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CPMM Policy Report

Brian C. Reisetter, MBA, PhD Partner, Medical Marketing Economics, LLC Adjunct Professor, University of Mississippi School of Pharmacy
David H. Dunson, RPh, MBA, CDE President, Black Diamond Pharmacy, LLC
E.M. (Mick) Kolassa, MBA, PhD Partner, Medical Marketing Economics, LLC Adjunct Professor, University of Mississippi School of Pharmacy
Philip Schwab, BS Doctoral Student, University of Mississippi School of Pharmacy
Corresponding Author Address: Brian C. Reisetter, PhD, Medical Marketing Economics, LLC, 400 South Lamar Blvd., Suite A, Oxford, MS 38655
Center for Pharmaceutical Marketing and Management, Research Institute of Pharmaceutical Sciences School of Pharmacy, The University of Mississippi Faser Hall; University, MS 38677 662-915-5498

ABSTRACT. This study measured the effect of Medicare Part D on community pharmacy profitability using data from the first months of implementation. Gross margins for individual prescriptions before and after January 1, 2006, were compared to determine any changes. A random sample of 30 prescriptions from each of 10 community pharmacies across the United States was examined to compare total pharmacy compensation for individual prescriptions. The average gross margin decreased 22.3% after implementation of Medicare Part D. If 30% of all prescriptions will be covered by a Medicare Part D provider, that decrease in gross margins will result in an overall decrease in margins to 22.0% from 23.6%, assuming margins for the other 70% of prescriptions remain constant. Such a decrease would likely result in a 21.1% reduction in the average total owner compensation for community pharmacies in the US.
Funding: This study was funded by a grant from the Community Pharmacy Foundation.

The passage of the Medicare Modernization Act (MMA) in 2003 initiated several changes in the execution of and payment for health care services for the elderly in the United States. The legislation created avenues for reform in physician reimbursement under Medicare Part B, increased assistance for lower income beneficiaries, and increased preventive care under Part B and Medicare Advantage (previously Medicare + Choice).1

The most well-known and discussed reform associated with the MMA, however, is the senior drug benefit, commonly referred to as Medicare Part D. Through Medicare Part D, the Centers for Medicare & Medicaid Services (CMS) created a voluntary drug benefit program, where beneficiaries pay a monthly premium to receive covered medications at the cost of a copay or coinsurance, similar to a private insurance drug plan. Medicare Part D is expected to reduce the burden of the exceptionally high out-of- pocket drug costs which the elderly population has endured in the past.2

Medicare Part D is also the avenue for access to outpatient drugs for those patients receiving both Medicare and Medicaid benefits. These patients are typically described as dual eligibles. Previously, these patients received outpatient prescription drug benefits through their state Medicaid programs.

MMA Effects on Pharmacy Profits
Although Medicare Part D is benefiting a vast number of elderly patients, there is reason to believe that the structure for reimbursing pharmacists could have a negative effect on the profitability of many pharmacies. The prescription drug plan (PDP) providers, often previously existing commercial managed care entities, typically have set pharmacy reimbursement rates that are lower than those provided through private pharmacy benefit plans, the state Medicaid programs, and the prices charged to cash- paying patients. This has resulted in lower profit margins for many pharmacies. Although lower, more competitive prices are to be expected within any commercially managed prescription plan,3 reimbursement rates set too low may result in unviable financial situations for some pharmacies.4,5

The effect of Part D on pharmacy profits is of concern to both the large chain pharmacies and the small community pharmacies. However, large chain pharmacies typically have lower dispensing costs for prescriptions6 and higher proportions of profitable nonprescription sales7 that may decrease the overall profit impact of this legislation on chains. Of particular concern are the community pharmacies serving rural areas throughout the US, many of which are privately owned independent pharmacies not affiliated with any chain or franchise. In fact, the access to care for elderly citizens living in rural areas was specifically addressed in the MMA legislation. The MMA language requires the PDPs to provide access in rural areas, which are defined as areas of population density less than 1,000 per square mile. The legislation requires that a participating retail pharmacy be located within 15 miles of at least 70% of a rural population.8    In fact, Mark McClellan, the administrator of CMS, specifically stated in a 2005 speech at the national American Pharmacists Association (APhA) meeting that “access requirements will only be satisfied with broad participation of community pharmacies.”

Community pharmacies, with lower prescription volumes and potentially higher drug acquisition costs, will require higher prices or reimbursement to make margins similar to those of their chain retail counterparts. Therefore, it will be important to follow the effect of Medicare Part D on all pharmacy profitability to ensure that the global impact of the plans does not have long-term deleterious effects on the community pharmacies that serve a significant number of our elderly citizens.

Study Objective
This study was designed to measure the effect of Medicare Part D on community pharmacy profitability using data from the first months of implementation. These findings are an estimate of the actual effect of Medicare Part D on the profitability for a typical community pharmacy using data from actual stores as inputs for the calculations. Although this is an estimate of changes in profitability based on a small sample of prescriptions and pharmacies, meant to be exemplary and not generalizable, information such as this will be important for policy makers in future decisions regarding Medicare Part D and access to care within US communities.

Pharmacies make money like any other retailers. They buy products at wholesale and sell them at retail prices that are commensurate with the services being provided at the retail level. Gross revenues from the sale of drugs are then used to pay expenses such as rent, heat, and payroll. The monies left after expenses are the profits available to disburse to the owners.
The National Community Pharmacists Association (NCPA) publishes an industry digest, The NCPA-Pfizer Digest, which reports the pharmacy operations averages annually.

With the advent of insurance companies and other third-party payers as the primary payers for prescription drugs, significantly less pricing discretion is available to the individual pharmacies. Instead, contracted payment metrics are used to determine the amount pharmacies get paid for each prescription dispensed with that drug payment plan. Over time, the margins between actual acquisition costs (AAC) and the reimbursed payment levels have decreased significantly for prescriptions reimbursed through a third- party plan. The Medicare Part D plans are no exception to this rule and, in fact, have some of the lowest reimbursement levels ever negotiated.

Currently, there are approximately 3.5 million Part D prescriptions being filled each day,10 which constitutes over 30% of all prescriptions filled daily in the US.11    For that reason, it will be imperative to track closely the effect of these plans on community pharmacy. Even relatively small changes in gross margins for over 30% of all prescriptions filled can have drastic effects on owner profitability. For example, the most recently available gross profit margin reported by NCPA is 23.6 for 2005 (see Exhibit 1). If Medicare Part D reimbursement results in a decrease in the gross margin by even 1 percentage point to 22.6%, the effect on net profit would be an approximate decrease of 4.2% (1% divided by 23.6%). In real dollars, the average pharmacy owner would realize a $37,450 decrease in profits due to that 1% decrease in gross margins (1% of $3,745,000).


This study was a retrospective analysis of prescription reimbursements in community pharmacy before and after Medicare Part D implementation. The Medicare Part D program began on January 1, 2006; therefore, the gross margins for individual prescriptions before and after that date were compared to determine any changes. A random sample of 30 prescriptions from a convenience sample of 10 community pharmacies across the United States was examined (300 total prescriptions) to compare total pharmacy compensation (reimbursement plus copay) for individual prescriptions.

The individual pharmacies were selected to provide a diverse representation of the US and represent a total of ten US states. A convenience sample of pharmacies was deemed necessary due to the sensitive and proprietary data requested. The selected pharmacies were identified as community retail pharmacies. The sample included independent, sole-owner pharmacies; franchise pharmacy chains; and regional, privately owned chains.

Patients with current Medicare Part D owner of the pharmacy for the collection of gross margin data. Comprehensive prescription reports were then printed for those patients for the months of November coverage were identified by the manager or 2005, December 2005, and January 2006. Systematic random sampling was applied to the list to select 30 prescriptions that met our inclusion criteria. The criteria for inclusion were: (1) the prescription must have been billed to a Medicare PDP provider in January of 2006 and (2) the exact prescription (i.e., drug, quantity, strength) must have been filled in the last quarter under the patient’s old drug coverage, with the most recent 2005 prescription being included in the sample. Because the Part D program began in January 2006, the 2005 prescriptions could be covered by cash, Medicaid, discount cards, or other forms of drug coverage. Each set of two prescriptions then represented the changes occurring in reimbursement and profit as a result of a switch to a new Medicare Part D PDP program.
For each of the 30 sets of 2 prescriptions, 3 pieces of information were collected: actual acquisition cost (AAC), the reimbursement amount paid by the third-party payer (TPP), and the copay amount paid by the patient. In the few cases where AAC was not available for specific prescriptions, the AAC was calculated using information regarding the purchase price arrangements the pharmacy had with a specific wholesaler.

This study provides evidence to support the claim that community pharmacists are facing financial pressures due to the Medicare Part D implementation. In our sample, the average gross margin decreased from 24.0% to 18.6%, a decrease of 22.3%. With the conservative assumption that 30% of all prescriptions will likely be covered and paid through a Medicare Part D provider, that decrease in gross margins will result in an overall decrease in margins to 22.0% from 23.6%, assuming equivalent sales in 2005 and 2006 and assuming that margins for the other 70% of non-Part D prescriptions remains constant. This also assumes that the average reduction in margins realized by these ten pharmacies is exemplary of national averages.
According to 2005 national averages from NCPA, that decrease in margins would likely result in a reduction in profit to pharmacy owners of approximately $50,722 for the

Policy Implications
Community pharmacy has survived decreases in margins over the last several decades, primarily due to an increase in the total number of prescriptions being filled. There are more outpatient pharmaceutical treatment options available today, and the aging baby boomer population has provided a constant stream of patients requiring these medications. As a result, community pharmacy has been able to replace the loss of revenues per prescription by increasing the number of prescriptions being filled. However, the rate of growth for both retail pharmacy sales and number of raw prescriptions filled has decreased over the last 3-4 years.12    Consequently, community pharmacy cannot continue depend on increased volume to support these lower margins.
Without an increase in volume to compensate for this loss, it is likely that many pharmacies will begin to question their desire to continue with the risks and struggles associated with entrepreneurship. In fact, many community pharmacists and small community pharmacy chains have already chosen to either close or sell pharmacies to larger chains. When purchased by chains, these stores are often closed and the records transferred to the closest store within that chain to decrease overhead costs rather than operated from the same location, resulting in patients driving further to fill their prescriptions. As mentioned by CMS, adequate access to care within Part D requires a sufficient network of community pharmacies, particularly in rural areas. Therefore, maintaining the viability of the community pharmacy business model becomes important for the success of the entire program.
Store closures are not the only effect of the decreased margins realized as a result of the Medicare Part D plans. In 2006, many stores were selective about the PDP plans in which they participated, only signing with the plans that guaranteed certain margins. In fact, several of the stores in our sample realizing the lowest decreases in Part D margins were similarly discriminating when enrolling in the 2006 Medicare PDP plans. It is likely that stores will become increasingly selective in future years. As a result, many rural patients may be limited in the plans available to them locally, which is again inconsistent with the goals of the overall Medicare Part D plan.


1.    US Department of Health and Human Services, Centers for Medicare & Medicaid Services, “The Facts About Upcoming New Benefits in Medicare” CMS-11054, January 2004, %20English.pdf (accessed 30 Oct 2006).
2.    US Department of Health and Human Services, Centers for Medicare & Medicaid Services, “The Facts About Upcoming New Benefits in Medicare” CMS-11054, January 2004, %20English.pdf (accessed 30 Oct 2006).
3.    Kenneth W. Schafermeyer, “The Impact of Managed Care on Pharmacy Practice,” in Robert P. Navarro, ed., Managed Care Pharmacy Practice (Gaithersburg, MD: Aspen Publishers, 1999), 461.
4.    “Prescriptions Drive Walgreen Profit Up 25%,” 25 September 2006, (accessed 30 October 2006).
5. Jacqueline H. Kostick, “Medicare Part D: A Financial Drain for Pharmacies?” Medscape Pharmacists 8, no. 2 (2006), (accessed 30 October 2006).
6.    Kenneth W. Schafermeyer, et al., “An Analysis of the Cost of Dispensing Third-Party Prescriptions in Chain Pharmacies,” Journal of Research in Pharmaceutical Economics 4, no. 3 (1992): 3-23.
7. Joseph Agnese, “Standard & Poor’s Sub-Industry Review: Drug Retail,” Standard & Poor’s NetAdvantage, n?url=/NASApp/NetAdvantage/ (accessed 20 August 2006).
8.    42 C.F.R. § 423.120 (2005). 9. Mark B. McClellan, “Medicare Part D: Opportunities and Challenges for Pharmacy,”
Journal of the American Pharmacists Association 45, no. 3 (2005): 328-335. 10. US Department of Health and Human Services, “Over 38 Million People with
Medicare Now Receiving Prescription Drug Coverage,” 14 June 2006, available at (accessed 31 October 2006).
11. US top-line industry data from IMS Health , National Prescription Audit, 2006, available at (accessed 25 October 2006).
12. US top-line industry data from IMS Health , National Prescription Audit, 2002-2006, available at (accessed 25 October 2006).