The rate of retail pharmacy mergers has increased in the last year, with the announcement of mega deals such as:
• CVS Health acquisition of Target’s 1,660 pharmacy and clinic businesses for $1.9 billion on June 15.
• Walgreens Boots Alliance buys Rite Aid’s 4,600 pharmacies and PBM EnvisionRx for a total transaction value of $17.2 billion on October 27.
• Kroger announces merger with Roundy’s 151 stores with 101 pharmacies on November 11.
The total pharmacies involved in these announced mergers is approximately 10% of the retail pharmacies in the country. We will spend a few minutes reviewing the market dynamics driving the accelerating consolidation in the industry.
Reasons for Consolidation
For the past 30 years, the gross profit margins generated by dispensing third-party prescriptions has decreased. Retail pharmacy has made up for these margin reductions by increasing productivity through advances in dispensing technology, higher prescription volume as the population ages, and cost reductions through efficient adjudication of third-party prescriptions. The industry is at an inflection point, where the ability to continually reduce costs in the face of declining margins is reaching its limits. The prescription volume that is required to run a profitable pharmacy continues to increase, and the ability to offset this loss of margin dollars through clinical services such as medication therapy management (MTM) sessions and comprehensive medication reviews (CMRs) is limited, even at an estimated $2- to $3-per-minute average fee.
Payers continue to exert downward margin pressure on retail pharmacies through the introduction of narrow and preferred pharmacy networks. These networks reduce the number of pharmacies available to members, with the pharmacies accepting lower reimbursement rates. This trend has accelerated with the introduction of Medicare Part D preferred networks and their associated direct and indirect remuneration (DIR) fees charged to pharmacies. DIR fees are retrospective fees charged on a flat dollar or percentage basis by the Medicare Part D plan; such fees lower the pharmacy’s profit dollars for each prescription. Payers are beginning to tie DIR fees to star ratings, i.e., a higher DIR fee is charged to pharmacies that have lower star ratings for their patient population. Pharmacies have been willing to pay the DIR fees for continued access to the Medicare Part D patients, which represent about one third of the retail prescriptions dispensed.
Retail pharmacies have also contributed to their declining profit margins with the introduction of discount generic programs that reduced the margin on their cash prescriptions. Third-party payers were quick to pick up on this willingness to accept lower prices and adjusted their maximum allowable cost (MAC) prices downward. Discount generic programs continue to be popular, but cover fewer products because of recent price increases for select generics due to generic industry consolidation, supply issues, and portfolio management activities where generic suppliers discontinue unprofitable products.
The lack of pricing power by the pharmacies in negotiating third-party reimbursement rates is a macroeconomic indicator that there are too many pharmacies in the market. The merger and acquisition activity reflects the consolidation needed to restore a semblance of pricing balance in the market. The lack of pricing power by pharmacies was exemplified by the Walgreens and Express Scripts battle in 2012. Express Scripts was able to continue to provide pharmacy network access sufficient enough to service the needs of the vast majority of their customers. This outcome forced Walgreens back to the negotiating table to reconcile the differences after losing an estimated $6 billion in sales during the first nine months of 2012.
The retail pharmacy market is segmented into traditional pharmacies, mass merchandisers, and grocery stores. Each type of business uses its pharmacies for different strategic business purposes. The traditional pharmacy typically generates over 70% of its sales from the pharmacy department and must have profitable sales to be successful. Mass merchandisers and grocery chain pharmacies represent between 5% and 15% of total store sales. These organizations use their pharmacies to generate store traffic where patients purchase additional food and general merchandise items. The differing strategic intent in each market segment creates downward pressure on margins that third-party payers have taken advantage of in their network negotiations.
Industry Responses The National Community Pharmacists Association (NCPA) has been aggressive on the legislative front in championing the passage of PBM (pharmacy benefit manager) transparency and MAC pricing legislation. These efforts have been successful, with over 20 states enacting legislation that establishes requirements for the frequency of MAC pricing updates and access to narrow networks.
New requirements went into place on January 1 for weekly MAC prices updates for Medicare Part D plans. This change will ensure that updates are made to reflect market supply issues that arise. When forced to update MAC prices weekly, the payer community may also take the opportunity to lower prices that reflect a reduction in acquisition cost pricing for specific generics. Pharmacies should closely monitor the overall impact of these legislative changes on generic profitability.
The looming industry consolidation will force pharmacy strategy changes to reflect the more concentrated purchasing power of the combined organizations. Here is a look from the stakeholders’ perspective on the upcoming changes.
Generic Manufacturers/Suppliers: With industry consolidation, there are fewer purchasers of generic products. These purchasers exert more buying power and lower acquisition costs by guaranteeing a specific purchase volume. The pooling of purchasing volume from different organizations will continue to exert downward pressure on generic prices.
When CMS began publishing average manufacturer prices (AMPs) two years ago, retail pharmacy had a transaction price benchmark with which to compare their acquisition costs. The monthly publication of AMPs provides insight into price trends and creates focused activity for pharmacy management to continually seek lower acquisition costs, which in turn decreases generic supplier margin.
Generic suppliers have responded by implementing portfolio management strategies for their product lines. Generic suppliers have exited markets where products are priced as commodities and/or have elected not to bring products to market that have very low margins. These changes have created opportunities for other manufacturers to raise prices when there are market shortages. This has led to a more dynamic pricing structure for generics.
Generic suppliers are focusing on product quality and guaranteed supply as a means to differentiate their product offerings and reducing the focus on lowest cost products. Big purchasers may trade a few percentage points in cost of goods sold for a quality product where the supply is guaranteed. This change in focus may help to stabilize generic prices and slow the race to the bottom, i.e., commodity pricing.
Payers: Industry consolidation will force payers to evaluate the network access standards for their preferred pharmacy networks. For a nationwide network to meet most access standards, 25,000 to 30,000 pharmacies are needed. Even if the number of retail locations decreases by 10% to 15%, payers should not have an issue with creating a network that provides adequate pharmacy access for their members. Furthermore, members and clients have accepted a narrow pharmacy network (Medicare Part D and exchange plans) to lower the rate of increase on actual insurance premiums.
Third-party payers have become more aggressive in lowering their MAC prices, especially after CMS began publishing AMP information. MAC prices are lowest for Medicare Part D and managed Medicaid plans where the payer has accepted risk for managing the drug spend. Payers, however, will continue to ask for lower network rates and higher DIR fees until they are unable to support a pharmacy network that provides sufficient access for their members.
From an overall drug spend perspective, payers are focusing their attention on the specialty drug spend and implementing tactics to ensure appropriate use of these expensive products. Newly launched specialty drugs can become budget busters overnight, e.g., hepatitis C drugs. Industry consolidation should not impact payer specialty drug strategies, as they have already limited the number of pharmacies that can dispense specialty drugs.
Retail Pharmacies: Consolidation in the industry will provide opportunities to increase purchasing power and lower the acquisition cost of generic products. Close monitoring of payer reimbursement rates is needed to quickly respond to market changes and raise awareness that a MAC pricing adjustment is warranted. Retail pharmacy should continue to support new legislation that improves the transparency of PBM operations and raise political awareness of these reimbursement issues. The ability to exert pricing power with payers will remain limited to situations where there is not a geographic concentration of stores and where payer clients are requesting access to specific pharmacies.
Retail pharmacy needs to continue to expand clinical services where financially feasible, e.g., immunizations, and modify dispensing workflow to facilitate the completion of MTM and CMR. Retail pharmacy must begin quantifying the clinical interventions performed and market the financial benefit to the payer community based on patient benefits. The value of these clinical interventions is not appreciated, due to the lack of information quantifying benefits. Robust data could change the focus of pharmacy discussions from the price of drugs to improved patient outcomes.
Consolidation will contribute to the stagnation of pharmacist wages. The shortage of pharmacists is history. Industry consolidation will put downward pressure on wages and enable employers to require a higher skill set for new employees. Most pharmacists working today only know a market where pharmacist services were in great demand, leading to high wages. The pendulum has begun swinging the other way on wages, limiting or eliminating wage increases. Industry consolidation will accelerate that trend, as well as the opening of new pharmacy schools and with existing schools graduating more pharmacists.
The recent merger and acquisition activity won’t turn the balance of power back in the favor of the pharmacies in the near term. We expect continued market consolidation as new partnerships are created and organizations sell or close their pharmacies. If access issues are created in rural areas due to store closures, we expect pharmacy boards to enact telepharmacy laws to mitigate these issues. Retail pharmacy will continue to be a challenging business as market forces continue to put downward pressure on prescription margins. CT
Tim Kosty, R.Ph., M.B.A., is president, and Don Dietz, R.Ph., M.S., is VP at Pharmacy Healthcare Solutions, Inc., which provides consulting solutions to pharmaceutical manufacturers, PBMs, retail pharmacy chains, and software companies on strategic business and marketing issues. The authors can be reached at email@example.com and firstname.lastname@example.org.