Drug Distribution Contracts and Pricing

Yao Zhao, PhD

Professor in

Supply Chain Management

News & Events

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The U.S. pharmaceutical and biotech supply chains recently underwent a drastic transformation from the Buy-and-Hold (BNH) agreement to the Fee-for-Service (FFS) agreement. Manufacturers’ responses are mixed, and the future of the FFS agreement is under debate among industry observers. Emerging competition from 3rd party logistics (3PL) service providers offers new options, such as a Direct-to-Pharmacy (DTP) agreement that transfers the ownership of channel inventory to the manufacturer. Drug manufacturers face fundamental normative questions about the optimal go-to-market channels strategy: Which contract (BNH, FFS, or DTP) would be best for the pharmaceutical supply chain and its individual participants?

My research in this area focuses on modeling and empirical studies of (1) drug distribution models and contracts that ensure mutual benefits to manufacturers and wholesalers, (2) drug pricing – how to predict drug prices based on observable factors.


Martino, K., Y. Zhao, A. Fein (2013). Resell versus Direct Models in Brand Drug Distribution. International Journal of Pharmaceutical and Healthcare Marketing 7: 324-340 (selected by the editorial team as one of the two Highly Commended Papers in 2013).

Abstract: In this paper, we present a mathematical model to study the comparative effectiveness of the BNH, FFS and DTP agreements for the manufacturer, the wholesaler and the supply chain as a whole. We consider cases where the aggregated demand is predictable and determine the profit maximizing production-inventory strategy in a multi-period setting for the manufacturer and wholesaler under each contractual agreement. We show that the DTP agreement eliminates the wholesaler's incentive to investment buy and thus always outperforms BNH and FFS agreements in terms of the total supply chain profit. Indeed, DTP achieves the global optimality for the entire supply chain. We also show that under DTP, one has the flexibility to split the additional profit in an arbitrary way, and thus for any FFS agreement, one can always find a DTP agreement that improves the profitability for both the manufacturer and the wholesaler. Based on data from a leading US pharmaceutical company, we quantify the impact of DTP on the total supply chain profit relative to FFS and BNH agreements. We briefly review one global manufacturer's implementation of the DTP agreement in U.K. and discuss its broader business implications in the U.S.

Martino, K., Y. Zhao, J. Sawhill (2010). A Multiple Regression Model to Explain the Cost of Brand-drugs. Socio-Economic Planning Sciences 47: 238-246.

Abstract: This paper is motivated by recent events pertaining to the rising cost of healthcare in the U.S., and a lack of definitive answers regarding what determines both the initial cost and markup costs of prescription drugs. We find observable characteristics of drugs that help outside parties to predict drug pricing. Observable characteristics are valuable because anyone can observe them at little cost or time, including (for instance) the therapeutic class, manufacturer, class type (brand or generic), and dosing levels. Based on real-world data of the most popular prescription drugs sold in US in 2007, we develop a regression model that can be used to determine an “expected price” for a given drug using these characteristics. Through ANOVA, the results have shown that while therapeutic classes have an impact on the drug wholesale prices, the manufacturers do not set their price differently. The results are also showing that the price differential between generic and brand drugs is not uniform across therapeutic classes, and competition contributes to it. The number of dosing levels has a more significant impact on drug prices than the incremental dosing amount.



Iacocca, K., J, Sawhill, Y. Zhao. 2014. Why Brand Drugs Priced Higher Than Generic Equivalents. Forthcoming at International Journal of Pharmaceutical and Healthcare Marketing.

Purpose: This paper investigates why brand-name drugs are priced higher than their generic equivalents in the U.S. market. We hypothesize that some consumers have a preference for brand names which outweighs the cost savings realized by switching to generics. Consumers may prefer a brand drug because the brand may have a higher perceived quality due to advertising and other promotional activities. Additionally, individuals are habitual in their consumption of prescription drugs, which leads to continued use of the brand in the face of generic competition.

Design/methodology/approach: We develop a structural demand model and proceed to estimate it using wholesale price and demand data from the years 2000 through 2004.

Findings: The results of our analysis reveal that customers have a strong preference for brand drugs. In addition, consumers exhibit high switching costs for prescription drugs.

Originality/value: Considering the price and quantity of prescriptions filled each day, determining why brand drugs do not lower their prices to compete with their generic equivalents is an important question. Unfortunately, the existing literature only acknowledges this counter-intuitive business practice, but does not mathematically explain it. We address this knowledge gap in literature and provide important insight for all players in this industry including consumers, pharmaceutical manufacturers, pharmacies, and health insurance companies.

Keywords: pharmaceutical drugs; generic competition; brand drug prices; consumer utility, nested logit model