Cardinal Health 2009 Annual Report Download - page 26

Pharmaceutical supply chain business model. The Healthcare Supply Chain Services segment’s
pharmaceutical supply chain business maintains prime vendor relationships with its customers that streamline the
purchasing process for its customers by reducing the number of vendors. Using a prime vendor offers customers
logistical savings and fosters partnerships between customer and distributor that result in greater efficiency and
lower costs.
Five primary factors influence the pharmaceutical supply chain business’ gross margin for pharmaceutical
products: customer discounts, manufacturer cash discounts, distribution service agreement fees, manufacturer
rebates and incentives, and pharmaceutical price appreciation.
In general, the Company sells branded pharmaceutical products to its customers at a contract price that is
based on the manufacturer’s published price or another designated price at the time of sale (in either case, the
“manufacturer’s designated price”). The contract price generally is determined by applying a discount to the
manufacturer’s designated price. The term “customer discounts” refers to the difference in dollars between the
sales price to customers for pharmaceutical products (net of discounts, rebates and incentives given to customers)
and the manufacturer’s designated price for those pharmaceutical products sold in a particular period.
The term “manufacturer cash discounts” refers to the aggregate amount in dollars of cash incentives the
Company receives from manufacturers for prompt payment of invoices. Manufacturer cash discounts are
typically a fixed percentage of the purchase price from the manufacturer.
The term “distribution service agreement fees” refers to aggregate fees paid by manufacturers for services
provided by the Company related to the distribution of the manufacturers’ products. The Company’s
fee-for-service arrangements are reflected in written distribution service agreements, and may provide for a fee or
a fee plus pharmaceutical price appreciation (as described below). In certain instances, the Company must
achieve certain performance criteria to receive the maximum fees under the agreement. The fee is typically a
fixed percentage of either the Company’s purchases from the manufacturer or the Company’s sales of the
manufacturer’s products to its customers.
The term “pharmaceutical price appreciation” refers to the impact on gross margin in dollars of
pharmaceutical price appreciation for pharmaceutical products sold during a particular period. The impact
happens when the Company purchases inventory and the manufacturer subsequently increases its published
price. By virtue of the Company’s contract price to customers being based upon the manufacturer’s designated
price at the time of the sale, the Company then sells that inventory on hand at a higher price. The Company
continues to generate a portion of its gross margin from the sale of some manufacturers’ products from
pharmaceutical price appreciation without receiving distribution service agreement fees. For these manufacturers,
a reduction in the frequency and magnitude of price increases, as well as restrictions in the amount of inventory
available to the Company, could adversely affect the Company’s results of operations and financial condition.
The term “manufacturer rebates and incentives” refers to discounts the Company receives from
manufacturers as a result of competition among manufacturers, including manufacturers of generic
pharmaceuticals, in pricing their products. Manufacturer rebates and incentives are based on either the
Company’s purchases from the manufacturer or the Company’s sales of the manufacturer’s products to its
customers. The Company generally earns the greatest margin dollars on generic pharmaceuticals during the
period immediately following the initial launch of a generic product in the marketplace because generic
pharmaceutical selling prices are generally deflationary.
Therefore, the Company’s pharmaceutical supply chain business generates gross margin primarily to the
extent that the selling price to its customers, net of customer discounts, exceeds in the aggregate, the cost of
products sold, net of manufacturer cash discounts, distribution service agreement fees, pharmaceutical price
appreciation and manufacturer rebates and incentives.
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