one of many factors drug manufacturers consider
     in developing drug pricing strategies. 

Therefore, the Coalition believes that any adverse effects on FSS or
other drug prices would be negligible and state and local purchasers
would have access to many FSS prices that would be lower than the
drug prices they currently pay. 

A Coalition analysis of the differences between FSS prices and the
prices nine public hospitals paid for drugs showed that, on average,
FSS prices were considerably lower than the hospitals' purchase
prices.\39 The analysis compared the prices for the 100 drugs each
hospital spent the most on during a recent fiscal year.\40 The
Coalition concluded that FSS prices, on average, were lower than the
hospitals' purchase prices for about 83 percent of the drugs.  The
FSS price, on average, was about 17 percent lower than the price the
hospitals paid. 

Had those hospitals been able to buy their top 100 drugs at FSS
prices whenever the FSS price was below the hospitals' regular
purchase price, they would have saved, on average, about 21 percent
on drug expenditures, the Coalition concluded.\41 For those drugs
with FSS prices below hospital purchase prices, the average savings
on total purchases of a drug would have been about 25 percent. 

If the pharmaceutical schedule is opened and FSS prices rise, the
extent to which state and local government purchasers could benefit
is unclear.  The drug prices paid by the hospitals in the Coalition's
analysis show that many FSS prices could rise and still be lower than
what the hospitals have paid.  The extent to which FSS prices would
increase, however, is uncertain.  In addition, if FSS prices increase
because drug manufacturers raise prices for their most-favored
customers, the impact on state and local purchasers could vary,
depending on whether a state or local purchaser was a most-favored
customer.  For each drug manufacturer, the most-favored customer can
vary by drug and by type of purchaser, such as a hospital, health
maintenance organization, or government purchaser.  Therefore, in
those instances in which the state and local purchaser was a
most-favored customer, the negotiated price could rise.  While an
increase in most-favored customer prices could affect state or local
purchasers differently, they would retain the freedom to try to
negotiate better prices for themselves.  The result for federal
purchasers, however, would be an increase in FSS prices. 


--------------------
\38 In addition to group purchasing organizations that represent
hospitals, state and local agencies in more than 25 states have
joined together to purchase drugs as a single group purchasing
organization. 

\39 The analysis was based on FSS and hospital purchase prices as of
Oct.  1, 1996. 

\40 Hospitals ranged in size from 140 to over 900 beds and included
some that received price discounts on outpatient drugs because they
serve a disproportionate share of Medicaid patients. 

\41 Total expenditures for each hospital for the top 100 drugs at the
lowest prices ranged from about $345,000 to about $7.3 million. 


   AGENCY COMMENTS AND OUR
   RESPONSE
------------------------------------------------------------ Letter :5

We received both written and oral comments on a draft of this report
from GSA, VA, PhRMA, and the Public Hospital Pharmacy Coalition. 

In general, GSA, VA, and PhRMA agreed that the report accurately
reflected the difficulty and complexity of assessing the potential
effects of opening the pharmaceutical FSS on schedule drug prices. 
PhRMA also commented that the report provided important insights into
characteristics of the market that could be affected by such a
change.  However, PhRMA said that in its view the report placed
unnecessary emphasis on the Coalition's study and did not
sufficiently analyze its flaws and limitations.  We did not provide a
point-by-point analysis of each study mentioned in the report because
the purpose of this report was to provide an overall assessment of
the potential effects of opening the pharmaceutical FSS. 

The Coalition's primary concern was that it believed the report
overemphasized the potential adverse effects of opening the schedule
and ignored potential competitive benefits.  For example, the
Coalition believed that opening the schedule would create downward
pressure on FSS prices.  The Coalition also said that drug
manufacturers could absorb any potential losses from providing lower
drug prices to state and local government entities.  Moreover, the
Coalition was concerned that the report offered no real analysis of
why FSS prices could increase and did not emphasize that federal
purchasers were not limited to purchasing pharmaceuticals from the
FSS.  The Coalition contended that the Medicaid rebate experience had
minimal relevance to opening the FSS because the FSS market would be
much smaller than the Medicaid market and participation in the
cooperative purchasing program would be optional for drug
manufacturers.  The Coalition also contended that because overall
drug prices did not increase after enactment of the Veteran's Health
Care Act--which set price ceilings on certain drugs for VA and other
agencies--opening the pharmaceutical schedule would have little or no
impact on FSS prices.  In addition, the Coalition recommended that we
delete any reference to diversion from the report because the
diversion of pharmaceuticals is already prohibited by the
Robinson-Patman Price Discrimination Act\42 and the Non-Profit
Institutions Act.\43 The Coalition also requested that we clarify
GSA's reasoning for proposing that the pharmaceutical schedule be
excluded from the cooperative purchasing program.  The Coalition
strongly rejected GSA's implication that a unique relationship
between the Veterans Health Care Act and the cooperative purchasing
program would cause an increase in FSS drug prices. 

Throughout the report we emphasize that it is not possible to predict
how pharmaceutical FSS prices would change if the schedule is opened. 
In response to the Coalition's comments, we modified the report to
underscore this point.  While we recognize that opening the FSS could
enable state and local government entities to purchase drugs at lower
prices, we focused on the potential for FSS drug prices to rise
because it was most relevant to GSA in determining whether to exclude
the schedule from the cooperative purchasing program.  GSA has
indicated that it is not the intent of the cooperative purchasing
program to increase schedule prices.  The report discusses the types
of pressures that could potentially result in increased FSS prices. 
We agree that federal purchasers can purchase pharmaceuticals from
sources other than the FSS and that the extent to which federal
purchasers buy products from other sources could have an impact on
schedule prices.  Nevertheless, VA, which spends the most federal
dollars on pharmaceuticals, currently depends on the FSS for most of
its pharmaceutical purchases. 

In our view, the Medicaid rebate experience provides a useful example
of how drug manufacturers have responded to requirements that they
provide lower prices to a significant share of the market and how FSS
prices could be affected if the size of the combined market
represented by federal, state, and local purchasers was also
significant.  The report recognizes the uncertainty that exists about
the size of this potential market as well as the economic reasons why
drug manufacturers would not be likely to opt out of cooperative
purchasing.  While we agree that overall pharmaceutical price changes
following the Veterans Health Care Act may be relevant in assessing
the potential impact of opening the pharmaceutical schedule, a better
indicator would be changes in pharmaceutical FSS prices following the
act's enactment.  According to VA's fiscal year 1998 budget
submission about 70 percent of all covered drugs' prices have
increased since then.  Some VA officials believed that the increase
in FSS prices was the result, in part, of drug manufacturers
responding to the act's drug pricing provisions, particularly those
that set price ceilings on certain drugs for VA and other agencies. 
These officials also indicated, however, that the increase in FSS
prices could be related to other factors as well.  In addition, we
agree with the Coalition that federal law already places restrictions
on the resale or diversion of discounted commodities purchased from
the FSS.  We included the issue in the report because of the concerns
raised by PhRMA and others.  Moreover, the Congress was sufficiently
concerned about the diversion of outpatient drugs to include specific
safeguards against it in the Veterans Health Care Act.\44

In response to the Coalition's comments, we added to the report GSA's
specific justification for proposing that the pharmaceutical schedule
be excluded from cooperative purchasing.  We agree that drug pricing
provisions in the Veterans Health Care Act alone or in combination
with other factors would not necessarily result in increased FSS drug
prices.  But the federal price ceilings set in the act would be a
factor in FSS negotiations between VA and drug manufacturers and
would be relevant to the ultimate FSS prices different government
purchasers could pay if the pharmaceutical schedule were opened. 

Each of the organizations provided a number of suggested technical
changes that we incorporated into the final report where appropriate. 


--------------------
\42 June 19, 1936, ch.  592 (15 U.S.C.  sec.  3-13c, 21a). 

\43 May 26, 1938, ch.  283 (15 U.S.C.  sec.  13c). 

\44 See P.L.  102-585, sec.  602. 


---------------------------------------------------------- Letter :5.1

We will make copies of this report available upon request.  This
report was prepared by John Hansen, Assistant Director, Joel
Hamilton, Leslie Albin, and Toni Navarro.  Please call me at (202)
512-7119 or Mr.  Hansen at (202) 512-7105 if you or your staff have
any questions about this report. 

Bernice Steinhardt
Director, Health Services Quality
 and Public Health Issues


*** End of document. ***