However, the conflicting interpretations of this report illustrate why it’s so hard to understand the reality facing independents. The report is also a good opportunity for me to analyze the unfortunate economic realities facing the owners of lower volume, less efficient independent pharmacies. In my opinion, owners of low-volume independent pharmacies must either Get big, Get lean, or Get out.
As always, I encourage you to read the full report and make up your own mind: Review of the Relationship between Medicare Part D Payments to Local, Community Pharmacies and the Pharmacies’ Drug Acquisition Costs
IS THERE A GLASS?
Don’t be alarmed if you can’t figure out if the new OIG report is good or bad for independent pharmacies.
The Association of Community Pharmacists said that the new report “validates their concerns that payments under the Medicare drug benefit are driving some of them out of business” in Pharmacists decry Medicare drug payments. In contrast, PCMA sees the glass as half full, arguing that the report runs counter to claims from the independent drugstore lobby.
Steve Anderson of NACDS issued a cautious official statement with the intriguing double negative phrase that “pharmacies are not overcompensated.” His wording reminds me of the time my daughter told me that my new shirt “didn’t look totally uncool, for a dad.” (Gee, thanks.)
WHAT THE REPORT ACTUALLY SAYS
The OIG studied actual data for a sample of independent pharmacies to measure two components of Gross Profit per Script under Part D:
- Spread: The difference between (a) the “ingredient cost” reimbursements received by a pharmacy from a Part D Prescription Drug Plan (PDP), minus (b) the pharmacy’s net cost for purchasing the product (including rebates).
- Dispensing fee: The fixed per prescription payment.
Here are the averages that I calculated from the OIG report:
Part D Revenue per Script = $127.49
Part D Gross Profit per Script = $11.29
Part D Gross Margin per Script = 8.9%
Part D Revenue per Script = $23.92
Part D Gross Profit per Script = $11.48
Part D Gross Margin per Script = 48.0%
I suspect that gross margins for the major chains -- CVS Caremark (CVS), Walgreens (WAG), and Rite-Aid (RAD) -- were similar to these figures. Note that generic and brand name scripts had roughly equivalent dollars per script even though gross margins differ by 39 percentage points.
YES, THE AVERAGE INDEPENDENT PHARMACY MADE MONEY WITH PART D
In the comments of Pharmacy Profits & PBM Contracts, I was accused of being misleading because I didn’t consider the cost of dispensing when discussing average revenue per script.
But I’m not a financial fool. I understand that gross profit is nothing more than PBE -- Profits before Expenses. Which brings us to the multi-million dollar question: Does the Part D Gross Profit per Script cover a pharmacy's fully-loaded per script operating expenses (a.k.a. the Cost of Dispensing)?
The OIG cites the National Study to Determine the Cost of Dispensing (COD) Prescriptions in Community Retail Pharmacies, which spawned the oft-repeated $10.50 average dispensing cost per prescription for 2006. Using the OIG data above (also 2006), the average COD leads to the following Return on Sales (Pretax Profit / Revenue) per Script:
Brand-name Drugs = 0.6%
Generic Drugs = 4.1%
While not spectacular, these figures suggest that the average pharmacy did make money at Part D. In addition, ROS only tells part of the profitability story because it ignores the balance sheet assets required to generate the income statement profit. Any wholesale or retail company should measure its true profitability using Return on Investment (Pretax Profit / Owner’s Equity). But I’ll leave it up to you to understand that ROS is only one of the three critical ratios in the Strategic Profit Model.
BUT SIZE MATTERS
However, Table 5 of the full COD study tells a different story when it reports COD for size-based quartiles. You will not be surprised to learn that these size-based differences have been conveniently ignored since publication of the report in January 2007.
Grant Thorton ranked the 23,152 pharmacies in the COD study by volume (number of prescriptions filled) and then grouped them into quartiles based on total prescriptions. Thus, the bottom quartile represented 25% of scripts and 46% of independent pharmacies. The top quartile also represented 25% of scripts but only 11% of independent pharmacies. In other words, the top quartile pharmacies were (by definition) larger.
Grant Thorton found a strong correlation between size and efficiency.
- The bottom size quartile (46% of independents) had average COD of $14.84, implying negative ROS for both brand and generic drugs in Part D.
- The top quartile had average COD of $9.01, implying ROS of 1.8% for brand-name drugs and 10.3% for generic drugs.
I can certainly sympathize with NCPA’s awkward position when confronted with these data because the 10,650 smaller, less efficient pharmacies (46% * 23,152) vastly outnumber the 2,547 larger, more efficient pharmacies (11% * 23,152).
MORE CONSOLIDATION TO COME
The Part D profit data hark back to my efficiency question posed last July in Heretical Questions about the AMP War: Does the U.S. retail pharmacy industry simply have too much capacity?
Now before you send me hate mail, I want you to recognize that I am just a messenger who is highlighting the evolutionary dynamics for you. You may not like the data that I present here, but these are the unpleasant facts.
OK, independent pharmacy owners – what do you think?