The exam you can’t afford to fail


Community pharmacy needs to learn from, and correct, its past mistakes if it is to remain competitive, say Bruce Annabel and Mal Scrymgeour

One of us had a school friend who had a habit of answering exam questions incorrectly. He had the almost unique ability to answer an exam question in a manner that would surprise anyone, even when he knew it was wrong, he just ploughed on.

The most memorable answer he provided incorrectly was in a biology exam when he named, in careful and deliberate handwriting, all the parts of the female reproductive system on a diagram. The only flaw was that the diagram was of the male reproductive system…. Surprisingly, he became a father of two, so he learnt from his mistake eventually. 

In contrast, community pharmacy is not learning from its mistakes. We’re failing a basic exam. Pharmacies continue discounting even though it’s taking a huge toll on profit, cash flow, financial viability and valuation. The number of failures and pharmacies under management by banks and wholesalers are testament to this. Persisting in the face of all evidence is wrong and a trait that you don’t want, but like sheep, much of the industry simply following one another. It is costing pharmacies and owners dearly.

The complications of pricing

In the old days, a decade or so ago, pricing used to be crude, but effective. The industry used to have standard margins that covered the cost of manufacture, distribution/logistics and pharmacy overheads while delivering a good return for the owner.

Today, pricing has become far more complicated for a variety of reasons:

  1. Customers are being educated that price is a value driver imposed on the market by hard discounters, particularly Chemist Warehouse (CW)… apparently.
  2. We say ‘apparently’ because the majority of customers still choose traditional community pharmacies, telling us that price is not the only value determinant. CW offers the lowest prices because they operate the lowest cost structure. So why are so many pharmacies obsessed with the CW price offer when the majority of health consumers choose a pharmacy based on convenient location, not low price?
  3. Unfortunately, the price obsession and apparent success of CW resulted in many owners believing price is the only driver while failing to recognise the value they provide patients through, at the very least, location convenience, hence time saved.
  4. The obsession has disconnected the relationship between price and margins needed to cover cost and generate a reasonable profit.
  5. That predicament has been exacerbated by many banner groups chasing throughput volume enticing pharmacists to join as a way to ‘compete’ with CW, which of course is impossible due to the disparity in cost structures. Very few if any of the banner group members are owned by those who own the banner groups. Therefore, a serious conflict of interest has arisen between the strategies of banners and the pharmacy owners, for which many of the latter group are paying the price.
  6. As many know only too well some patients, aware of a handful of CW prices, pressure pharmacy staff to match price. Those who do often are selling below cost of purchase and overheads, resulting in profitless sales.
  7. The soft discounter banner groups are driving low prices while running the highest industry cost structures. Fortunately dispensing and S2/3 profits are so strong that, despite this, a modest below market average profit still remains.
  8. The retail theory is that lower price drives up volumes and customer visits, more than enough to offset the low margins. But, the data tells us that hasn’t eventuated, with last financial year customer visits shrinking 3.5% and total items sold dropping 2.4% including shrinking script volumes.1 The conclusion is that price is no longer the value driver it was unless your pharmacy offers the lowest prices backed up by the lowest cost structure. There’s only one and you know who that is.
  9. Traditional pharmacy discounting has only continued through cutting wages (i.e. pharmacists and staff are funding it), high dispensing profitability and supplier-funded banner groups continuing to push the price agenda.
  10. Amount invested in product promotions, promotional flyers and price discounting doesn’t deliver competitiveness or good returns for many owners. Simply holding volume requires more discounting which isn’t sustainable in the absence of introducing other value drivers important to patients.

Adjusting for a new era

We have a new decade. What worked before is now redundant—because the customer has changed. Consider these points:

Value is in the centre of patient thinking—not price.

  1. CW would have 100% market share if price was the only thing important to patients.
  2. Patients patronise your pharmacy despite knowing CW is cheaper. There must be a reason other than price.
  3. Clearly patients choose to visit a particular pharmacy for various reasons, dominated by time saved i.e. location convenience.
  4. Patients attribute different levels of intrinsic value between products such as acute v’s chronic; availability of advice, even on open selling lines such as wound care or digestion; trading hours; accessibility, such as near the doctor or bus stop, supermarket, etc.
  5. Others see value in health services, medication management and pharmacist professional service offered compared with the standard pharmacist dispensing with assistants at the front.
  6. People from all walks of life and demographics will shop at a CW whether they are financially well off or otherwise. Value is in the eye of the beholder.
  7. Therefore, a pharmacy or a banner can’t be everything to everyone. So, a choice must be made and if that’s price the precursor is operating the lowest cost model.

2. Understand the discount challenge discounting brings
a) Script items dispensed for less than $9, on average,1 will lose money because, while the cost of buying the product should be covered, it won’t be sufficient to recover wages, rent and other overheads. Do the numbers yourself.

Here is a quote from one of our smarter owners illustrating the point: “I did an analysis for a pharmacy that had seen a small drop in below co-pay script volumes. Their proposed response was to remove the surcharges to ‘pretend’ discount, which takes $5 off every below co-pay Rx. They would have to generate a 4-fold increase in Rx volume to maintain their margin $$. Which we know can’t and won’t happen. All of this to regain a 5% reduction in a small cohort of Rx customers…

b) What appears to be a modest price discount often presents a significant and often insurmountable challenge. For example, if an item currently earning a gross profit margin of 40% is discounted by 15%, sales volume/units must increase by 60% to maintain the same gross profit $$. It doesn’t happen so the bottom line is hit hard!

The point is, giving away a reactive discount, or price discounting generally, seems reasonably easy and a logical way to retain the patient. Done occasionally is OK but make a habit of it and mistakenly matching CW raises the enormous challenge presented in the table.

3. Understand you can raise prices
Pricing is both an art and a science so, just as discounting raises challenges, the flip side is the opportunity every pharmacy and banner has by raising prices. Some say once price has been cut it can’t be restored but that isn’t correct, particularly working on below patient co-pay and private scripts and the health-related retail health departments, particularly S2/3 (acute medications), practitioner lines, wound care, digestion and services such as DAAs.

Our experience shows that patients perceive great value in these and, being professional service and advice driven, can command a premium; plus the discussion is about solution recommendations, not price.

Our key message here is that lifting profitability through managing margins up is a better bet than attempting to raise income through price discounting. Some pharmacies and banner groups we know of have discounted schedule medicines from around 50% GP to circa 35% and seen virtually no sales or margin $$ bounce.

Instead the pharmacy bottom line has been smashed unnecessarily. Applying a 15% price lift carefully over time will work in our experience because volume drop is modest, if any, and certainly doesn’t approach the 30% point past where the pharmacy is worse off.

4. KVI pricing while enjoying high margins
Many of our clients, including those near hard discounters, achieve margins of 40% or above by avoiding broad discounting, not ever matching a CW price, managing up the margins/prices in the high service/advice sensitive departments and avoid constant price promotions.

In the meantime, they always keep an eagle eye on the prices of only 30 to 70 known value items which patients use to judge pharmacy pricing as it applies to the whole business and every product in it.

The price being paid by pharmacy owners of excessive price discounting is taking an unnecessary toll on traditional community pharmacy and is no longer working.

A new decade requires new thinking. Innovate. Think differently. Don’t persist with the same strategy that doesn’t work. At stake isn’t an embarrassing result in a biology exam, it’s much worse than that; it’s a personal economics exam which determines your income and your future. It’s an exam you can’t afford to fail.

 

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