Owning a Pharmacy: Still Pretty Profitable

Today’s surprising news: independent pharmacy owners are doing financially quite well, averaging about $274K in personal income in 2009.

This result comes from my analysis of the independent pharmacy industry based on The 2010 NCPA Digest Sponsored by Cardinal Health. My observations about independent pharmacies:

• Pharmacy profit margins are not declining.
• Pharmacy profits have doubled since 1999.
• Pharmacy owners earned about $274K in 2009.

I think it’s important to review these facts every year since the pharmacy industry always describes margins to politicians as “thin” or “slim.” Any attempt to discuss pharmaceutical reimbursement is trumpeted as a “threat to patient health and access.” In reality, things are still pretty sweet for the average independent pharmacy owner.

Below are my computations and analysis. Take a moment to leave a comment with your own perspective or observations.

PHARMACY PROFIT PRIMER

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

• Gross Profit is the difference between the revenues received by a pharmacy minus the costs of products sold by the pharmacy. Gross profit measures the portion of revenues available to cover the operating expenses and operating profit of a pharmacy. Think gross profit of as Earnings Before Expenses (EBE).
  
  
• Gross Margin expresses gross profit as a percentage of revenues.

Pharmacies have two sources of gross profit when dispensing a prescription that is reimbursed by a third-party payer such as a Pharmacy Benefit manager (PBM), Medicare Part D Provider, a State Medicaid program, or an employer:

• Spread: The difference between (a) the Estimated Acquisition Cost (EAC) reimbursement that a pharmacy gets from a third-party payer, minus (b) the pharmacy’s net acquisition cost for purchasing the product.
  
  
• Dispensing Fee: A fixed per-prescription payment.

The majority of a pharmacy’s profits are earned from the spread, not the dispensing fee.

POINT 1: PHARMACY PROFIT MARGINS ARE NOT DECLINING.

Despite what you may have heard, gross margins for independent pharmacies are not dropping. In fact, the average total gross margin for pharmacies in the NCPA Digest increased by 60 basis points from 23.2% in 2008 to 23.8% in 2009—its highest level since 2003.

The NCPA admitted this point in the Digest by noting that the total gross margin has “…remained in the 22–24 percent range seen over the past 10 years.”

The NCPA data are consistent with the objective data collected from the U.S. Census Bureau, although the data are not directly comparable. You can read more about pharmacy margins in my pharmacy industry report.

POINT 2: PHARMACY PROFITS HAVE DOUBLED SINCE 1999.

Average revenues per pharmacy location were $4.026 million in 2009, up 3.7% versus 2007. Gross profits per pharmacy were therefore about $958,000.

Since gross margins have remained fairly stable, gross profits have grown right along with revenues. In 1999, average revenues were $1.967 million and gross profits per pharmacy were $472,000—less than half of 2009’s gross profits.

POINT 3: PHARMACY OWNERS EARNED ABOUT $275K in 2009.

I estimate that a pharmacy owner got a bit less than 30% of gross profits—about $274,000 in 2009—as discretionary income. Good news in a year when the economy sucked wind, but down from 2008’s more remunerative $291,000 average.

Here’s my math for the inevitable skeptics.

A pharmacy’s gross profit gets spent in three primary ways:

• Non-Owner Operating Expenses: Everything you need to operate the pharmacy—payroll, rent, licenses, insurance—except the salary and benefits of the owner.
  
  
• Owner Compensation: 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 of instead reporting a positive net profit on the NCPA survey.

The NCPA Digest reports the sum of Owner Compensation and Net Operating Income as Owner's Discretionary Profit (ODP). These are 2 of the 3 ways a pharmacy's gross profit gets spent.

The Median Owner’s Discretionary Profit Percentage as a Percentage of Total Sales in 2009 was 6.8% (per page 9 of the 2010 NCPA Digest). Thus, ODP averaged about $274K (because 0.068 * 4,026,000=$273,768).

(Math geeks should not fret that I am multiplying an average by a median. The Bowley Skewness implies that the distribution of ODP is not statistically significantly different from skew=0, i.e., symmetry. See last year’s “Bonus Comment For Math Geeks” at the bottom of NCPA Responds to Drug Channels.)

POINT 4: EVERYONE IS ENTITLED TO HIS OWN OPINION, BUT…

C’mon, say it with me: “Everyone is entitled to his own opinion, but not his own facts.”

You may not agree with the numbers above. You may be a pharmacy owner who earned less than the average in 2009. (About half did so.) You may be mad at me for pointing out the conclusions above. You may be a plan sponsor who is surprised to learn where your money goes or a manufacturer who is just figuring out who else makes money from your products.

Whatever. It doesn’t really matter what you feel. The data above tell an objective story.

That said, the Digest data are certainly not perfect. Some major flaws:

• 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 release information on samples size or provide confidence intervals around the point estimates in the Digest.
  
  
• The data were self-reported. NCPA 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.

When I wrote a comparable analysis in 2009, NCPA chose to impugn my reputation rather than celebrate the success of its members. (Read their blog post from 2009.) Let’s hope they respond in a more constructive manner this time around.