Common Agent or Double Agent? Pharmacy Benefit Managers in the Prescription Drug Market

Abstract Pharmacy benefit managers dominate the U.S. pharmaceutical market but are controversial and poorly understood. We analyze PBMs as market intermediaries that operate formulary contests in which on-patent brand-drug makers compete for favorable placement by offering rebates off list price. These formulary contests deliver efficiency gains compared to drug makers selling directly to consumers; PBMs capture some of these gains. Our approach answers key questions regarding the determinants of efficiency, rebates, list prices, and PBM market power in the pharmaceutical market. Our analysis also explains how common contracting practices, federal regulations, and incentives within formulary contests can undermine market efficiency.