17

-tennis H. Tootelian
qalph M. Gaedeke
3arl L Gordon
Massive purchasing power, geographic out-
reach and defined buying methods often
make public-aid recipients an attractive
target market for pharmacies Yet one must
question how profitable such a target might
be This study shows that pharmacy profit
levels for public-aid recipients below those
earned in marketing to fhe private-pay
patients may result in hidden benefits
Dennis H. Tootelian is Professor of Market-
ing and Director of the Center for Small
Business at California State University,
Sacramento In 1973, he received the Ph D,
in Marketing from Arizona State University
Dr Tootelian has co-authored four texts.
Marketing Principles and Applications. Mar-
keting f\Aanagemeni Cases and Readings,
Small Business Management and Small
BusinessManagemenf OperationsandPro-
'iles H IS articles have appeared in such
publications as the Journal of Marketing.
Journal of Retailing, Journal of Business
Research and California Pharmacist
Ralph M. Gaedeiw is Professor of Market-
ing at California State University, Sacra-
mento He received the Ph,D from The Uni-
versity of Washington Dr Gaedeke has
authored or co-authored six textbooks, of
which the most recent are Marketing Prin-
ciples and Applications and Small Business
Management H is articles have appeared in
such journals as the California Manage-
Review, the Journal of Consumer
and the Journal of Retailing
^ L Gordon is Associate Professor of
Decision Sciences in the School of Busi-
ness and Public Administration, Calrfomia
State University, Sacramento H e received
t'le Ph D in Business Administration from
Arizona State University in 1970 Dr Gor-
fion s research areas of emphasis include
quantitative systems, industrial engineering
and economics
MARKETING TO PUBLIC-
AID RECIPIENTS:
AN EXAMINATION OF
PHARMACY
PROFITABILITY
INTRODUCTION
Government spending for prescription Pharmaceuticals, the focal point
for this study, approaches $2 billion annuallyan amount almost evenly
split between the federal government and various state/local governmen-
tal units {The State ofSmall Business: A Report of the President. 1982). For
the approximately 50,000 pharmacies in the United States, such spending
represents a very attractive market in terms of revenue-generating poten-
tial. Despite its attractions, there are well-publicized drawbacks when
marketing to public-aid recipients. In particular, the bureaucratic problems
of "red tape" and slow reimbursement are the most commonly cited.
The purposes of the study reported here were to attempt to answer the
following two questions' (1) Is the marketing of prescription services to
public-aid recipients profitable? and, if so, (2) How do these profits compare
to private party prescription service profits? Although limited in scope, this
study analyzed the marketing of prescription Pharmaceuticals to patients
under federal or state health care programs, as prescription services
represent a significant dollar expenditure for governmental units. Further-
more, prescription services offered to patients under public-aid programs
are essentially the same as those offered private-sector patients, which
permits an analysis of the issues of profitability.
CONDUCT OF STUDY
Two evaluations were necessary to examine the extent to which
marketing prescription services to public-aid recipients is profitable and
whether or not profitability levels are comparable for similar services to the
private sector. First, to address the issue of overall profits, an average cost
of dispensing a prescription was determined This cost was defined to be
the direct costs of the prescription department (e.g., prescription supplies,
computer), plus an allocated share of the indirect costs such as utilities,
accounting services, manager's salary, etc. These costs were then divided
by the number of prescnptions dispensed. Such calculations were per-
formed using the results of published studies and industry statistics (H er-
man and Zabloski, 1978; Lilly Digest, 1982) The resulting costs were then
subtracted from the professional fee paid by federal and state health care
programs to determine the gross profit per prescription. Since states
;<oumai of HMHI I Care Marketing
- 4, No. 4 (Fan, 1984), pp. 17-21
18
pay ingredient drug costs separately, such costs were
excluded from the calculations. In California, the site of this
study, the fee paid by the Department of Health Services
under the Medi-Cal program was $3.60, plus a set rate for
the cost of the drug ingredient. A pharmacy's actual ingre-
dient cost may deviate from the reimbursed ingredient
cost approved by Medi-Cal, so attempting to separate this
highly individual cost factor would have made the survey
more cumbersomepossibly resulting in a lower response
rate. Since approved reimbursement rates are set based
on actual costs, averages were considered to be ade-
quate for the purposes of this study. Conditions in other
states are not unlike those in California relative to prescrip-
tion profitability
METHODOLOGY
Sampie
To examine the comparable profitabilities, a sample of
California chain, hospital outpatient and nonchain phar-
macies was surveyed. According to the criterion used by
the California State Board of Pharmacy, chain pharmacies
were defined to be those stores with five or more outlets.
Only hospital outpatient pharmacies were included be-
cause of the operating and pricing differences used in the
dispensing of inpatient prescriptions. These types of
pharmacies have become an increasingly competitive
factor in the retail market for prescriptions (Kubica, 1983).
From a total of 4,910 pharmacies licensed and operating in
the state, 1,109 were selected from a table of random
numbers on a probability basis of study. This sample was
divided between the three groups of pharmacies so that
the sample of 229 chain, 109 hospital outpatient, and 771
nonchain pharmacies were in proportion to the total
number of pharmacies in the state.
Data CoHection
Due to the widespread geographic distribution of the
sample population, a mail questionnaire was used for data
collection. The questionnaire was pretested on a group of
20 pharmacy owners who were selected after the sample
was drawn for the survey and were not included in the
results. The final questionnaire consisted of two parts. In
the first part, respondents were asked to price each of 40
prescriptions, 11 branded and 29 multi-source (generic)
prescription drugs, in quantities determined appropriate by
a panel of four pharmacists. The specific prescription
drugs represented the ones for which the Department of
Health Services spent the most money during the 1980-81
fiscal year, accounting for over 37% of its total Medi-Cal
drug program expenditures. The second part consisted ot
questions concerning selected store characteristics (i)
number of prescriptions dispensed per week; (2) total
prescription sales; and, (3) percent of prescriptions dis-
pensed through Medi-Cal. In addition, respondents were
asked to identify the pharmacies they most patronized so
that verifications of the prescription prices could be made
Since state law requires that prescription prices be given
to interested parties, respondent identifications would not
adversely affect response rates or the actual responses,
RESULTS
Responses to the survey on prescription prices were
received from 115 chain, 29 hospital outpatient, and 441
nonchain pharmacies, for a 53.4% response rate (see
Table 1). This was found to be adequate to provide results
at a .95 confidence level with an allowable error of + $019
Average dispensing costs are presented in Table 2.
When these dispensing costs are subtracted from the
professional fee paid by the Department of Health Ser-
vices, the result is the gross profit per prescription. As can
be seen in Table 2 (Column 4), low-volume pharmacies
do not earn as much profit on each prescription dispensed
under this public-aid program as do higher volume stores
Only when the costs can be spread out over a larger
number of prescriptions does the profitability increase
To compare levels of profitability between the private
sector and public-aid recipients, the ingredient cost of the
prescriptions was subtracted from the price responses
using industry-provided cost data. With an average retail
price of $16.13, and an average ingredient cost of $9.91,
the professional fee per prescription (i.e., price minus
ingredient cost) in the private sector was found to be $6.22,
This represented an average return on the ingredient
costs of 62.76%. Comparing the Medi-Cal professional fee
of $3.60 with the private sector fee showed that pharma-
cies received, on an average, $2.62 rrtore on a private
sector prescription than for a public-aid recipient prescrip-
tion. As shown in Table 2 (Columns 5 and 6), public-aid
prescription gross profits were found to be no greater than
34.3% of the private sector prescriptions. Thus, one private
prescription would eam the same dollar profitability derived
from between 2.9 and 4.9% of public-aid prescriptions
ImpcHiantly, the service provided for dispensing a prescrip-
tion is basically the same, except that more paperwork is
involved in the dispensing of a public-aid prescription
Also, there is ordinarily a five- to 45-day time lag before a
MtCU, Vor. 4, Ito. 4 (FaN, 19(41
19
TABLE 1
QuesUormatoe Re^xMise Rate^^^
Que^ionnalres
Mailed
Less Postal Rejection
Effectively Mailed
Total Returned
Percent Returned
Unusable Returns
Usable Returns
Percent Usable Returns
(3) This table reflects raw data
Chain
229
1
228
115
5044%
7
108
47.37%
Pfiarmacy Type
Hospital
109
10
99
29
2929%
1
28
2828%
Nonchafai
771
3
768
441
57,42%
17
424
5521%
AH
1,109
14
1,095
585
53,42%
25
560
51 14%
TABLE 2
Avefage costs ma Gross pronis
(1)
Store Sales Volume
Under $100,000
$100,000-$150,000
$150,000-$200,000
$200,000 - $250,000
$250,000 - $300,000
$300,000 - $350,000
$350,000 - $400,000
$400,00) - $450,000
$450,(XX) - $500,000
$500,000 - $600,000
$600,000 - $750,000
$750,000 - $1,000,000
Over $1,000,000
Average
(3) Source: Lilly Digest, 1982, pp 12-14
of Dispensing
(2)
Number
Dispensed
7236
11,040
14222
17,116
20.792
23015
26,111
27,821
31,121
33,306
38,135
50,124
56,832
27225
Prescriptions
(3)
Cost of
[Mspensing
$2 92
2 59
248
2 46
254
2,41
246
2 37
2 46
248
235
225
2.33
$2.39
(a)
(4)
Gross Profit
Prescription
$0,68
101
1 12
1 14
106
119
1 14
123
1 14
1 12
125
137
127
$121
(5)
Gross Profit
Per Private Pay
Krescnpnon
$330
363
3 74
376
3.68
3.81
376
3.65
376
374
3.87
399
3.89
$3.83
(6)
IMedi-Cal
Profitability as
% of PilvBte Psy
Profitability
206
27 8
299
30,3
28.8
312
303
31.9
303
299
32.3
343
326
316
' *^i l n9 To PHMC- AM ftedptoms: An
^fflinMonirf Phmmey ProlNAMty
20
pharmacy receives payment from the Department of
Health Services.
Further analysis of professional fees on the basis of
select variables was made to ensure that any distinct
characteristics relating to these fees were identified. As
shown in Table 3, professional fees tended to decline as
the volume of prescriptions increased above 600 per
week. Similarly, as seen in Table 3, the fees were lower in
stores with prescription sales higher than $300,000 per
year. Both of these would be expected, of course, as
normal business phenomena. More importantly, when pro-
fessional fees were compared on the basis of the percen-
tage of the pharmacy's prescriptions dispensed through
the Medi-Cal program, differences were apparent (see
Table 3). Pharmacies which have a greater proportion of
their prescription business in the Medi-Cal program,
especially those with over 40%, have higher fees (by an
average of $0.81) for private sector customers. Whether
this was the result of an attempt to defray the lower profits
of public-aid prescriptions, or reflects higher operating
costs, could not t>e determined.
CONCLUSIONS
This study sought to shed light on two of the most
critical issues in the marketing of pharmaceutical services
to public-aid recipients: (1) the profitability of such practice;
and, (2) how profits from that sector compare to profits
obtained for similar services provided to the private sector.
The results indicate that while marketing to public-aid
recipients can be profitable, the levels of profits are not
especially high for small-volume stores. To the extent that
these health care provider types concentrate much of
their limited resources to this market suggests that these
stores may be endangering their overall profitability.
Marketing to public-aid recipients, however, appears
to be beneficial to the extent that resulting revenues can
help defray the pharmacy's fixed costs. And, the increased
volume might permit purchasing on the most advantage-
ous terms possible. But, in instances where higher over-
head (e.g., an added pharmacist, an extra computer termi-
nal) might be incurred to satisfy public-aid demand, or
where the store's marketing efforts are focused on such a
sector rather than on the private sector, the incremental
profitability may be nonexistent.
The implications of the above findings are that provid-
ers should not simply be attracted by dollar sales potential
TABLE 3
Professional Fees By Select Variables
(1) PreKT^itlons DIspenwd
Number ot
PPBtcrtptioiM
Dtaperaed
Professional
Fees
Under 250
250 - 4(X)
401 - 6(D0
601 - 750
751 -1,000
Over 1,000
$6.8329
6,4523
6.7230
6.2878
5.5094
4 4099
(2) Total I
PiescrlpUon
Sales ($)
Professional
Fees
Under 100,000 $64922
100,001 -200,000 6.5445
200,001 -300,000 67193
300.001 -400,000 6.3139
400,001 -500,000 54325
Over 500,000 4.4743
(3) Percent of PreM1ptlons Dispensed Through Me<N-Cal
^Dispensed
Throui^
Med-Cal
Professional
Fees
Under 10
10-25
26-40
41 -60
61 -75
Over 75
$6.0799
5.7421
6.5595
6.9336
7.0205
65256
N=558; Z=6.46
N=542; Z=4.44
N=556; Z=4.05
JHCM, Vol. 4, No. 4 (Fan, 191^
21
ind automatically presume that marketing to public-aid
.ecipients will be highly profitable. Instead, they should
consider the lower professional fees as well as a number
of countervailing factors. To some extent, lower fees may
be offset by greater utilization of the store's existing facili-
ties and personnel. Furthermore, the added prescription
volume may improve the pharmacy's ability to purchase
on favorable terms as well as general front-end sales.
Since front-end sales account for over 45% of an average
pharmacy's total sales, some increases in nonprescription
revenues could be expected due to factors such as con-
venience. Importantly, however, these are not necessarily
assured and must be carefully analyzed.
Additionally, providers should carefully examine the
prospects of earning public-aid sector profits vis-a-vis a
more intense effort to penetrate private sector markets.
As already shown, small increases in revenues from the
private sector may well generate higher levels of profits
than do the considerably greater revenues received
under government programs. Detailed case studies of
the actual costs incurred, and the incremental revenues
generated, would be quite helpful in better assessing
this profitability issue. Such studies should, however,
cover both prescription and nonprescription costs as
well as benefits.
REFERENCES
Herman, Golman M and Edward J Zabloski (1978), ' An Assessment of Pre-
scription Dispensing Costs and Related Factors," Med/ca/Care Review 35
(August), 15
Kubica, Anthony J (1983), "Competing for Scarce Resources The Insfitutional
Pharmacists' Challenge," Current Concepts in Hospital Pharmacy Man-
agement (Spring), 6-8
Lilly Digest {\X2) Philadelphia Eli Lilly Drug Co.
The Stale ot Small Business: A Report ol ihe President (1962). US Small
Business Administration (March). 329
^"wtbtg To PubNc-AM Redptontt: An