Thursday, January 10, 2008

Pharmacy Profits & PBM Contracts

Here’s a post that should generate some heat.

An expert report filed last month in the FirstDataBank Average Wholesale Price (AWP) settlement case sheds light on the usually hidden economics of retail pharmacies. However, the data also provide a fresh perspective on the rhetoric regarding reimbursement levels to independent pharmacies.

A Treasure Trove of Contracts

The Pharmaceutical Care Management Association (PCMA) and the National Community Pharmacists Association (NCPA) are formally objecting to the proposed class settlement with First DataBank. (See Pharmacies Fight First DataBank Settlement at Pharmalot.) Neither PCMA nor NCPA are parties to the case. Fans of legal documents can read the formal NCPA objection to the Settlement Agreement and Release.

The really interesting data comes from the Declaration of H. Edward Heckman concerning FirstData Bank. Mr. Heckman was hired by NCPA to examine the economic impact of the settlement on independent pharmacies.

As the owner of PAAS National, Mr. Heckman had access to 410 third-party payer contracts offered to independent pharmacies from 1998 through 2005. The complete list of contracts and key financial terms (brand and generic) are listed in Exhibit D of his report. The list includes the Pharmacy Benefit Manager (PBM) contract sponsor – Caremark (CVS), Express Scripts (ESRX), Medco Health Solutions (MHS), et al. Normally, these detailed contract data are not publicly available.

Dollars vs. Margins

Based on these contracts, third-party payers increased the discount off AWP that was offered to pharmacies as reimbursement for the “ingredient cost” of filling a prescription. The Average AWP Brand Discount went from -11.54% in 1998 to -15.62% in 2005 – a drop of 408 basis points. (See Table 3 in Mr. Heckman’s report.) This decline is consistent with the rhetoric about decreasing PBM reimbursements offered to pharmacies.

Yet I can’t help but notice that the average AWP of a brand prescription increased by almost 150% over the same time period (Table 2). As a result, the Average Brand Reimbursement (excluding dispensing fee) to an independent pharmacy rose dramatically from $48.50 in 1998 to $111.69 in 2005.

Put another way, the data in Mr. Heckman’s report imply that a smaller percentage of a bigger number was worth much more to a pharmacy than a bigger percentage of a smaller number. For comparison, $48.50 in 1998 had the same buying power as $58.11 in 2005 according to the Bureau of Labor Statistics Inflation Calculator.

Perhaps I have misinterpreted the data, so please feel free to explain if my calculations are incorrect. Note that I am not claiming a financial windfall for independents from brand drugs. As I've noted in the past, profits on generic drugs subsidize the retail and wholesale distribution of more expensive branded products. (See the comments below.)

Pharmacy Extinction?

The estimated number of independent pharmacies ranges from 17,500 (NACDS) to 24,000 (NCPA).

In his expert report, Mr. Heckman states that the AWP settlement will drive “potentially over 50%” of independent pharmacies out of business. Meanwhile, an expert report prepared in November for the AMP lawsuit estimated that AMP-based FULs would lead to “the loss of 10,000 to 12,000” independent pharmacies.

If my math is right, then the combination of the First DataBank settlement and AMP-based FULs will wipe out every independent pharmacy in the U.S. – except perhaps the one run by Will Smith. (Legend Pharmacy?)

(UPDATED at 10:14 AM EST with clarification about financial windfall.)

13 comments:

  1. I do think you have misrepresented the data. Assuming in 1998 $48.50 was awp-11.54%, awp was $54.83. I probably bought at awp-16%, or $46.05, profit of $2.45. In 2005, $111.69 was awp-15.62%, awp was $132.37. I bought at awp-21%, because of increased spread, so paid $104.57, profit was $7.12. I can tell you dispensing fees were reduced during this time also. Costs of doing business increased, imagine the increased cost of inventory, pharmacist wages increased due to shortages, more time spent of prior authorizations, formulary changes, pbm fees per transaction (Medco doubled), e-prescribing fees paid by pharmacy not docs, etc. Cost of dispensing per script in in the $10 range, I think you can see there is not much profit in brand name drugs for pharmacies, no windfall as you try to portray. And the 2 studies about impact on independent retail pharmacies, basicly say the same thing, 50% would go out of business. I think you are not interpreting the data correctly.

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  2. Matt,

    Neither my post nor Mr. Heckman's report mention acquisition cost. As you correctly point out, a complete accounting of the economic impact should consider many factors in addition to the change in AWP discount.

    Just to be clear, I am not claiming a windfall for independents from brand drugs. As I've said repeatedly on Drug Channels, profits on generic drugs subsidize the retail and wholesale distribution of more expensive branded products. For example: The Attack on Generic Profits in Drug Channels.

    And I'm not sure how to interpret the "50% out of business" estimates b/c it's not clear that the two reports refer to the same 50%. Plus, I just saw "I am Legend," so the movie was on my mind.

    A

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  3. Adam, for a guy who writes and uses numbers for a living this article was indeed very misleading. You spend the entire article implying that the difference in reimbursements has actually helped pharmacy. And that "rhetoric" about falling profit margins is only doublespeak to squeeze out more profits. Then at the end, you slip in that the reimbursement spreads may not have helped pharmacy after all.

    Secondly, as anyone who has an adult mind could tell you 2 studies both predicting that %50 of pharmacies will be shut down does not mean that %100 of independents will close. That is just ridiculous. That is like saying Jose Canseco says that %50 of baseball players are on steroids, while Curt Shilling says that %40 are on steroids. So that must mean %90 percent of baseball players are juiced. This makes no sense at all. Did it ever occur to you that there will be overlap in the amount of independents that close down?

    Normally I like your writing, and agree with you on some articles. But this article was just sloppily done. Way to look at just one number, and then extrapolate to say that AMP will be A-OK.

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  4. To Anonymous:

    Both you and Matt agree that the true state of pharmacy economics is more complex than "discount off AWP." Therefore, the post accomplished its mission.

    As for my 50%+50% math ... I thought that the Will Smith comment gave me away ... so I suggest that you check this link to better understand my true meaning.

    A

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  5. It is not pharmacy that needs to be reminded that the reimbursement model is complicated. We see the whole picture every day.

    The way to show us that the reimbursement model was complicated was to write a misleading article?

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  6. I think you are trying to say pbms are not so bad. That’s not my personal experience, but I understand that your numbers show things are not as bad as ncpa says they are. I think the other people missed your point. But I looked at the awp report. Why would Pbms allow it to be published? It shows all their contract data!

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  7. Dr. Fein,
    I would like to comment on the following quote from your entry:
    "the data in Mr. Heckman’s report imply that a smaller percentage of a bigger number was worth much more to a pharmacy than a bigger percentage of a smaller number. For comparison, $48.50 in 1998 had the same buying power as $58.11 in 2005"
    As a pharmacy owner, I can tell you that I would rather have a "bigger percentage of a smaller number", which is in line with your opinion of "profits on generic drugs subsidize the retail and wholesale distribution of more expensive branded products". I can afford to have a larger inventory if everything was costing me less.. whether that means I make more money off generics or I'm paying less for my brand name drugs is the same thing. Retail can be simplified to one phrase: Buy Low - Sell High. That may not be all you have to do to be successful in retail (ANY retail, not just pharmacy), but I believe it to be the most important thing, followed by keeping all the expenses of running the business as low as possible.
    Please post another entry that can more thoroughly analyze the data, because I'm sorry, but this last one just doesn't cut it for me, and I've been following your blog for quite a while now.

    Joe.

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  8. Adam,

    Pharmacy refuses to look in the mirror and place blame where it really belongs . We had a generation of businessmen and pharmacists who didn't pay attention to the fact that pharmacy is a business. They all preached the "professional" end of it in the late sixties and got what they wanted a "professional dispensing fee". They played games with the "AWP" later on in the eighties and ninties. Starting in 2000 on they started whinning.

    One fact- If you can't keep your doors open for business and pay your bills you can't practice your "profession"

    They did't teach that in Pharmacy school starting in the sixties.

    As a practicing pharmacist all I have to say to my collegues is what Walt Kelly had Pogo say to Porky in the Pogo comic strip in 1972 "Yep Son, we have met the enemy and he is us".

    Every one needs to quit playing games and put this business back on the course that every business major learns in business school.

    Pharmacists- quit whining and do something about your problem and be honest about it. Talk with your congressmen about it but tell them the real story.

    Stop playing games with the brands and generics. Go for a reasonable "gross margin" on all pharmaceuticals. Get rid of the dispensing fees and quit refering to them as "professional fees" We are a retail business !!! We need a reasonable gross margin on all products.

    As far as NCDS -"small business" pharmacies will never disappear. We will evolve but quit hoping for our demise.

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  9. Oh

    By the way, at least Will Smith is carrying a weapon and has a dog to help defend himself.

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  10. Well said, Tex! You got my between-the-lines message. Given the comments on this post, I'll have more to say regarding profitability next week.

    A

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  11. ASSUMING PHARMACY'S PURCHASE PRICE FOR DRUGS IS AWP -20% FOR ALL TIME PERIODS

    IN 1998 PFOFIT MARGIN WAS
    20%-11.54% = 8.46% + 3.00 DISPENSING FEE (AVERAGE DISPENSING FEE AT THIS TIME WAS $3.00)

    AVERAGE COST RX IS $48.50
    PROFIT $4.10 + $3.00 DISPENSING FEE
    = $7.10

    IN 2005 PROFIT MARGIN WAS
    20%-15.62% = 4.38% + 2.00 DISPENSING FEE (AVERAGE DISPENSING GEE AT THIS TIME)

    AVERAGE RX = 111.69
    PROFIT $4.89 + $2.00 = $6.89

    PROFIT PER SCRIPT
    1998 $7.10
    2005 $6.89

    COST TO DISPENSE A PRESCRIPTION
    INCREASED SUBSTANTIALLY WITH $10.00
    BEING THE NUMBER TOSSED AROUND BY MOST. ADD TO THIS THE FACT THAT LARGE CHAINS CAN BREAK EVEN IN THE PHARMACY DEPARTMENT OF THE STORE SINCE 40% OF THE SALES ARE DERIVED FROM OVER THE COUNTER PRODUCTS WITH GREATER THEN 30% MARGINS. INDEPENDENT RETAIL PHARMACY IS WITHOUT A DOUBT GOING TO BE EXTINCT IN THE NEAR FUTURE. IT WILL BE MISSED MORE THEN ANYONE CAN MEASURE. HEALTH CARE NO LONGER REQUIRES CARING FOR SOMEONE WHICH IS AT THE HEART OF MANY PROBLEMS.

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  12. Matt,

    Your calculations would be more realistic if you used the acquisition cost of AWP-23% not AWP-20%

    Gross profit then becomes $10.24 / brand Rx in 2005 not your $6.89

    While the industry average dispensing costs might be around $10 / Rx, for WAG and CVS is is more likely around $8 / Rx due to their volume per store.

    Even more interesting than the calculation of gross profit per brand is the one for generics, or better yet, what I call a "hybrid generic" like simvastatin in the first six months which has an AWP like a brand -- around $111 / Rx, but a reimbursement like a generic -- around AWP -44%

    Consider the following calculation for a generic with an AWP = $35 and a reimbursement of AWP-44% and an acquition cost of AWP-74% plus a $2 dispensing fee. Gross profit would be 35*.3 + 2 = $12.50 versus for the generic vs the above calculation of $10.24 for the brand

    Assume simvastatin in the first six months had an AWP of $111, but was reimbursed and costed like a generic. Gross profit would be $111*.3 = $33.30 +2 = $35.30 versus $12.50 for a typical brand.

    PBMs and the chains love AWP - a fixed % pricing, as opposed to AMP + a fix $ pricing, because it lends itself to inflated gross profits / script whenever "hybrid generics" like simvastatin come along.

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  13. I'd love to buy at AWP-23%, never happens. Also pbms are very quick to mac the new generics, you won't get reimbursed at awp- for more than a month, not 6 months.

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