Wal-Mart’s announcement of its expanded generic drug program and Walgreen’s weak profits are further evidence of this trend. But contrary to some press reports, I don't see a direct cause-and-effect relationship between these two events.
Yesterday, Walgreen Co (WAG) announced a rare profit decline driven in part by lower reimbursements on generic drugs. (See Walgreen's Earnings Fall Spurs Concern in Sector.) The company’s stock dropped by 15 percent – a $7 billion loss in market cap.
But as I noted last week, chains such as CVS Corp (CVS) or Walgreens (WAG) are not really vulnerable to Wal-Mart’s program because customers with third-party insurance do not save much versus standard co-pays.
My take: payers and pharmacy benefit managers now recognize the generic profit potential, so they are squeezing pharmacies sooner and harder than ever before.
In contrast, Wal-Mart’s program highlights the high generic margins embedded in the pharmacy business model, especially for cash-pay customers. Yet Wal-Mart’s $4 generics program is neither a loss leader nor a “classic bait-and-switch,” as the National Community Pharmacists Association claims.
Still not sure? Then let’s do some math!
OIG reported average pharmacy acquisition costs for a set of generic drugs in its June report Deficit Reduction Act of 2005: Impact on the Medicaid Federal Upper Limit Program. The cost data were collected from the three largest national drug wholesalers plus two regional wholesalers.
Six of the generic drugs in the OIG study also appear on Wal-Mart’s list. Here’s what I found:
Weighted average margin = 24%. These calculations dramatically underestimate Wal-Mart’s actual gross margin because Wal-Mart's product acquisition costs are much lower than the independents, supermarkets, and small chains that buy through wholesalers. (See my January post for background.)
Add in Wal-Mart’s minimal incremental costs of dispensing and it's clear that the $4 generics program could be very profitable.
BTW, these margins are below what retail pharmacies were earning when dispensing generics under Medicaid in 2002. But isn’t that what led to Average Manufacturer Price (AMP) in the first place?
For fun (?), I searched for a few drugs on the New York State Attorney General’s Office Prescription Drug Price Website. Example: the cash-pay, no-insurance price for Metformin 500 mg ranges from $4 at Target or Wal-Mart to more than $50 at many independents. CVS charges $24.89 and Walgreen (WAG) charges $29.99. I checked some online prices and found similar numbers – Drugstore.com charges $39.99.
Last week, NCPA accused Wal-Mart of "devaluing and destroying the practice of pharmacy." From my perspective, it looks like retail pharmacy is finally facing the consequences of their own business decisions. Wal-Mart is merely targeting an area of excess profits, to the ultimate detriment of less-efficient retail pharmacies. Stay tuned – this will get uglier!