While many stakeholders criticize high drug prices, few understand the complex system used to establish the cost of prescription medications.

Here’s a breakdown of the pharmaceutical supply chain and how prescription drug prices are set.

1. Drug companies set the list price for their drugs based on how much they need to recoup for research and development costs. The companies also consider production costs and room for profit when setting prices.

2. The drugmakers sell their medications to wholesalers at a negotiated discount.

3. The wholesaler distributes the drug to pharmacies and hospitals at a slightly lower discount, keeping the difference as profit, according to the report.

4. The amount consumers and their health plan sponsors pay for a drug at the pharmacy counter depends on a customer’s individual health plan. Typically, consumers pay a set co-pay amount and the pharmacy bills the health plan through a pharmacy benefit manager for the remaining amount, along with a small fee for profit.

5. Pharmacy benefit managers are third-party companies that manage prescription benefits for health plans. PBMs represent millions of patients and use them as leverage to negotiate bigger rebates from the drug company in exchange for offering preferred coverage status for a drug.

6. Once a rebate is successfully negotiated, the drugmaker pays the PBM, who then passes all, some or none of the rebate amount on to the health plan sponsor, depending on their contract.