Pharmacy Ownership: Getting Less Profitable

Time for my always-controversial annual look at independent pharmacy owners’ true economics, courtesy of the just-released 2012 NCPA Digest, Sponsored by Cardinal Health. Here's the press release: NCPA Digest Finds Independent Community Pharmacists Cut Costs Through Generic Drugs; Boosting Patient Adherence.

The news is not as good as previous years. Here are five observations from the new report:

• Overall pharmacy profit margins remain stable.
• An independent pharmacy’s profits per prescription are decreasing. In 2011, gross profit dollars per prescription were $12.40, vs. 2010's $13.43.
• The average pharmacist owning a single pharmacy earned about $234,000 in 2011—8% less than 2009.
• The average pharmacist owning multiple pharmacies earned about $982,000, down 12% vs. 2010.
• Despite the sad economic news, the total number of independent pharmacies increased in 2011.

As always, I welcome your comments on this peek at pharmacy economics. To keep things civil, I include a few helpful ground rules below.

THE NCPA DIGEST DATA

Let’s start with a review of the data’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 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. Click here for a December 2011 example that cites the net profit margin data and “number of independent pharmacies operating at a loss.”
• 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

• There is an amazing lack of transparency regarding survey methodology. We don’t even know the sample size!
• 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 made their profit data look better or worse than reality.
• Many items on the survey instrument were not defined and therefore may have been interpreted differently by respondents.

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

• Shhhh! Owning a Pharmacy is Very Profitable (2008 data)
• Owning a Pharmacy: Still Pretty Profitable (2009 data) 
• The True Economics of Pharmacy Ownership (2010 data)

PHARMACY PROFIT PRIMER

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

Gross profit equals the revenues received by a pharmacy minus the costs of products (net of discounts and returns) bought from a manufacturer or a wholesaler. Gross profit measures the portion of these revenues available for the operating expenses and operating profit of a pharmacy. Think of gross profit as Earnings Before Expenses (EBE). 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: 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 chooses 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 2 of the 3 ways a pharmacy's gross profit can be spent.

OBSERVATION 1: Overall pharmacy profit margins remain stable.

In 2011, independent pharmacies' overall gross margin from prescription and non-prescription products decreased by 110 basis points to 22.9%. After four years of growth, total gross margins have fallen back to 2006’s 22.8% gross margin.

The Digest again notes that gross margin "…remained in the 22–24 percent range seen over the last 10 years." This survey finding is consistent with the U.S. Census Bureau’s data, which consistently show stable drugstore gross margins. See Drugstore Margins Remain Stable in Latest Gov’t Data.

OBSERVATION 2: An independent pharmacy’s profits per prescription are decreasing.

Gross margins on prescription sales were 22.1% in 2011, vs. 23.3% in 2010. As the chart below shows, this decline reverses the 2006 to 2009 trend.

Average prescription prices in the NCPA sample also declined, from $57.64 per prescription in 2010 to $56.09 per prescription in 2011. As a result, gross profit dollars per prescription also shrank, from $13.43 per prescription in 2010 to $12.40 per prescription in 2011.

As I see it, these data highlight the risk and reward from the generic wave. The substitution of brand-name drugs for generic drugs is reducing pharmacies’ revenue growth. For the first time ever (?), the Digest's average per-pharmacy revenue dropped, from $4.0 million in 2010 to $3.8 million in 2011.

The superior profitability of generic drugs is simultaneously under attack. Retail pharmacies are engaging in a generic-prescription price war, competing more aggressively with mail pharmacies, and losing consumers to chain pharmacies. Legislation that "levels the playing field" with mail pharmacies tend to reduce independent pharmacy margins. Meanwhile, payers are becoming more knowledgeable about pharmacy profits from generic drugs. Government-led margin transparency won’t help.

OBSERVATION 3: The average pharmacist owning a single pharmacy earned about $234,000 in 2011—about 8% less than 2009.

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 fell again, from $253K in 2010 to $234K in 2011 (-8%). The drop reflects both lower per-pharmacy revenue in the 2011 sample and a slightly lower median ODP figure.

In 2011, 76% of the Digest’s sample had ownership in a single pharmacy. As I pointed out last year, pharmacy owners have not been immune to broader U.S. economic weakness.

OBSERVATION 4: The average pharmacist owning multiple pharmacies earned about $982,000, down 12% vs. 2010.

The 2012 NCPA Digest reports that 2011’s average pharmacy owner had ownership in 1.76 pharmacies, vs. ownership in 1.89 pharmacies in 2010. (Market trend or sampling effect? No way to tell.)

Mathematically, the 2011 figure implies that 24% of independent owners had ownership in an average of 4.2 pharmacies. (Algebraically: [76%*1] + [24%*4.2] = 1.76) In the 2010 sample, 26% of independent owners had ownership in 4.4 pharmacies. These owners must be pharmacists to meet the NCPA’s definition of “independent pharmacy.”

Put another way, the NCPA Digest imply that the owner of multiple pharmacies saw average earnings decline, from 2010’s $1.1 million (=$253K*4.4) to 2011’s $982,000 (=$234*4.2)—a decrease of $134K (-12%). On the other hand, average earnings are still above 2009’s $958,000.

OBSERVATION 5: The total number of independent pharmacies increased in 2011.

Given the numbers above, you may be surprised to know that the total number of independent community pharmacies increased slightly, from 23,064 in 2010 to 23,106 in 2011. The appeal of ownership clearly hasn’t dimmed.

These data are especially ironic given NCPA’s constant “independents are vanishing” drumbeat. Consider this July 2011 NCPA blog post: Independent Pharmacy Closures Illustrate Need for Pro-Patient, Pro-Pharmacy Policies. Yes, you read that right. The NCPA's article was posted during a year when new pharmacy openings were greater than pharmacy closures.

I wonder how turnover affects the NCPA Digest. Do 2011’s slightly worse economic results reflect a new generation of pharmacy owners who are still building their businesses?

TELL ME WHAT YOU THINK 

As always, I encourage constructive comments on the NCPA Digest data. Alas, these annual reviews tend to generate heated remarks from pharmacy owners. Excluding the Lake Wobegon pharmacies, half of the owners will write to complain that they are below average. The other half remain silent.

If you choose to share your thoughts, please keep the following ground rules in mind:

• Thoughtful comments are always welcome on Drug Channels.
• Personal attacks are not welcome, so please skip the argumentum ad hominem.
• Make sure your comment is related to the topics of this article.
• Avoid profanity.
• Direct any complaints, criticisms, and compliments about the survey’s methodology to NCPA.

Comment away!

1 Math geeks should not fret that I am multiplying an average by a median. The distribution of Owner’s Discretionary Profit Percentage in the 2012 Digest has a very slight positive Bowley skewness (+0.03), i.e., the average is greater than the median. 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.