Profits Up Again for Independent Pharmacy Owners

Time for my annual look at independent pharmacy owners’ business economics, drawn from the recently 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 Drug Savings

Once again, independent pharmacy owners are doing better than you might expect. In 2013, overall profits increased (again), while the average pharmacist owning a single pharmacy earned about $247,000. The number of independent pharmacies continues to hold steady.

Bottom line: Smaller independent pharmacies remain an important and healthy industry segment. Keep that in mind when pharmacies ask for any new special legislative protections.

As always, I welcome your constructive comments. Just remember our Drug Channels 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 2014 NCPA Digest, Sponsored by Cardinal Health publishes 2013 financial and operating data submitted by pharmacy owners. It remains the only consistent source of pharmacy owners’ financial data. (Below, I consider the Digest’s strengths and weaknesses.)

This year, NCPA decided not to release the detailed financials. Perhaps NCPA didn't want to advertise the good profit news. (Plausible deniability?) However, a little algebra plus some educated guesswork gives us everything we need.

Here are my previous analyses of these data:

• 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)

• Profits Rebound for Pharmacy Owners (2012 data)

A PHARMACY PROFIT PRIMER

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

Gross profit equals a pharmacy’s revenues minus the costs of products (net of discounts and returns) bought from a manufacturer or a wholesaler. Gross margin expresses gross profit as a percentage of revenues. A drugstore’s total revenues come from prescription drugs, over-the-counter products, vitamins, cosmetics, groceries, and other merchandise. A typical independent pharmacy generates more than 90% of its revenues from prescriptions.

Gross profit measures the portion of revenues available for a pharmacy's operating expenses and operating income. Operating expenses include: (1) Non-Owner Payroll Expenses—the wages, taxes, and benefits paid to the pharmacy’s staff, (2) Owner Compensation—the wages, taxes, and benefits paid to the working pharmacy owner, and (3) General Business Expenses—everything else needed to run the pharmacy, such as rent, utilities, licenses fees, insurance, advertising, and other business costs. Operating income equals gross profits minus operating expenses.

To be profitable, a pharmacy’s gross profits must exceed its operating expenses. For example, increasing Owner Compensation will decrease operating profit. 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 dollars can be spent.

For more on pharmacy and prescription economics, see Chapters 5 and 7 of the 2013–14 Economic Report on Retail, Mail, and Specialty Pharmacies.

OBSERVATION 1: Overall pharmacy profit margins increased.

In 2013, independent pharmacies' overall gross margin from prescription and non-prescription products increased by 10 basis points, to 23.3%. This is the third year in which profit margins grew.

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

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

While NCPA no longer reports gross margins on prescription vs. non-prescription sales, I estimate that gross margins on prescription sales were 22.7% in 2013 vs. 22.5% in 2012. Here’s a look at prescription gross margins since the introduction of Medicare Part D.

[Click to Enlarge]

In 2013, average prescription revenues in the NCPA sample increased to $57.50, compared with $56.04 per prescription in 2012. Given the slight increase in gross margin, gross profit dollars per prescription grew by 3.5%, from $12.60 per prescription in 2012 to $13.03 per prescription in 2013.

The Digest's average per-pharmacy revenue increased slightly (+1.0%). However, average revenue has dropped slightly from its peak of $4.0 million, in 2009, to $3.9 million in 2013. The revenue decline is due to brand-to-generic substitution, not volume. Total prescriptions per pharmacy have increased over the past few years.

OBSERVATION 3: The average pharmacist owning a single pharmacy earned about $247,000 in 2013.

Since NCPA no longer publishes financial details, I multiplied last year’s median Owner’s Discretionary Profit (ODP) figure by average revenues. On a per-pharmacy basis, this figure grew, from $245K in 2012 to $247K in 2013 (+1%). The increase reflects higher pharmacy margins in the 2013 sample.

Note that a pharmacy owner earns more than twice the salary of a employed pharmacist, per For 2013, Pharmacist Salaries Rise Yet Again For This Family-Friendly Occupation.

OBSERVATION 4: The average pharmacist owning multiple pharmacies earned about $900,000 in 2013.

The NCPA Digest reports that in 2013, 27% of the Digest’s sample owned two or more pharmacies. With a bit of algebra, I computed that this 27% of the sample owned an average of 3.6 pharmacies. The remaining 73% 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 2014 NCPA Digest implies that the owner of multiple pharmacies saw a slight decrease in average total earnings, from 2012’s $1,016,000 (=$245*4.2 pharmacies) to 2013’s $897,200 (=$247*3.6 pharmacies)—a decrease of $118.5K (-11.7%). The decrease is due entirely to the lower average number of pharmacies (3.6 vs. 4.2) in this year’s sample.

Total profits for multiple-pharmacy owner could be lower than this figure, because the owner may need to pay pharmacists to work in the different stores.

OBSERVATION 5: The total number of independent pharmacies continues to hold steady.

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; 23,029 in 2012; and 22,814 in 2013. The appeal of ownership clearly hasn't dimmed. Note that NCPA’s figures are higher than those from other third-party sources.

Since NCPA has hidden the financial data, we don’t know how many pharmacies supposedly “operate at a loss.” Last year, the Digest claimed that 24.3% of pharmacies were operating at a loss, compared with 23.6% in 2011.

Miraculously, the industry has not been collapsing. And if you understand the above components of gross profit, you'll see why such "operating at a 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 demonstrate, the profit story for pharmacy owners remains good.

For more on the outlook for independent pharmacies (along with the implications for pharmaceutical wholesalers), see pages 18-28 in 2014-15 Economic Report on Pharmaceutical Wholesalers and Specialty Distributors.

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 that independent community pharmacies are an $88.8 billion “health care marketplace.” (NCPA multiplies the $3.9 million average revenue figure by 22,814 pharmacies.)

• The digest’s profit data have been 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 previous lawsuit over Average Manufacturer Price (AMP). I presume the data will be dragged out when NACDS and NCPA file their next lawsuit against the elusive AMP-based FULs.

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.