Can Independent Pharmacy SURVIVE?

,-Viewpoint r

Can Independent Pharmacy

SURVIVE? By THOMAS McGREGOR

T

he Lilly Digest has provided pharmacy-particularly community pharmacy-with a source of economic information for more than fifty years. In this publication, pharmacy owners and managers can refer to the "Heart of the Digest" section to compare their own operational data with pharmacies of similar characteristics. In recent years, the pharmaceutical press has used the Digest summaries as the basis for reporting trends in pharmacy operations. In brief, sales in 1982 grew 13.4%; prescription sales grew 13.8%; and total income of self-employed pharmacists increased to more than $44,000, in spite of a reduction in gross margin to 33.6% of sales. However, none of this represents an accurate assessment of trends in community pharmacy but is, rather, an expression of the change in the "average" of all the pharmacies tabulated in the Lilly Digest. The following analysis was developed for a lecture to advanced pharmacy administration students at the University of Wisconsin. Management by analysis is the theme of the course "Contemporary Pharmacy Management," in which students are taught the techniques used

Thomas McGregor, RPIz, is a com/nullity pharmacist at Moreland Plaza Pharmacy, 827 W. Moreland Blvd., Waukesha, WI53186, and is an instructor in contemporary pharmacy manageIllent at the University of Wisconsin School of Pharmacy, Madison, WI.

American Pharmacy Vol. NS24, No.4, April 1984/169

....

to solve management problems. There is no attempt here to criti-

cize the analysis performed by the Lilly Digest and its editor, Carl

Table 1.

Pharmacies Tabulated in Lilly Digest 1979

(% of Total sample) 1981 1980

1982

Less than 300,000 300-400,000 400-500,000 500-600,000 600-750,000 More than 750,000

46.5% 17.9 13.0 8.0 6.4 8.2

41.4% 19.7 11.9 9.0 7.6 10.4

39.0% 18.8 12.8 9.0 8.3 12.1

31.2% 19.7 14.1 10.2 8.4 16.4

Total pharmacies

1,458

2,070

1,750

1,528

Sales

($)

5

Comparison of Medi·a ·n Pharmacies 1979 TO'tal sales Digest table NO'. of pharmacies NO'. O'f pharmacies with <75 daily Rx NO'. O'f pharmacies with > 75 daily Rx % tO'tal sales = Rx" TO'tal sales margin (%)* TO'tal incO'me (salary + net prO' fit) * TO'tal incO'me (% O'f sales)*

$391,681 ($350.-400,000) 122

1982

1981

1980

$416,161 ($400-450,000) 143

$498,021 ($450-500,000) 106

$439,133 ($400-450,000) 126

71 (58%)

65 (45%)

59 (47%)

38 (36%)

51 (42%) 52.2%

78 (55%) 55.3%

67 (53%) 57.4%

68 (64%) 62.6 %

36.0%

35.0%

34.9%

33.8%

$ 38,948

$ 43,156

$ 43,806

$ 42,222

9·.9%

10.4%

10.0%

8.5%

*Determined by weighted average of all pharmacies reporting in this sales range .

Deiner. In fact, without their contribution, the symptoms of an impending economic crisis for community pharmacy could not have been identified. Also, pharmacy graduates who intend to take up positions in community practice and management must be encouraged to use·the data reported in the Digest and to exercise their managemen t skills in assessing its significance.

The Sample Mix In Table 1 (p. 5), I have grouped all pharmacies reporting for each year and expressed ranges of sales volume as percentages of that year's total sample.

While pharmacy managers should expect some sales increase to be reported for 1982, is it logical to believe that sales increased by 13.4% during a period of minimal inflation? Or, did the mix of pharmacies'reporting operational data for 1982 change so significantly that the sample itself became the major determinant of the trends reported? An examination of the sample mix for 1981 and 1982 does show a decline of 7.8% of the total sample (or a 20% change) among those pharmacies reporting less than $300,000 in annual sales, while those with sales greater than $750,000 comprised 4.3%

more of the total sample (or a 35% change). If the trend-reporters are correct and pharmacy sales in 1982 did increase by 13.4%, then we can assume that the sample is representative and that community pharmacies in the United States producing sales of less than $300,000 declined by more than 20%, while those attaining sales in excess of $750,000 increased by more than 35%. I suggest that the sample mix, and not community pharmacy sales, represents the greater change and that the 13.4% sales increase is grossly overstated.

Table 3.

Non·- Merchandising Pharmacies W.i th $250-300,000 Annual Sales 1979

1980

1981

1982

TO'tal sales ($)

277,942

277,659

280,218

277,477

Rx sales ($) Rx sales (%)

218,003 78.4

223,746 80.6

229,908 82.0

216,379 78.0

Margin ($)

105,622

101,523

107,326

99,080

Margin (%)

38.0

36.6

38.3

35.7

Pharmacies. repO'rting

47

40

30

86

American Pharmacy Vol. NS24, No.4, April 1984/170

Table 4.

Alternative Analysis Table 2 (p . 6) demonstrates an alternative method of identifying trends in pharmacy in which the operational data of the median group of pharmacies, as recorded in the "Heart of the Digest," are compared. The decline in gross margin, expressed as a percentage of sales from 1979-1982 (36.0 % to 33.8 %), occurred in spite of an increase in prescription sales, from 52.2 % to 62.6% of total phanriacy revenue. Independent pharmacy has apparently made a dramatic downward adjustment in financial reward for professional service. The fact that the greatest change is seen when these data are compared for 1981 and 1982 should alert community pharmacists to an impending financial crisis that is not depicted in popular trend analyses. With prescription revenues exceeding 60 % of total sales, managers must recognize the increased significance of adequate compensation for professional service. With nonprescription sales at the saIne time representing a declining source for pharmacy income, can the profession continue the tendency to "commodi ty price" pharmaceu tical services? Table 3 (p. 6) summarizes the operational data for non-merchandising (clinic) pharmacies reporting $250,000-$300,000 in annual sales during the same period. While total sales and prescription revenue display little change, the "Heart of the Digest" again reports a general decline in gross margin percent. Apparently, even the more professionally oriented prescription pharmacies have reduced their compensation for professional service from 38.0 % to 35.7% of total sales, representing a decline of more than $6,500 in gross profit.

Pricing Studies Rather than speculate on what factors may contribute to the declining gross margin in the prescription department, we can use prescription pricing analysis to identify the actual causes. As shown in Table 4 (above), 1981

American Pharmacy Vol. NS24, No.4, April 1984/171

Wiscon$in Prescription Pricing Studies Averages:

Selling price

Cost (AAC)

Margin

Margin

($)

(%)

1981 Private pay 1983 Private pay % change

$ 8.46 10.99 + (29.9 %)

$4.69 6.90 +(47.1 %)

$3.77 4.09 +(8.5 %)

45.2 % 37.2

1981 Third-party 1983 Third-party % change

9.03 11.44 + (26.7 %)

5.65 7.21 +(27.6 %)

3.38 4.23 + (25.1 %)

38.3 36.9

independent prescription prICIng studies* in Wisconsin community pharmacies found a gross margin of 45.2 % for private-pay prescriptions and 38.3 % for a composite of thirdparty programs. Similar studies conducted in 1983 show that third-party programs have remained relatively stable, with proportionate increases in selling price, ingredient cost, and margin (fee). However, private-pay prescription analysis in 1983 tells another story. Although average selling price

Independent pharmacy has apparently made a dramatic downward adiustment in financial reward for professional service. increased by 29.9 %, pharmacy compensation increased by only 8.5 %, resulting in a decline in gross margin to 37.2 % of sales. Therefore, trends in community pharmacy may be more accurately described as: 1. Larger pharmacies have come to comprise the Lilly Digest data base; 2. Net profit fell to 2.9 % of sales, in spite of a sharp increase in pre·Presc ription pricing ana lysis is o ne of severa l fi eld projects conducted in "Contemporary Pharmacy Management," a pharmacy adminis tration elective offered to se nio r pharmacy stude nts a t the Uni ve rsity of Wisconsin.

scription revenue to more than 60 % of total sales; 3. Prescription pricing trends result in a drama tic decline in gross margin, expressed as a percentage of sales; 4. Return on investment for community pharmacy shows a potential for sharp decline.

Future Pricing At present, Wisconsin pharmacies are being encouraged to participa te in preferred provider organization- and HMO-type contracts that offer an average margin of $2.85 and a gross margin of 28.3 %.** By referring to Table 4, we can see tha t this program is demanding a reduction in compensation of more than 32 % (from $4.23 to $2.85) per prescription and a margin percentage that is lower than any recent studies have reported. In essence, the rationale seems to be "something is better than nothing," or "if we don't take this, we can't have anything. " The impact of such future prescription pricing, even for a pharmacy involved in a limited number of third-party programs, can be seen by reconstructing the financial statemen t of the 1982 "Median Pharmacy," as reported in the Lilly Digest, 1983. The following assumptions are included in the calculations: 1. The 37% gross margin developed in the Wisconsin independent ··" Ma xica re" co ntra ct provisions wert' ;; pplied to the 1983 Wisco n s in prescription pricing studies. The "Prime Care" co ntrac t curre ntl y is offering a lowe r compensa tion level.

7

.....

Adiusting Median Pharmacy Profits for 1982 Margin (%)

Gross margin

(jiJ

37.0 % 28.4 % 33.8

$115,351 52,980 168,331

$249,409 62,352 311,761

@ @

37.0 % 37.0 %

$ 92,281 23,070 115,351

$249,409 54,830 304,239 186,260 $490,499

@ @:

37.0 % 28.3 %

$ 92,281 15,517 107,798

Sales 62.6 % 37.4 % 100.0%

Prescription Other

• Assume Rx sales are: 80 % Private pay 20 % Third-party • Apply 28.3 % margin for third-party Rx and AAC unchanged: Private pay -12 % sales Third -party - 2.4 % sales Total Rx sales Other sales -1.5 % sales Total sales

$311,761 186,260 498,021

~D

1982

Adjusted

1982

Net profit + Manager salary Manager salary Net profit

$ 42,222 30,000 12,222

• Assume net worth = $81,000 Return on investment (ROI)

15 %

pricing studies reflects regional data; 2. Only 20 % of Median Pharmacy's prescription revenue is derived from third-party programs; 3. All third-party prescription revenues will logically adjust to any lower level of compensation actively sought by a large segment of pharmacy.

Red uced Profit Using these assumptions, 1982 Median Pharmacy reports a gross profit of $115,351 from prescription revenue; $23,070 of this total was generated by third-party prescriptions (see box, above). If these insurance programs reduced gross profit to the 28.3 % previously mentioned, third-party revenue would decline by 12 %; total prescription revenue by 2.4%; and total pharmacy sales by 1.5%. More specifically, gross profit-and, logically, net profit-for Median Phar-

-$7,553

$ 34,669 30,000 4,669 5.7%

macy 1982 would decline by approximately $7,500. Table 27 of the Digest shows an average net worth of $81,000 for

Prescription pricing has reduced gross profit expectations to the lowest point in modern history ... a vulnerable economic posture. pharmacies reporting sales of $400,000-$600,000 annually. The owner of Median Pharmacy 1982 earned $42,222, which included both salary for pharmacist/manager and net profit. If we assume that a $30,000 salary is reasonable, the balance of $12,222 represents net profit and a

15% return on the $81,000 investment (ROI). However, had third-party compensation been reduced to 28.3 % in 1982, net profit would have declined to $4,669 or 5.7% ROI.

The Economic Threat "The fact that over 50% of total revenue is centered in the prescription department attests to the significant impact this area has on the financial records of the average independent community pharmacy." Editor Carl Deiner makes this statemen t on page 4 of the 1983 Lilly Digest, and he has been quoted by numerous pharmacy publications. The fact that more than 60 % of Median Pharmacy's revenue is generated by the prescription department, and that prescription pricing has reduced gross profit expectations to its lowest point in modern history, signals a vulnerable economic posture for independent pharmacy. If management is planning to accept additional reductions in professional compensation, owners should not expect a return on their investment that is even comparable to that paid for deposits in banks and savings and loan institutions. Although major publications may choose to report pharmacy's increased sales and increased profits in an inflated fashion, I think it is appropriate that we also recognize those economic conditions that threaten our independence . If the summary of 1983 operations to be reported in the Lilly Digest, 1984, indicates a continuation of the trends identified in this report, it would not be unreasonable to expect the beginning of a sharp decline in the number of independent community pharmacies. While Americans have begun to express a strong desire for pharmaceutical services and increased confidence in their family pharmacist, the profession itself seems to be engulfed in financial trends that will force the reduction and possible elimination of the very professional functions that are responsible for pharmacy's improved sense of identity. D

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American Pharmacy Vol. NS24, No. 4, April 1984117{