Quantifying the Value of Blockchain-Based Supply Chain Networks—Part Two

Structure and Challenges of the Pharmaceutical Supply Chain


Pharmaceutical supply chains face a number of challenges that could be mitigated by the adoption of multi-enterprise supply chain application network technology. Here we describe the structure of pharmaceutical supply chains and key challenges faced, such as: diverse and divergent incentives among different supply chain participants, complexity and opacity of product and financial flows, strict regulations, perishable products, and elusive patient adherence.


In Part One of this series, we described what supply chain application networks are and how blockchain technology can potentially lower the cost of implementing those networks. Here in part two, we begin the process of quantifying the value that these networks can bring, using pharmaceutical supply chains as the example target industry. We describe some of the challenges that the pharma supply chains face, which supply chain application networks could potentially help solve.

Pharmaceutical end-to-end chain-of-custody

Pharmaceutical supply chains: complex and challenging

Our first hypothetical BSN provides end-to-end chain-of-custody functionality for pharmaceutical supply chains. Pharmaceutical supply chains are complex, with many participants. At a high level, supply chain participants operate in one or more of the following functional segments:
   1) inputs—companies providing the input materials (e.g., active pharmaceutical ingredients (APIs), excipients, diluents, binders, etc.)
   2) discovery—those involved in R&D and discovering new treatments
   3) development—those developing drugs, conducting clinical trials, and shepherding the drugs through the regulatory approval process
   4) manufacturing—those firms manufacturing, packaging, and marketing the drugs
   5) distribution—those companies distributing drugs from the manufacturer to the dispensers
   6) dispensers—those dispensing the drugs to patients (including retail pharmacies and various healthcare providers)
   7) patients—perhaps the most important segment, as the whole chain exists to serve and treat them.

In addition to these seven supply chain segments, critical and highly influential roles are played by various service providers, payers, regulators, and industry groups.

Figure 1 – Scope of Proposed Blockchain-based Supply Chain Network (BSN) for Pharmaceuticals

The pharmaceutical supply chain faces many challenges, some of which can potentially be alleviated by a blockchain-based end-to-end chain-of-custody solution:

  • Diverse, divergent, and conflicting incentives—In addition to the typical set of conflicting interests1 between trading partners, pharmaceutical supply chains have a set of unique characteristics and conventions that create some industry-specific, widely varying, and often conflicting incentives for players up and down the chain. This often results in suboptimal supply chain decisions. For example, there is enormous variance between the margins earned by different types of players. Gross margins for pharma manufacturers are on average 71.1 percent, for wholesalers only 3.7 percent, and for pharmacies 20.1 percent.2 To bring a single drug to market, manufacturers can invest over a billion dollars, and take more than a decade of effort. In contrast, wholesale distributors have no investment in developing the drug, but make major capital investments in warehouses, IT systems, and developing various expertise.3 These vastly different investments and margins lead to vastly different optimization strategies and decisions, such as deciding the optimal inventory level by location for each drug. Manufacturers earn much higher margins on branded drugs than on generics, but for wholesalers and pharmacy benefit managers (PBMs), it is reversed—the margins on generics are much higher.4 A chain-of-custody blockchain network will not change these fundamentally different incentives, but it provides much better transparency and precise visibility of the flow of pharmaceuti­cals through the network, helping the various players better understand the consequences of their decisions and collaborate better to realize supply chain-wide improvements.
Source: USC Schaeffer, Graphic from Flow of Money Through the Pharmaceutical Distribution System, June 6 2017, DOI: https://doi.org/10.25549/hypg-r802 (Modified by ChainLink Research)
Figure 2 – Margins and flow of payments, drugs, and services in pharmaceuticals
  • Financial complexity/opacity—The pharma industry has a byzantine and ever-changing set of payment flows, parts of which are opaque, contributing to enigmatic (and sometimes perverse) incentives for different players. This has been exacerbated by the rise in power and changing role of PBMs, as well as group purchasing organizations (GPOs) and pharmacy services administration organizations (PSAOs),5 an obscure flow of rebates, and in the U.S., a patchwork of state pharmaceutical regulations as well as a seemingly endless flow of ideas for new regulations and pricing mechanisms6 to try to lower prescription drug costs. A chain-of-custody blockchain network could be extended to illuminate financial flows as well.
  • Distribution complexity/opacity—The distribution path a shipment of drugs takes from the manufacturer to the dispenser can be highly circuitous, changing hands through a dozen or more different parties, especially outside of the U.S. In the U.S., about 90 percent of drugs flow through the three main national wholesale distributors, but there are still several regional wholesalers and almost 7,000 secondary wholesalers. Globally there are about 300,000 wholesalers7 who constantly buy and sell from each other to meet current market demand, frequently stripping off original packaging and repackaging products in the process. This can create all kinds of challenges, such as grey market diversion, injection of counter­feits into the supply chain, and cold chain excursions. A chain-of-custody blockchain network can help solve these kinds of problems.
  • Onerous and Ever-evolving regulation—As one of the most highly regulated industries, pharmaceutical manufacturers and supply chain participants must comply with the U.S. Drug Supply Chain Security Act (DSCSA) and similar supply chain regulations worldwide. A blockchain-based chain-of-custody solution is ideally suited to help companies provide the end-to-end traceability mandated by these regulations. More broadly, regulation requirements make it more difficult for pharmaceutical companies to change processes and procedures up and down the chain, constraining changes to everything from manufacturing batch sizes, to procedures for handling of drugs in transit, to packaging changes. An industry-standard blockchain solution could help the industry make progress along many dimensions, while reducing the regulatory compliance burdens for each individual participating company.
  • Perishable, condition-sensitive products—The market share of biologics is predicted to continue to rise rapidly.8 These drugs are usually temperature sensitive, often with short shelf lives and/or other environ­men­tal sensitivities. This temperature sensitivity applies as well to the raw materials (APIs) and work-in-progress (WIP) ­inventory. Furthermore, about half of drugs are moisture- or humidity-sensitive.9 A chain-of-custody solution that includes temperature and condition monitoring can help manage environmental conditions as input ingredients and pharmaceuticals change hands across the many players in the supply chain.
  • Source: pharmacydirectgb.co.uk/ from Flickr
    (CC BY 2.0 Deed)
  • Patient adherence—Patient non-adherence is a perennial problem. Research shows that 20 percent to 30 percent of prescriptions are never filled, and about 50 percent of drugs for chronic illnesses are not taken as prescribed (Viswanathan, et al. 2012). In the U.S., non-adherence leads to an estimated 125,000 deaths and adds healthcare costs of $100B-$300B annually (Viswanathan, et al. 2012). The economic cost of lost productivity is estimated to average 2.3 times those added healthcare costs (Healthentic 2015). A diverse set of interventions are used to try to improve patient compliance, including better drug packaging design, case management and counseling, education and coaching, reminders, and other decisions aids. The move to outcome-based pricing will provide even more motivation for drug companies to get involved in improving patient adherence. A true end-to-end chain-of-custody solution, going all the way to the patient, could add a set of tools for monitoring and encouraging patient compliance.

In Part Three of this series, we describe a supply chain application network providing a ‘produce-to-use’ chain-of-custody solution. We describe what that solution is comprised of, and estimate (in dollars) the value it could provide to an archetypal pharmaceutical manufacturer.

1 Virtually all supply chains have the usual ”standard set” of conflicting interests for things like price (“I want to sell for more, you want to buy for less”), terms (“I want to get paid today, you want to pay me six months from now”), and inven­tory (“The other guy should hold the inventory”). These are typically negotiated based on the relative power position of the players. — Return to article text above

2 According to the USC Schaeffer (Sood 2017) — Return to article text above

3 Wholesale distributors invest heavily in building up expertise, systems, and processes in areas such as procurement, demand management and forecasting, distribution and logistics, and financial management. — Return to article text above

4 For manufacturers, the COGS (Cost of Goods Sold) on branded drugs is less than half of that for generic drugs and less than a quarter of their selling price. In stark contrast, wholesalers’ gross margin for generic drugs is about 18 times their margin on branded drugs (Comer 2019). — Return to article text above

5 PBMs negotiate the formularies that heavily influence which drugs are consumed. GPOs aggregate purchases for providers and pharmacies. PSAOs provide tools and services to pharmacies, including negotiating contracts with PBMs and payors. — Return to article text above

6 There has been a longstanding broad push for value-based pricing, a fundamental change that has been slow to realize in practice, but which is starting to take hold (enabled in part by wider adoption of electronic health records). New pricing mo­dels dramatically reshape the incentives for pharma manufacturers. These models include financial risk-based con­tracts, health outcomes contracts, mortgage models, subscription models, and indication-specific pricing (Comer 2019). — Return to article text above

7 Source: (Dun and Bradstreet 2021) — Return to article text above

8 One source shows the market share of biologics in high-potency active pharmaceutical ingredients rising from less than 22 percent in 2015 to 25 percent in 2020 to almost 29 percent by 2025 (Grand View Research 2017). Other sources show slightly lower numbers for biologics as a percent share of the pharmaceuticals market, but with very similar market share growth rates. — Return to article text above

9 Too low humidity creates static charges that can dry out medications, affect solvents, and cause crumbling or sticking. Too high humidity can compromise efficacy or even lead to toxicity in some drugs. (Colorcon 2020) — Return to article text above

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