Tuesday, November 05, 2013

Profits Rebound for Pharmacy Owners

Time for my annual look at independent pharmacy owners’ true economics, courtesy of the just-released 2013 National Community Pharmacists Association (NCPA) Digest, Sponsored by Cardinal Health. Here's the press release: NCPA Digest: Community Pharmacists Promoting Medication Adherence, Generic Drugs To Improve Health Outcomes and Reduce Costs

The news is pretty good for pharmacy owners. Here are my observations from crunching the Digest's latest numbers. Full details below.
  • An independent pharmacy's overall margins and per-prescription profits increased in 2012.
  • The average pharmacist owning a single pharmacy earned about $245,000 in 2012—up 5% from 2011. Owners of multiple pharmacies earned much, much more.
  • The NCPA estimates that the total number of independent pharmacies continues to hold steady.
Hmmm, what happened to the doom-and-gloom predictions about the Express Scripts/Medco merger, which would, as NCPA said, “make an already bad situation even worse”? As the data below show, it was never that bad, and it hasn’t grown worse.

As always, I welcome your constructive comments. Just remember our philosophy, courtesy of the late Senator Patrick Moynihan: "Everyone is entitled to his own opinion, but not his own facts."

THE NCPA DIGEST DATA

The 2013 NCPA Digest, Sponsored by Cardinal Health publishes self-reported 2012 financial and operating data submitted by pharmacy owners. While the report has some methodological flaws, it remains the only consistent source of pharmacy financial data. At the bottom of this article, I consider the Digest’s strengths and weaknesses.

Take a bounce down memory lane by reviewing my previous analyses:

A PHARMACY PROFIT PRIMER

Here are some basic definitions to clarify the pharmacy profit story.

Gross profit equals: (1) the revenues received by a pharmacy minus (2) the costs of products, net of discounts and returns, bought from a manufacturer or a wholesaler. Gross profit measures the portion of revenues available for the operating expenses and operating profit of a pharmacy. It reflects how much a pharmacy is compensated for taking on specific tasks and functions in the distribution system. Gross margin expresses gross profit as a percentage of revenues.

A pharmacy’s gross profit dollars can be spent in three primary ways:
  • Non-Owner Operating Expenses—This includes everything needed to operate the pharmacy—payroll, rent, licenses, insurance—except the salary and benefits of the owner
  • Owner Compensation—Pre-tax salary and benefits of the working pharmacy owner
  • Net Operating Income—The so-called “bottom line”
This is a zero-sum formula: increasing one part will decrease another. For example, increasing Owner Compensation will decrease Net Operating Income. A pharmacy could report a “net loss” if the pharmacy owner chose to pay himself or herself a larger bonus instead of reporting a positive net profit.

The NCPA Digest reports the sum of Owner Compensation and Net Operating Income as Owner's Discretionary Profit (ODP). Thus, ODP represents two of the three ways a pharmacy's gross profit can be spent.

For more on pharmacy economics, see the 2012–13 Economic Report on Retail, Mail, and Specialty Pharmacies.

OBSERVATION 1: Overall pharmacy profit margins increased.

In 2012, independent pharmacies' overall gross margin from prescription and non-prescription products increased by 30 basis points, to 23.2%. As the Digest observes: “It appears that independent community pharmacy owners attempt to maintain a gross margin of 22 to 24 percent in order to maintain their business.”

This survey finding is consistent with the U.S. Census Bureau’s data, which consistently show stable drugstore gross margins. See Drugstore Industry Profits Rise Again in Latest Gov't Data.

OBSERVATION 2: An independent pharmacy’s profit per prescription increased slightly.

This year, NCPA stopped reporting gross margins on prescription vs. non-prescription sales. However, I estimate that gross margins on prescription sales were 22.5% in 2012 vs. 22.1% in 2011. Here’s a look at gross margins since the introduction of Medicare Part D.


Average prescription revenues in the NCPA sample were stable, at $56.04 per prescription in 2012 compared with $56.09 per prescription in 2011. Given the slight increase in gross margin, gross profit dollars per prescription grew slightly, from $12.40 per prescription in 2011 to $12.61 per prescription in 2012.

The Digest's average per-pharmacy revenue increased slightly (+0.6%). However, average revenue has dropped from its peak of $4.03 million, in 2009, to $3.85 million in 2012. This decline mirrors the overall industry trend that I describe in Drugstore Sales Drop Along with Drug Trend: Implications for Retail Pharmacy. The revenue decline is due to brand-to-generic substitution, not volume. Total prescriptions per pharmacy have remained fairly stable.

OBSERVATION 3: The average pharmacist owning a single pharmacy earned about $245,000 in 2012—up 5% from 2011.

As in previous years, I compute the Owner’s Discretionary Profit (ODP) by multiplying the median ODP by average revenues.1 On a per-pharmacy basis, this figure grew, from $234K in 2011 to $245K in 2012 (+5%). The increase reflects both slightly higher per-pharmacy revenue in the 2012 sample and a higher median ODP.

Note that a pharmacy owner earns more than twice the salary of a employed pharmacist, per Pharmacist Salaries Hit $117K and Keep Climbing.

OBSERVATION 4: The average pharmacist owning multiple pharmacies earned about $1 million in 2012.

The NCPA Digest reports that in 2012, 25% of the Digest’s sample owned two or more pharmacies. With a bit of algebra, I computed that this 25% of the sample owned an average of 4.2 pharmacies. The remaining 75% owned a single pharmacy. In either case, these owners must be pharmacists to meet the NCPA’s definition of “independent pharmacy.”

Put another way, the 2013 NCPA Digest implies that the owner of multiple pharmacies saw a slight increase in average total earnings, from 2011’s $982,000 (=$234*4.2 pharmacies) to 2012’s $1,016,000 (=$245*4.2 pharmacies)—an increase of $34K (+3.5%). In 2012, average earnings were above the 2009 figure of $958,000.

OBSERVATION 5: The total number of independent pharmacies held steady in 2012.

According to the NCPA’s counting, the total number of independent community pharmacies has remained roughly stable: 23,064 in 2010; 23,106 in 2011; and 23,029 in 2012. The appeal of ownership clearly hasn't dimmed. Note that NCPA’s figures are higher than those from other third-party sources.

These data may be surprising, given that the NCPA Digest insists on presenting how many pharmacies “operate at a loss.” In 2012, the Digest claims 24.3% of pharmacies were operating at a loss, compared with 23.6% in 2011, 23.0% in 2010, 21.0% in 2009, etc.

If you understand the components of gross profit above, you'll see why the loss figures are completely bogus. A net loss may simply mean that the owner drew a salary and bonus that pushed the business’s net profit figure into an accounting loss. As the data above demonstrate, the profit story for pharmacy owners remains good.

METHODOLOGY

Here’s a quick summary of the NCPA Digest’s strengths and weaknesses.

Strengths
  • The NCPA digest data provide the only publicly available look at the financial position of independent pharmacies.
  • In NCPA press releases, the digest data are used to compute the total size of the independent community pharmacy “health care marketplace.”
  • The digest’s profit data are cited in sworn testimony to the U.S. Congress.
  • The data have been analyzed in peer-reviewed academic articles and were featured in an expert report written on behalf of NACDS and NCPA in their lawsuit over Average Manufacturer Price (AMP).
Weaknesses
  • NCPA provide no transparency into the survey methodology. We aren't told the sample size or how the responses are collected. We also don't know who analyzed these data: NCPA or an independent third-party organization?
  • The NCPA data come from a self-selected sample. Pharmacies doing better or worse than average may not have returned the survey in equal proportions.
  • Year-over-year differences may not be statistically significant. NCPA does not provide confidence intervals around the Digest's point estimates.
  • The data were self-reported, not based on audited financial statements. Respondents could have altered their profit data to make it look better or worse than reality.
  • Many items on the survey instrument were not defined and therefore may have been interpreted differently by respondents.
1 When computing average pharmacy owner earnings in Observation 3, math geeks may fret that I am multiplying an average by a median. Never fear! The distribution of Owner’s Discretionary Profit Percentage in the 2013 Digest has a very slight negative Bowley skewness (-0.01), i.e., the median is slightly greater than the average. However, this figure is not statistically significantly different from skew=0, i.e., symmetry, so the average and median ODP are pretty close. See “Bonus Comment For Math Geeks” at the bottom of 2009’s NCPA Responds to Drug Channels

7 comments:

  1. Adam - A couple of comments...

    1. this Digest data really only looks as the successful owners, as those that are unsuccessful ($$) or not comfortable sharing their data, are visibly absent from the numbers..

    2. Most of the independents (either directly or thru PSAOs) have not yet been rolled into the new 'ESI (post-Medco)' contract terms, so they don't know the 'love' yet...

    Enjoy your postings, and often spot on...

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  2. It's hard to believe a pharmacy averaging $12 per rx, when we are seeing reimbursements for generic meds at $1.25 above acquisition cost. Maybe it's just us in Texas that are getting screwed royally by the devil (PBM)....I doubt it though.

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  3. The GP$ figure is a credible average, and consistent with lots of other data out there. Sorry, but it's just not plausible that all of your pharmacy's scripts earn $1.25 in gross profit.

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  4. It's also worth pointing out that the $12 is based on an average transaction price that appears to include both brand and generics. As we know, these two classes of product tend to involve wildly different dollar amounts, so this average isn't necessarily representative of any actual prescription.



    To make things more confusing, generics often have a direct acquisition cost that is quite different from the net-landed cost, due to quarterly/annual rebate programs for this class of product.



    Basically, I think the NCPA average transaction price and GP margin number would be much more useful (as well as less confusing) if they was broken into two value pairs - one for brand and one for generic.

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  5. Adam, since managed care took over the Medicaid program here in Texas in March 2012, our reimbursements have been cut by about 45%. All of these generics that we make a $1.25 gross profit are given the MAC price, which no one knows how these PBMs come up with these numbers. If you factor in brand name drugs, we are averaging about $6 per rx. Because Medicare publishes the NADAC information without mandating an increase in dispensing fee, all of these PBMs are paying the "acquisition" price plus $1.25 dispensing fee, giving us a $1.25 gross profit on generics. PBMs and their lobbying groups like to tout that they drive down costs and negotiate better dispensing fees, which are well below state medicaid dispensing fees, but they don't tell everyone that the formula that the state pays and the formula that the PBMs use is totally different. A lot of states are paying based on acquisition cost plus a reasonable dispensing fee that matches the cost to dispense, vs a PBM that pays whatever they feel like on generics, and AWP minus a % on brands. It's all rhetoric and a big game for the PBMs to make as much money as they can. I am all in favor of reimbursement that is fair and transparent, like acquisition cost plus a fair dispensing fee, versus letting a PBM make up whatever they want and keep everyone in the dark while the rake in record profits.

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  6. Adam you clearly state that all your “facts” rely on several
    assumptions and poorly collected and poorly sampled numbers. The digest is in no way scientific and in no way allows you to tag them as fact or even theory.
    Calling a fact does not make it fact .

    The digest sample collection method is a kin to asking how the
    starting 8 on each major league baseball team is doing financially then extrapolating that out to the thousands of other baseball players who are not starting or even in the majors.

    We as independent pharmacist realize that of the 20,000 independents pharmacies only 1000 to 2000 report in any given year to the NCPA digest and additionally those pharmacies reporting are heavily weighted with the most successful pharmacies who are NCPA members. The
    struggling and treading water pharmacies do not have the time or inclination to create the needed NCPA reports to be added to the digest.

    I make no mistake, profitability is an important “Fact” It’s a necessary but not sufficient condition, however, to describe pharmacy. Pharmacies that are profitable go bankrupt all that time.


    Pharmacy entrepreneurs are often rudely introduced to
    that old saw “Cash is king.” Put another way, profit is theory, cash is fact.
    I’m sure you’ve heard someone say that they made money / were profitable “on paper.” That’s where profit lives, on paper – and it’s not the kind of paper they print money on or we can pay a wholesaler with.

    Profit is really just a theoretical accounting term. Other
    than people being impressed that you finally made it that far, it won’t get you far in the real world.

    Loan payments aren’t part of your operating expenses, only
    the interest on them is. So if you’re turning a profit of $5,000 a month, you
    have little money in the bank, and you have a $35,000 debt payment come due,
    that’s all she wrote.

    If you’re using the accrual method of accounting, you book
    revenue when you make a sale. But what if your customer(s) suddenly can’t pay you? Now the $5,000 profit is even more theoretical, and you can’t pay your bills.

    Finally you probably could have made money selling buggies and
    carriages in 1907, but for how long? The world is moving faster and faster, and so are customers’ wants and needs. If you’re an under-funded profitable pharmacy in 2014 you are in trouble

    ReplyDelete

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