Independent Pharmacy Economics: Profits Steady, but Sales Down (Maybe)

Time for my annual look at independent pharmacy owners’ business economics, drawn from the recently released 2015 National Community Pharmacists Association (NCPA) Digest, Sponsored by Cardinal Health. Here's the press release: NCPA Digest: Adherence, Diversified Revenue Critical for Community Pharmacies.

The data reveal that independent pharmacy owners are doing better than you might expect. In 2014, the average pharmacist owning a single pharmacy earned about $228,000. The number of independent pharmacies continues to hold steady.

In the NCPA Digest sample, average per-prescription revenue declined, which reduced gross profits and average prescription revenues. On the other hand, IMS Health data imply independents' revenue and prescriptions are growing, not declining. Hmmm.

As always, I welcome your constructive and civil comments. Please remember our Drug Channels philosophy, courtesy of the late senator Daniel Patrick Moynihan: "Everyone is entitled to his own opinion, but not his own facts."

THE NCPA DIGEST DATA

The 2015 NCPA Digest, Sponsored by Cardinal Health publishes 2014 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.)

Today’s post marks my seventh annual review of the digest’s data. Hooray! Here are my previous six 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)

• Profits Rebound for Pharmacy Owners (2012 data)

• Profits Up Again for Independent Pharmacy Owners (2013 data)

A PHARMACY PROFIT PRIMER

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

A pharmacy’s 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 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.

Gross profit measures the portion of revenues available for the operating expenses and operating profit. To be profitable, a pharmacy’s gross profits must exceed its operating expenses. Operating expenses include: (1) payroll expenses—the wages, taxes, and benefits paid to the pharmacy’s staff, including the business owners, and (2) 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 drugstore’s gross profits must exceed its operating expenses. For example, a pharmacist-operated drugstore 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.

In a previous report, the NCPA Digest defined the sum of Owner Compensation and 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 our Economic Report on Retail, Mail, and Specialty Pharmacies.

For my most recent thoughts on the outlook for independent drugstores, see section 6.1.3. of our new 2015-16 Economic Report on Pharmaceutical Wholesalers and Specialty Distributors.

OBSERVATION 1: Overall independent pharmacy profit margins remain stable.

In 2014, independent pharmacies' overall gross margin from prescription and non-prescription products was 22.9%, a slight drop from the previous year’s result. Even the digest concedes that gross margin “remained relatively stable.”

Once again, this survey's findings are consistent with the U.S. Census Bureau’s data, which show stable drugstore gross margins. See May 2015’s Surprise! Government Data Again Show Rising Drugstore Profits.

OBSERVATION 2: An independent pharmacy’s prescription profit margins were also stable.

While NCPA no longer reports gross margins on prescription vs. non-prescription sales, I estimate that gross margins on prescription sales were 22.3% in 2014. Here’s a look at prescription gross margins since the introduction of Medicare Part D. As you can see, these figures have remained fairly stable in recent years.

[Click to Enlarge]

OBSERVATION 3: An independent pharmacy’s gross profit per prescription declined.

In 2014, average per-prescription revenues in the NCPA sample decreased to $54.41, compared with $57.50 per prescription in 2013. Combined with the slight decrease in gross margin, gross profit dollars per prescription shrank by 7.0%, from $13.03 per prescription in 2013 to $12.12 per prescription in 2014.

OBSERVATION 4: Brand-to-generic substitution is reducing retail pharmacy revenues.

For the first time in seven years, the digest's average per-pharmacy prescription revenue also decreased. From 2011 through 2013, average prescription revenue was about $3.5 million. In the 2014 sample, average prescription revenue dropped below $3.4 million.

I estimate that about 80% of the prescription revenue decline was due to the lower average prescription prices noted above. In this year’s sample, average annual prescription volume per pharmacy dropped by only 1.4%, to 61,568 prescriptions.

Ongoing brand-to-generic substitution is the most likely explanation for average revenue decline. The NCPA Digest reports that the generic dispensing rate was 80% in 2014. While that figure is two percentage points higher than last year’s figure, it is also below the overall market’s generic dispensing rate.

Here’s an interesting counterpoint to the NCPA Digest data. For 2014, IMS Health data show that independent pharmacies’ overall drug purchases grew by more than $5 billion. IMS Health data also show prescription growth for independents in 2014. (See 2014’s Winners and Losers: Prescription Market Share by Dispensing Format.) Hmmm.

OBSERVATION 5: The average pharmacist owning a single pharmacy earned about $228,000 in 2014.

I estimated that the Owner’s Discretionary Profit (ODP) dropped. On a per-pharmacy basis, this figure shrank, from $247K in 2013 to $228K in 2014. The decrease primarily reflects lower pharmacy revenues in the 2014 sample.

Note that a pharmacy owner still earns almost twice the salary of an employed pharmacist. See Pharmacist Salaries Keep Rising, Hitting $119K in 2014.

OBSERVATION 6: The total number of independent pharmacies continues to hold steady.

According to the NCPA’s counting, the total number of independent community pharmacies has been relatively stable: 23,064 in 2010; 23,106 in 2011; 23,029 in 2012; 22,814 in 2013; and 22,478 in 2014.

Naturally, NCPA provides no source for these data.

BTW, I consider it a minor personal victory that NCPA has stopped reporting its completely bogus computation of how many pharmacies “operate at a loss.” In previous years, the digest claimed that about one-quarter of pharmacies were operating at a loss. Yet miraculously, the number of pharmacies remained stable! If you understand the three components of gross profit, you'll see why NCPA was eventually shamed into burying the "operating at a loss" data. After all, 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. Shhh.

METHODOLOGICAL MYSTERIES

For what it’s worth, here are some issues to consider as you evaluate the digest’s data:

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 $81.4 billion “health care marketplace.” As far as I can tell, NCPA arrived at this figure by multiplying the survey’s $3.6 million average revenue figure by 22,478 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).

Weaknesses

• NCPA provides 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.

This year, I made a good-faith effort to discover the sample size. Alas, NCPA didn't respond to my requests to reveal this apparently top-secret figure. According to the digest: “NCPA has exercised the utmost professional care in compiling the information received.” Apparently, this professionalism doesn’t extend to answering one of the most basic questions about the results. Make of that what you will.