Monday, January 14, 2008

Pharmacy Profits & Part D

The OIG released a new study last week on Part D economics for independent pharmacies. The report does a reasonably thorough job of examining actual, audited data on prescriptions filled by independent pharmacies under Part D.

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


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.)


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.
Note that OIG expresses the spread as a percent of costs, not as a percent of revenues. Thus, we need to do some math to convert these data into more familiar Gross Margins, which express Gross Profit per Script as a percent of Revenue per Script.

Here are the averages that I calculated from the OIG report:

Brand-name drugs
Part D Revenue per Script = $127.49
Part D Gross Profit per Script = $11.29
Part D Gross Margin per Script = 8.9%

Generic Drugs
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.


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.


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.
In other words, almost half of all independent pharmacies lost money with Part D prescriptions according to the data in the NCPA/NACDS Cost of Dispensing study. Yet the more efficient pharmacies made very respectable profits under Part D.

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).


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?



  2. Dear Dr. Fein,

    Thank you for the great analysis of the data. This really confirms what many of us owners were afraid is true. What the data is basically saying is that the system is going to weed out the pharmacies that are not running efficiently, or not filling a high enough volume of prescriptions. While nobody wants to hear this, this has been a long time coming, as it is something that the PBM's had been doing slowly for several years now by cutting back on payments. What Medicare D did is essentially speed up that process, and it is forcing many people to sell/close their pharmacies.

    The problem is that many of these pharmacies are in rural areas in the middle of nowhere, and they are the only ones servicing the area for miles and miles around them. They do not have as much control over several aspects of operational costs as they may get hit with fuel surcharges on their delivered merchandise, for instance. Also consider if one of these stores needs a covering pharmacist, and all the additional expense that goes along with that, from higher salary, to travel costs, etc...

    Great job with the report. I'll wait to see what others have to say.

  3. Joe,

    Thanks for the compliment.

    I share your concerns about rural pharmacies. If what you suggest is true, then perhaps NCPA/NACDS should be lobbying for supplemental payments to rural and "essential" pharmacies rather than across-the-board increases in reimbursements. A more limited strategy would be less confrontational, better grounded in the real economics of the pharmacy industry, and may have a greater chance of success.


  4. Now you can see the importance of S.1954. It is egregious that PDPs are paid prospectively and then delay payments to providers for a month or longer.

  5. Adam,

    I guess we can draw the same conclusion about other providers of service. We have too many grocery stores, car dealers, barber and beauty shops, fast food establishments,,etc, etc.

    Difference is that they operate with the ablility to set their own profit margins !!! They can succeed or fail based on that.

    Pharmacy lost that ability long ago.

    The consumer wants a choice and they don't have it under the observations you deliver as the messenger. Pharmacy lost the abiltiy to negotiate contracts long ago ( and it was their fault)

    Pharmacy requires high priced professionals(Rphs and Techs) to operate. If we could do away with the RPH it would not be a question of surviving( for a while). If Mail order gets its wish they will eliminate the pharmacist.

    In any case when the following things occurs who will answer for it.

    1. 24-48 hrs to have your emergency prescriptions filled.
    2. drive 50-60 miles to have your prescription filled in rural areas.
    3. wait 10-14 days for refills to arrive by mail.
    4. unsafe storage for many medicines delived by mail order( spend a day in the back of a Fed-ex truck in the summer)
    5. who is there to consult on your medicines by phone.( you can if you want to wait on the phone for your oportunity)

    Oh wait a minute- all of that is already happening is a lot areas. So I guess no one is going to answer. In the mean time let us look at the average compensation of our corporate leaders at Aetna, United HealthCare, CVS, Walgreen, etc, etc.

    By the way Adam,

    Please refer to me as a small business owner who operates a retail pharmacy. I am not indepedent! I might be dependent on the other hand. I may be eliminated but lots of people will not like it. They will not gain a thing except poor service, reduced service, reduced coverage, restrictive formularies and probably will get higher prices in the long run. The chains are any different than the mail order boys corporate board room. The people in the stores don't set the policies or operating procedures

    The only ones who will gain are -well you know.

    Is that good?? Is that really good in the long run???

    Adam, everyone doesn't live in New York or a congested SMSA. There are people who like life like it was. You had choices in making your purchases.

    Actually I worked my way into the real root of this whole thing. Let's end the way pharmaceuticals are purchased today by 90%+ of the consumers . Let them go back and pay cash for them and submit their claims to their insurers.

    What do you think would happen then to the supply chain of retail pharmacy??

  6. Another point not usually talked about is the reimbursement paid to chains (with bargaining power) is higher than that paid to independent retail pharmacies, in the same plan. In fact, a patient in medicare D will reach their gap quicker if they fill their scripts at one of the chains. How many diffent mac lists do you think a pbm uses, certainly not one. They arbitrarily lower mac levels with no notice. That's an easy way to increase their profit. Read Express Scripts annual report, they gross over $7.50 per script, doing what, just manipulating the market. Do you think Caremark/CVS pays other pharmacies at the same rate they do themselves? Very difficult to break that number out I am sure. I think drug manufactures will soon rue the day they aligned themselves with pbms, rather than work with pharmacy for equitable reimbursement.

  7. Tommorrow is here.

    How long can a starving person live?

    By the way all of you "independents" out there. When are going to realize that you have to work together to solve this problem. You can't do it alone or independently. So you might stop refering to yourself as "independent" You are not independent. You are very dependent on working with each other legistatively and economically. This has progressed to this point by the inaction everyone has taken the last 40 years. It is not going to change overnight.

    Adam, I believe you said " Get Big, get lean or get out!" It has been applied to other busienss models in the past and applies to retail pharmacy on the small business side(independents)

    Good luck all!!

  8. The NCPA finally responded to the OIG study on Tuesday (one day after this blog post) in OIG Report Confirms Dangerously Thin Margins for Community Pharmacy (Subtle!)

    Since NCPA is a frequent visitor to your friendly neighborhood Drug Channels blog, it is interesting to note that the press release concedes positive operating margins under Part D.

    Naturally, there is no mention of the huge variation among pharmacies that is hidden by the average margin.


  9. Adam, how bout you do a report on the profit margins of drug companies or the insurance companies. Of coarse you wouldn't dare to do so since you are probably on their payroll.

  10. Re: Anonymous (jan 16)

    Well, well. Here we have another brave soul who criticizes my motives, fails to offer any contradictory evidence, adds nothing to the blog conversation, and hides behind a veil of anonymity. At least the people who send me private hate mail have the courtesy to insult me with their real names!

    Ok, enough snarkiness.

    To answer your question, Yahoo has some good resources for tracking industry average profitability. Try Drug Manufacturers - Major, Health Care Plans, or Drug Stores.


  11. Adam,

    Look at the profit margins in retail pharmacy.

    Now look at the Manufactures

    Now look at the PBM's

    Please address:

    Pharm Manufactures (brand) giving pbm rebates in the 20-40% range, selling the same medications in other contries for a fraction of the price they charge in the US, and over the last decade being one of the most profitable industries.

    Insurance companies do not provide health care, they are a leach on the system.

    How can a pbm make more on a prescription than the pharmacy filling it?

    A local self-insured union used Caremark to process claims. Guess what? Caremark upcharged the union on generics (one example pharmacy reimbursed 25.00, union charged 125.00 by caremark).

  12. AnonymousJune 25, 2011

    Hey Adam,

    I'm a new pharmacist and new owner of an independent pharmacy (~6months). I'm learning so much from your analyses as well as the postings from your visitors. Comparing my financials to the national averages, it appears to me that a lot of it holds true. We gross about 4mil but gross profit (by percentage) is only about 20%. I don't know why that is the case. Nearly all our customers are Medicare and we have very few MediCal(caid) patients. There is a huge SBA loan to be repayed so my budget is very tight which is really the reason I started doing internet research, stumbling onto your site.

    I have many questions (and complaints) but I wasn't sure this part of your analyses was correct. From the OIG report, the gross profit per script, at about ~$11/script, does that really apply to the chains? I would assume that their costs of goods would be much lower due to their buying power. Can you post a response, I would love to hear your thoughts. Thanks very much.

  13. Anon,

    The net delivered cost to a store (not a warehouse) is fairly comparable for chains vs. independents, especially for brands.

    Note that this article is more than 3 years old. For the most current data, check out my pharmacy industry economic report. It has a lot of data on profit margins.