United States General Accounting Office

GAO 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

GAO United States

General Accounting Office

Washington, D.C. 20548

Health, Education, and

Human Services Division

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

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.

Page 1 GAO/HEHS-97-60 Pharmaceutical FSS
B-276585 

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

schedule4

 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

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.

Page 2 GAO/HEHS-97-60 Pharmaceutical FSS
B-276585 

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.

Results in Brief 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,

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.

Page 3 GAO/HEHS-97-60 Pharmaceutical FSS
B-276585 

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 The federal supply schedule (FSS) for pharmaceuticals is a price catalog

currently containing almost 23,000 pharmaceutical products10 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.

10The 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.

Page 4 GAO/HEHS-97-60 Pharmaceutical FSS
B-276585 

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

11See 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.

12The 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.

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

Page 5 GAO/HEHS-97-60 Pharmaceutical FSS
B-276585 

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 products14 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.

Impact of Opening the

FSS Depends Largely

on Price Negotiations

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

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.

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

15Federal 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.

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

Page 6 GAO/HEHS-97-60 Pharmaceutical FSS
B-276585 

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

17Drugs 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.

18See CBO Papers: How the Medicaid Rebate on Prescription Drugs Affects Pricing in the

Pharmaceutical Industry (Washington, D.C.: CBO, Jan. 1996).

Page 7 GAO/HEHS-97-60 Pharmaceutical FSS
B-276585 

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

19PhRMA 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.

Page 8 GAO/HEHS-97-60 Pharmaceutical FSS
B-276585 

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.

Size of Market Eligible for

FSS Prices Would Be Key

Factor

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

20According 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.

21See GSA’s Federal Register notice, Apr. 7, 1995, and the Federal Acquisition Streamlining Act of 1994,

P.L. 103-355, sec. 1555.

Page 9 GAO/HEHS-97-60 Pharmaceutical FSS
B-276585 

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.

22Coalition estimates indicate that these types of facilities could represent over 30 percent of about

7,900 potential eligible state and local entities.

23PhRMA 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.

24See 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).

Page 10 GAO/HEHS-97-60 Pharmaceutical FSS
B-276585 

Figure 1: Composition of the State and

Local Market for FSS Sales Based on

the Public Hospital Pharmacy

Coalition’s Proposal

•

8.4%

Mental Retardation Residential

Facilities

13.4% •

Mental Health Facilities

1.5%

Skilled Nursing Facilities •

3.2%

Correctional Institutions

67.0%•

Community Hospitals

•

5.3%

Psychiatric Hospitals

1.2%

Chronic and TB Hospitals

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

Page 11 GAO/HEHS-97-60 Pharmaceutical FSS
B-276585 

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 respondents25 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

25Respondents represented 48 states and 2 territories.

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

27According 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.

Page 12 GAO/HEHS-97-60 Pharmaceutical FSS
B-276585 

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 prices29 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

FSS Price Changes

Would Affect

Government

Purchasers Differently

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

28See Medicaid: Changes in Drug Prices Paid by HMOs and Hospitals Since Enactment of Rebate

Provisions (GAO/HRD-93-43, Jan. 15, 1993).

29See Medicaid: Changes in Best Price for Outpatient Drugs Purchased by HMOs and Hospitals

(GAO/HEHS-94-194FS, Aug. 5, 1994).

30A 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).

31See 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.

Page 13 GAO/HEHS-97-60 Pharmaceutical FSS
B-276585 

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

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

32As of Sept. 30, 1996, the FSS included 22,828 products—6,243 were covered drugs and 16,585 were

not covered.

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

Page 14 GAO/HEHS-97-60 Pharmaceutical FSS
B-276585 

Figure 2: FSS Price Relative to FCP for

Schedule Drugs as of September 30,

1996

16.9% •

FSS Price Above FCP

• 2.4%

FSS Price Same as FCP •

8.0%

FSS Price Below FCP

72.7%•

FSS Price Not Subject to FCP

Not Covered by the Veterans Health Care Act

Covered by the Veterans Health Care Act

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.

Page 15 GAO/HEHS-97-60 Pharmaceutical FSS
B-276585 

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

34DOD and Indian Health Service officials agreed with VA’s assumptions about the potential effects of

opening the schedule.

35According to VA, calculations were based on actual contract purchase prices from VA’s prime vendor

network from Jan. 1 through June 30, 1994.

36Any 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.

Page 16 GAO/HEHS-97-60 Pharmaceutical FSS
B-276585 

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

FSS price paid

Purchaser Before FSS opened After FSS opened Implications

VA, DOD, Public

Health Service, Coast

Guard

Lower of FSS or

federal ceiling price

for covered drugs;

FSS for drugs not

covered

Lower of FSS or

federal ceiling price

for covered drugs;

FSS for drugs not

covered

FSS price for 8% of

drugs could

increase up to

federal ceiling price;

FSS price could

increase for many

drugs not covered

Other federal

government entities

FSS FSS FSS prices could

increase for many

covered and

uncovered drugs

State and local

government entities

Not applicable—

negotiated prices

FSS FSS prices, even if

they increase, 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.

State and Local Purchasers

Could Choose Between

FSS or Other Drug Prices

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,

37About 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.

Page 17 GAO/HEHS-97-60 Pharmaceutical FSS
B-276585 

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.

38In 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.

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

40Hospitals 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.

Page 18 GAO/HEHS-97-60 Pharmaceutical FSS
B-276585 

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.

Agency Comments

and Our Response

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.

41Total expenditures for each hospital for the top 100 drugs at the lowest prices ranged from about

$345,000 to about $7.3 million.

Page 19 GAO/HEHS-97-60 Pharmaceutical FSS
B-276585 

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 Act42 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

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

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

Page 20 GAO/HEHS-97-60 Pharmaceutical FSS
B-276585 

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.

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

Page 21 GAO/HEHS-97-60 Pharmaceutical FSS
B-276585 

Each of the organizations provided a number of suggested technical

changes that we incorporated into the final report where appropriate.

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

(108294) Page 22 GAO/HEHS-97-60 Pharmaceutical FSS
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