- Email: [email protected]
A Psychological Barrier to the Fee System
Ii
fee system
• economic or psychological barrier
by Glen L. Cureton ne important factor preventing the pharmacist from using the prescription fee is the fear that he will not recover an adequate return on his investment. To help dispel this notion we must show that a fee system which entails spreading all costs equally over all prescriptions is economically sound. Most likely, the pharmacist originated a markup based on cost of medications because he has a more complex situation than other professionals. He has to deal with a product and must cover the expense required to stock a broad in-
O
Glen L. Cureton has been with the Stanford Research Institute since 1964, serving first in the life sciences research area and now as an industrial economist with the chemical process industry economics group. At the Institute he has studied computer recording of preclinical pharmacological data and gastric physiology. He also has been an author on longrange planning reports of the Institute. APhA member Cureton has a doctorate in pharmacy from the University of California Medical Center (1962) where he was class president and editor of the campus newspaper. From 196264 Cureton attended Harvard University, earning a master of business administration degree.
ventory. Thus, he is working in a tighter economic situation than men in other professions and he has chosen to simplify matters by chargirg for his services predominantly in relation to the cost of medications. Since this system of pricing has proved successful, the fee system is regarded with a certain amount of suspicion. The pharmacist's apprehension about the fee system is expressed by the oftheard statementIt would be unsound to charge a twodollar fee as the markup for a prescription that contains $10 worth of medication.
Such an idea is symptomatic of the basic misconception that the largest cost in dispensing is the investment in inventory. Because of this belief, the pharmacist persists in basing his markup (fee for professional services) on his investment in the drugs in each individual prescription order. A markup based on costs of medications arbitrarily allocates all costs of dispensing to the investment in drug inventory. In reality, the only cost that can be directly related to the inventory (other than the inventory itself) is the "cost of capital" (the cost of the money invested in the medicine.)* Such a figure would be five to 15 times less than a 50 percent markup on the wholesale cost. Most costs of dispensing a prescription would be correctly allocated to the time involved in dispensing and record keeping. Since this time does not vary significantly for more than 97 percent of prescriptionst (those prefabricated by the manufacturer), a markup designed on this basis would be
*
Cost of capital is the cost, after tax, of borrowing money or the after-tax return on an alternative investment of the money tied up in inventory. The after-tax cost of borrowing money would be approximately three percent on a four percent loan. Since interest is tax deductible, the reciprocal of the tax rate times the interest is the cost to the borrower. In the case of a pharmacy having net profits of $25,000 or less, this reciprocal would be .78 (100 - .22 tax rate). t The Gosselin Survey reports that only two and four-tenths percent of prescriptions were compounded in 1963.
the same for nearly every prescription. Thus, a markup system entailing an equal markup (fee) for each prescription would be matching costs and revenues to a greater extent than a percentage markup system based on the wholesale cost of the medication. On a true "matching costs and revenue" markup system, the "cost of capital" would be the only variable cost that would be correctly allocated to cost of medications. t Since this cost is fairly small, such sophistication is not necessary. If the pharmacist were willing to distribute arbitrarily this "cost of capital" for his investment in drug inventory equally among all prescriptions, he could charge a consistent professional fee plus his cost of medication. Allocating the "cost of capital" for the total average investment in inventory in equal portions to each prescription is economically sound. This procedure involves normalizing the relatively small "cost of capital" per prescription. The equal allocation per item of the total cost of factors that varies per item is acceptable, provided it serves a purpose without resulting in economic folly (such as a sizable variance in matching costs and revenues which results in poor profits or non-competitive charges). Since the pharmacist's total investment will not change, regardless of the system he uses, § a fee system, which normalizes the cost of capital and is designed to provide the same net return that is currently enjoyed under a markup system, would result in the same return on investment provided by the latter system. In retrospect then, any pricing system should be designed to cover the cost of the product, other costs and profits. Pricing systems vary in ways of allocating the costs of handling products, including the investment in inventory, and (continued on page 647) ~ For purposes of comparison, compounded prescriptions are not included in this discussion. § This is true unless the unexplored competitive nature of the fee system results in a significantly greater frequency of high (or low) cost-of-goods prescription orders than is presently dispensed.
Vol. NS5, No. 12, December 1965
635
prescription fee system (continued from page 635)
in allocating a profit factor per item. A markup as a percent of sales ignores operational cost factors in favor of maintaining an equal or sliding percent of sales as the gross margin for each item. However, all systems are somewhat arbitrary and they all can be set to provide a predetermined return on investment. For example, the prescription fee may be set with one of several goals in mind1. to provide the pharmacist with the same net return he now enjoys 2. to provide a predetermined percentage of sales as net reven ue 3. to provide a predetermined net return on investment.
Since return on investment is the soundest measure of economic success, the third example is the most desirable objective. Although the initial calculation of a fee for a particular operation is somewhat involved, a number of articles explaining the fee system have appeared in THIS JOURNAL and elsewhere. 1 - s In essence, the pharmacist must determine his total investment in the prescription department, all direct and indirect costs of the prescription department and his average annual number of prescriptions dispensed. The pharmacist should incorporate a factor designed to guarantee a certain return on his investment in pricing prescriptions. This factor can be included as all-or part-of the profit portion of his fee for professional services. The fee system is economically sound; it matches costs and revenues and may be adjusted to obtain the economic criteria set by the individual pharmacist. An initial difficulty in figuring a suitable fee should not be the deciding factor in the pharmacist's charge for his services. (N either should the phannacist continue to jeopardize his professional standing by charging for the prescription as if it were only a product.) Thus, the prescription fee system allows for sophisticated financial management and the only "economic" barrier in adopting the fee system is psychological. • references 1.
2. 3. 4. 5
Labson, David E., The Impact of a Professional Fee on the Profession of Pharmacy, (master's thesis exploring fee calculation in detail) Industrial Management Department, MIT, 1963, 144 pp. Available from the Microfilm Department, MIT Library, at four cents/page for microfilm, 20 cents/page for Xerox copy. Oddis, Joseph A., "Hospital Pharmacy and the Professional Fee," THIS JOURNAL, NS2, 529(Sept. 1962). Bicket, James, "Transition to the Professional Fee," ibid., 531. Symposium on "Professional Fee Method in Operation," ibid., 532. Jacoff, Michael D., "Professional Fee Evaluation," ibid., 565(Nov. 1963).
DECEMBER Remington Medal presentation dinner, Roosevelt Hotel, New York, N.Y. 1-4 American Public Welfare Assn. biennial roundtable conference, Edgewater Beach Hotel, Chicago, III. 6 FDA and Food Law I nstitute 9th annual joint educational conference, Marriott Twin Bridges Motor Hotel, Washington, D.C. 6-8 Pharmaceutical Manufacturers Assn. midyear meeting, Continental Hotel, Chicago, III. 8-10 ASHP-APhA special conference on drug distribution, Marriott Twin Bridges Motor Hotel, Washington, D.C. 9 Proprietary Assn. annual research and scientific development conference, Hotel Roosevelt, New York, N.Y. 9 USAN Council II industry conference on nonproprietary nomenclature for drugs, Americana Hotel, New York, N.Y. 26-31 American Assn. for the Advancement of Science, U. of Calif., Berkeley, Calif. 1
JANUARY 1966 Mont. State Pharmaceutical Assn. midwinter meeting, The Placer, Helena, Mont. 18-19 Mass. State Pharmaceutical Assn. midwinter meeting, Schine Inn, Chicopee, Mass. 22-23 Idaho State Pharmaceutical Assn. midwinter meeting, Coeur d'Alene, Idaho 23-27 N.J. Pharmaceutical Assn. midwinter meeting, Rickshaw Inn, Cherry Hill, N.J. 31-Feb. 1 Mich. State Pharmaceutical Assn. midwinter meeting, Jack Tar Hotel, Lansing, Mich. 16
FEBRUARY 2-4 Federal Wholesale Druggists Assn. midyear meeting, Biltmore Hotel, New York, N.Y. 4 Parenteral Drug Assn. N.Y. meeting, Statler-Hilton, New York, N.Y. 13-18 Educational conference on industrial pharmacy, APhA Acad. of Pharmaceutical Sciences industrial pharmacy section in cooperation with Columbia U. college of pharmacy, Arden House, Harriman, N.Y. 16 Conn. Pharmaceutical Assn. midwinter meeting, Waverly Inn, Cheshire, Conn. 16-17 AMA II national voluntary health conference, Chicago, III. 16-19 Institute of Management Sciences national meeting (includes session on pharmaceuticals), Statler Hilton, Dallas, Tex. 26Druggists' Service Council annual March 3 meeting and trade show, WaldorfAstoria, New York, N.Y. MARCH Drug, Chemical and Allied Trades Assn. 3 annual dinner and symposium, Americana Hotel, New York, N.Y. AMA national congress on medical 5-6 ethics and professionalism, Chicago. Pharmaceutical Wholesalers Assn. an14-18 nual convention, Dunes Hotel, Las Vegas, Nev.
American Pharmaceutical Assn. annual meeting 1966
April 24-29 Dallas, Texas
1967
April 9-14 Las Vegas, Nevada
25-27 27-28
Okla. Pharmaceutical Assn. annual meeting, Sheraton-Oklahoma, Oklahoma City, Okla. Kans. Pharmaceutical Assn. annual meeting, Ramada Inn, Topeka, Kans.
APRIL 4-6
Pharmaceutical Manufacturers Assn. annual meeting, Boca Raton Club, Boca Raton, Fla. 15 Parenteral Drug Assn. Chicago meeting, O'Hara Inn, Chicago, III. 16-18 Iowa Pharmaceutical Assn. annual meeting, Hanford Hotel, Mason City, Iowa. 16-18 Neb. Pharmaceutical Assn. annual meeting, Holiday Inn, Kearney, Neb. 16-21 Wholesale Druggists Merchandising Assn. annual meeting, Sheraton Charles, New Orleans, La. 17-20 Ga. Pharmaceutical Assn. annual meeting, Marriott Hotel, Atlanta, Ga. 24-29 American Pharmaceutical Assn. annual meeting, Dallas, Tex., including American Assn. of Colleges of Pharmacy American College of Apothecaries American Institute of the History of Pharmacy American Society of Hospital Pharmacists Metropolitan Pharmaceutical Secreta ries Assn. Nat'l Assn. of Boards of Pharmacy Nat'l Council of State Pharmaceutical Assn. Executives 30-May 2 Nat'l Assn. of Chain Drug Stores annual meeting, Hollywood Beach and Diplomat Hotels, Hollywood, Fla.
International JANUARY 1966 24-30 Symposium on CNS drugs, council of scientific and industrial research, government of I ndia, regional research laboratory, Hyderabad, India APRIL 25-29
Health Congress of the Royal Society of Health, Blackpool, Lancashire, England 27-May 1 I meeting of Italian Pharmaceutical Organizations and IX National Congress of Unione Technica Italiana Farmacist, Naples, Italy
MAY 23-28
2nd International Congress on Hormonal Steroids, University Building, Milan, Italy
JULY 24-30 28-31
III International Pharmacological Congress, Sao Paulo, Brazil International Congress of Psychosomatic Medicine in Obstetrics and Gynecology, Vienna, Austria
Vol. NS5, No. 12, December 1965
647
fee system
• economic or psychological barrier
by Glen L. Cureton ne important factor preventing the pharmacist from using the prescription fee is the fear that he will not recover an adequate return on his investment. To help dispel this notion we must show that a fee system which entails spreading all costs equally over all prescriptions is economically sound. Most likely, the pharmacist originated a markup based on cost of medications because he has a more complex situation than other professionals. He has to deal with a product and must cover the expense required to stock a broad in-
O
Glen L. Cureton has been with the Stanford Research Institute since 1964, serving first in the life sciences research area and now as an industrial economist with the chemical process industry economics group. At the Institute he has studied computer recording of preclinical pharmacological data and gastric physiology. He also has been an author on longrange planning reports of the Institute. APhA member Cureton has a doctorate in pharmacy from the University of California Medical Center (1962) where he was class president and editor of the campus newspaper. From 196264 Cureton attended Harvard University, earning a master of business administration degree.
ventory. Thus, he is working in a tighter economic situation than men in other professions and he has chosen to simplify matters by chargirg for his services predominantly in relation to the cost of medications. Since this system of pricing has proved successful, the fee system is regarded with a certain amount of suspicion. The pharmacist's apprehension about the fee system is expressed by the oftheard statementIt would be unsound to charge a twodollar fee as the markup for a prescription that contains $10 worth of medication.
Such an idea is symptomatic of the basic misconception that the largest cost in dispensing is the investment in inventory. Because of this belief, the pharmacist persists in basing his markup (fee for professional services) on his investment in the drugs in each individual prescription order. A markup based on costs of medications arbitrarily allocates all costs of dispensing to the investment in drug inventory. In reality, the only cost that can be directly related to the inventory (other than the inventory itself) is the "cost of capital" (the cost of the money invested in the medicine.)* Such a figure would be five to 15 times less than a 50 percent markup on the wholesale cost. Most costs of dispensing a prescription would be correctly allocated to the time involved in dispensing and record keeping. Since this time does not vary significantly for more than 97 percent of prescriptionst (those prefabricated by the manufacturer), a markup designed on this basis would be
*
Cost of capital is the cost, after tax, of borrowing money or the after-tax return on an alternative investment of the money tied up in inventory. The after-tax cost of borrowing money would be approximately three percent on a four percent loan. Since interest is tax deductible, the reciprocal of the tax rate times the interest is the cost to the borrower. In the case of a pharmacy having net profits of $25,000 or less, this reciprocal would be .78 (100 - .22 tax rate). t The Gosselin Survey reports that only two and four-tenths percent of prescriptions were compounded in 1963.
the same for nearly every prescription. Thus, a markup system entailing an equal markup (fee) for each prescription would be matching costs and revenues to a greater extent than a percentage markup system based on the wholesale cost of the medication. On a true "matching costs and revenue" markup system, the "cost of capital" would be the only variable cost that would be correctly allocated to cost of medications. t Since this cost is fairly small, such sophistication is not necessary. If the pharmacist were willing to distribute arbitrarily this "cost of capital" for his investment in drug inventory equally among all prescriptions, he could charge a consistent professional fee plus his cost of medication. Allocating the "cost of capital" for the total average investment in inventory in equal portions to each prescription is economically sound. This procedure involves normalizing the relatively small "cost of capital" per prescription. The equal allocation per item of the total cost of factors that varies per item is acceptable, provided it serves a purpose without resulting in economic folly (such as a sizable variance in matching costs and revenues which results in poor profits or non-competitive charges). Since the pharmacist's total investment will not change, regardless of the system he uses, § a fee system, which normalizes the cost of capital and is designed to provide the same net return that is currently enjoyed under a markup system, would result in the same return on investment provided by the latter system. In retrospect then, any pricing system should be designed to cover the cost of the product, other costs and profits. Pricing systems vary in ways of allocating the costs of handling products, including the investment in inventory, and (continued on page 647) ~ For purposes of comparison, compounded prescriptions are not included in this discussion. § This is true unless the unexplored competitive nature of the fee system results in a significantly greater frequency of high (or low) cost-of-goods prescription orders than is presently dispensed.
Vol. NS5, No. 12, December 1965
635
prescription fee system (continued from page 635)
in allocating a profit factor per item. A markup as a percent of sales ignores operational cost factors in favor of maintaining an equal or sliding percent of sales as the gross margin for each item. However, all systems are somewhat arbitrary and they all can be set to provide a predetermined return on investment. For example, the prescription fee may be set with one of several goals in mind1. to provide the pharmacist with the same net return he now enjoys 2. to provide a predetermined percentage of sales as net reven ue 3. to provide a predetermined net return on investment.
Since return on investment is the soundest measure of economic success, the third example is the most desirable objective. Although the initial calculation of a fee for a particular operation is somewhat involved, a number of articles explaining the fee system have appeared in THIS JOURNAL and elsewhere. 1 - s In essence, the pharmacist must determine his total investment in the prescription department, all direct and indirect costs of the prescription department and his average annual number of prescriptions dispensed. The pharmacist should incorporate a factor designed to guarantee a certain return on his investment in pricing prescriptions. This factor can be included as all-or part-of the profit portion of his fee for professional services. The fee system is economically sound; it matches costs and revenues and may be adjusted to obtain the economic criteria set by the individual pharmacist. An initial difficulty in figuring a suitable fee should not be the deciding factor in the pharmacist's charge for his services. (N either should the phannacist continue to jeopardize his professional standing by charging for the prescription as if it were only a product.) Thus, the prescription fee system allows for sophisticated financial management and the only "economic" barrier in adopting the fee system is psychological. • references 1.
2. 3. 4. 5
Labson, David E., The Impact of a Professional Fee on the Profession of Pharmacy, (master's thesis exploring fee calculation in detail) Industrial Management Department, MIT, 1963, 144 pp. Available from the Microfilm Department, MIT Library, at four cents/page for microfilm, 20 cents/page for Xerox copy. Oddis, Joseph A., "Hospital Pharmacy and the Professional Fee," THIS JOURNAL, NS2, 529(Sept. 1962). Bicket, James, "Transition to the Professional Fee," ibid., 531. Symposium on "Professional Fee Method in Operation," ibid., 532. Jacoff, Michael D., "Professional Fee Evaluation," ibid., 565(Nov. 1963).
DECEMBER Remington Medal presentation dinner, Roosevelt Hotel, New York, N.Y. 1-4 American Public Welfare Assn. biennial roundtable conference, Edgewater Beach Hotel, Chicago, III. 6 FDA and Food Law I nstitute 9th annual joint educational conference, Marriott Twin Bridges Motor Hotel, Washington, D.C. 6-8 Pharmaceutical Manufacturers Assn. midyear meeting, Continental Hotel, Chicago, III. 8-10 ASHP-APhA special conference on drug distribution, Marriott Twin Bridges Motor Hotel, Washington, D.C. 9 Proprietary Assn. annual research and scientific development conference, Hotel Roosevelt, New York, N.Y. 9 USAN Council II industry conference on nonproprietary nomenclature for drugs, Americana Hotel, New York, N.Y. 26-31 American Assn. for the Advancement of Science, U. of Calif., Berkeley, Calif. 1
JANUARY 1966 Mont. State Pharmaceutical Assn. midwinter meeting, The Placer, Helena, Mont. 18-19 Mass. State Pharmaceutical Assn. midwinter meeting, Schine Inn, Chicopee, Mass. 22-23 Idaho State Pharmaceutical Assn. midwinter meeting, Coeur d'Alene, Idaho 23-27 N.J. Pharmaceutical Assn. midwinter meeting, Rickshaw Inn, Cherry Hill, N.J. 31-Feb. 1 Mich. State Pharmaceutical Assn. midwinter meeting, Jack Tar Hotel, Lansing, Mich. 16
FEBRUARY 2-4 Federal Wholesale Druggists Assn. midyear meeting, Biltmore Hotel, New York, N.Y. 4 Parenteral Drug Assn. N.Y. meeting, Statler-Hilton, New York, N.Y. 13-18 Educational conference on industrial pharmacy, APhA Acad. of Pharmaceutical Sciences industrial pharmacy section in cooperation with Columbia U. college of pharmacy, Arden House, Harriman, N.Y. 16 Conn. Pharmaceutical Assn. midwinter meeting, Waverly Inn, Cheshire, Conn. 16-17 AMA II national voluntary health conference, Chicago, III. 16-19 Institute of Management Sciences national meeting (includes session on pharmaceuticals), Statler Hilton, Dallas, Tex. 26Druggists' Service Council annual March 3 meeting and trade show, WaldorfAstoria, New York, N.Y. MARCH Drug, Chemical and Allied Trades Assn. 3 annual dinner and symposium, Americana Hotel, New York, N.Y. AMA national congress on medical 5-6 ethics and professionalism, Chicago. Pharmaceutical Wholesalers Assn. an14-18 nual convention, Dunes Hotel, Las Vegas, Nev.
American Pharmaceutical Assn. annual meeting 1966
April 24-29 Dallas, Texas
1967
April 9-14 Las Vegas, Nevada
25-27 27-28
Okla. Pharmaceutical Assn. annual meeting, Sheraton-Oklahoma, Oklahoma City, Okla. Kans. Pharmaceutical Assn. annual meeting, Ramada Inn, Topeka, Kans.
APRIL 4-6
Pharmaceutical Manufacturers Assn. annual meeting, Boca Raton Club, Boca Raton, Fla. 15 Parenteral Drug Assn. Chicago meeting, O'Hara Inn, Chicago, III. 16-18 Iowa Pharmaceutical Assn. annual meeting, Hanford Hotel, Mason City, Iowa. 16-18 Neb. Pharmaceutical Assn. annual meeting, Holiday Inn, Kearney, Neb. 16-21 Wholesale Druggists Merchandising Assn. annual meeting, Sheraton Charles, New Orleans, La. 17-20 Ga. Pharmaceutical Assn. annual meeting, Marriott Hotel, Atlanta, Ga. 24-29 American Pharmaceutical Assn. annual meeting, Dallas, Tex., including American Assn. of Colleges of Pharmacy American College of Apothecaries American Institute of the History of Pharmacy American Society of Hospital Pharmacists Metropolitan Pharmaceutical Secreta ries Assn. Nat'l Assn. of Boards of Pharmacy Nat'l Council of State Pharmaceutical Assn. Executives 30-May 2 Nat'l Assn. of Chain Drug Stores annual meeting, Hollywood Beach and Diplomat Hotels, Hollywood, Fla.
International JANUARY 1966 24-30 Symposium on CNS drugs, council of scientific and industrial research, government of I ndia, regional research laboratory, Hyderabad, India APRIL 25-29
Health Congress of the Royal Society of Health, Blackpool, Lancashire, England 27-May 1 I meeting of Italian Pharmaceutical Organizations and IX National Congress of Unione Technica Italiana Farmacist, Naples, Italy
MAY 23-28
2nd International Congress on Hormonal Steroids, University Building, Milan, Italy
JULY 24-30 28-31
III International Pharmacological Congress, Sao Paulo, Brazil International Congress of Psychosomatic Medicine in Obstetrics and Gynecology, Vienna, Austria
Vol. NS5, No. 12, December 1965
647