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:

• 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 Ownership: Getting Less Profitable (2011 data) 

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.