Cash customers at retail pharmacies include people without coverage and people with indemnity coverage who pay for their own prescriptions and are later reimbursed by their insurer.4 Prices are set by a series of transactions linking the manufacturer to the cash customer through the wholesaler and the retail pharmacy, as shown in Table 3-1.
Sale by Manufacturer to Wholesaler
In the first transaction, the manufacturer sells the drug to a wholesaler. The manufacturer establishes a price that varies by the form and strength of the product; for example, a 500 milligram tablet of a given drug will have a different price from a 250 milligram tablet of the same drug. Price may also vary by packaging; for example, a package containing 1,000 tablets of a given medication might have a lower price per tablet than a package of 500 tablets. When there is only a single manufacturer of a drug, as is often the case with a brand-name drug, there is only one price for a specific product and package size. Once generic versions of the drug become available, the equivalent medication (in form, strength, and package) may be offered at different prices by different manufacturers.5
Wholesalers may sometimes receive discounts from manufacturers, based on volume or prompt payment. A manufacturer of a multi-source drug (i.e., one that is produced by more than one manufacturer) may offer a discount to induce wholesalers to promote its particular version of the drug. Thus the manufacturer's price is only a guideline, and may not represent the price that all wholesalers ultimately pay for the drug. The manufacturer's price itself represents both the cost of producing the drug and a share of the manufacturer's research and development costs, taxes, and profits. For any particular drug, the price may reflect the market position of the drug more than the cost of its production; for example, a company may set a higher price for an innovator drug than for one which has several competitors. Further breakdown of these components of the manufacturer's price is outside the scope of this study.
Sale by Wholesaler to Retail Pharmacy
In the second transaction, the wholesaler sells the drug to a retail pharmacy at a price reflecting its cost of acquiring the drug plus a markup. This price may be referred to as the wholesale price or acquisition price. A price that is commonly cited in the industry is the "average wholesale price," or AWP. Despite what this name would suggest, the AWP is not the average of the amounts actually paid by retail pharmacies to wholesalers for a particular drug. Instead it is a published wholesale price or "list price" suggested by the manufacturer of the drug. A wholesaler may sell specific drugs to all pharmacies at prices below the AWP, or may grant a general discount to certain pharmacies. Thus, although the AWP is often used by pharmacies as a cost basis for pricing purposes, it does not represent the actual cost to a retail pharmacy of acquiring the drug. It is merely a wholesale list price that can be used as a benchmark in comparing retail and wholesale prices.6
Industry sources suggest that the price charged by the manufacturer to the wholesaler typically runs about 20 percent below the list price or AWP. In the example in Table 3-1, the acquisition price (paid by the pharmacy to the wholesaler) is $9 below the AWP. The markup added by the wholesaler is generally small, perhaps 2 percent to 4 percent.
Sale by Retail Pharmacy to the Consumer
In the third transaction, the pharmacy sells the drug to a consumer at a price that includes its cost for acquiring the drug from the wholesaler plus a retail markup. Part of this markup is a fixed cost that is not related to the cost of acquiring a specific drug. This is because the cost to the pharmacy of filling a prescription for a low-price drug is likely to be the same as for a high-price drug. As a result, the fixed cost is a higher percentage markup over acquisition cost for a low-price drug than for a high-price one. Different pharmacies have different fixed costs. Because of economies of scale, a large chain pharmacy may have lower costs than a small independent one.
Part of the markup varies by drug. Pharmacies employ a variety of pricing strategies when determining this markup for their sales to cash customers. For example, they may set a lower markup for maintenance medications and a higher markup for acute medications, or may routinely discount certain commonly used medications as "loss leaders," in order to attract cash customers who will then buy other medications or other merchandise.
Some industry sources have suggested that retail markups in the range of 20 percent to 25 percent over the pharmacy's acquisition price are typical. This markup includes both the fixed operating costs of the pharmacy as well as taxes and profits. These same sources also suggest that the fixed costs represent most of this markup amount. In the example in Table 3-1, the $52 cash price is 4 percent above the AWP. The pharmacy in this example includes a retail markup of about 25 percent over its acquisition cost in the price charged to its cash customers.
Pharmacies may also offer across-the-board discounts on drugs to certain groups of cash customers, such as senior citizens. In addition, some organizations negotiate discounts on behalf of people without drug coverage or people who pay cash because their coverage is an indemnity plan. For example, AARP offers its members a Member Choice Program operated by RPS, Inc. In return for a $15 annual fee, members receive access to discounts negotiated with pharmacies by RPS. AARP reports that members receive average discounts of $7.26 per prescription or about $160 per year. Some insurers that sell both indemnity coverage and coverage that pays pharmacies directly may offer their indemnity purchasers access to the discounts they have negotiated on behalf of their other enrollees. This is true of United Health Care, which sells Medigap coverage through AARP, and of some Blue Cross/Blue Shield Medigap plans. These various discounts are part of the average prices cited later in this chapter.
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