The pharmacy industry: Healthy and wealthy

The Australian pharmacies industry plays an important role in the provision of community primary health care. The nation’s 5,115 community pharmacies provide services such as medication management information and advice on minor ailments, and over-the-counter (OTC) medicines and preventative care services.

They are also the primary distribution points for both prescription and scheduled OTC medicines. The industry is highly fragmented and is made up of a large number of individual operators. Despite this, the industry makes a significant contribution to the Australian economy as it generates in excess of $11 billion in revenue annually. It also employs about 48,300 people.

The industry also constitutes part of the general Australian health and beauty care sector, which generates annual sales in excess of $15 billion. In 2009-10, community pharmacies helped supply 183 million PBS (Pharmaceutical Benefits Scheme) scripts, up from 181.8 million scripts in the previous year.

With a growth rate of 1.9% per annum over the past five years, the industry is expected to generate revenue of $12.2 billion in 2010-11, up 2.0% from 2009-10. During the year, changes will be made associated with the introduction of the Fifth Community Pharmacy Agreement (5CPA) and ongoing changes will be brought about by the fundamental reform process currently occurring within the PBS.

In the near term, industry growth will be driven by an ageing population. At the same time, however, slower growth within the PBS (at just 2.1% per annum over the next four years according to the latest government budget projections) will also restrain growth. Industry revenue is expected to increase by 2.4% per annum over the next five years, reaching $13.72 billion in 2015-16.

Industry outlook

Long-term underlying economic, demographic and social trends bode well for the industry. In particular, an ageing population, changing community attitudes to health and skin care, various psychological motivations and ongoing product development and innovation are expected to contribute to the continued moderate growth of the industry.

At the same time, however, growth rates will be constrained by flat PBS volumes (which in turn will have implications for the quantity of drugs dispensed) and the continued loss of market share to external forces. Overall, growth in industry revenue is expected to average 2.4% per annum over the next five years to reach an estimated $13.72 billion by 2015-16. In the near term, a number of Queensland pharmacies may remain closed as a result of extensive flood damage.

Regulatory backdrop

As in the past, the regulatory nature of the industry will provide a framework for the overall growth profile of the industry. In the near term, this particular segment will be affected by the introduction of the Fifth Community Pharmacy Agreement (5CPA), which commenced in July 2010 and may result in further changes to the operating environment.

The continued operation of the Pharmaceutical Benefits Scheme (PBS), combined with government policies designed to cap healthcare expenditure, including cutting government subsidies of prescription pharmaceuticals, will also influence the industry via the level of revenue received from dispensary sales. In the near term the industry will continue to be affected by the ongoing PBS reforms, which have resulted in the PBS split into two formularies comprising F1 and F2 drugs. As per the Memorandum of Understanding reached between Medicines Australia and the government, additional price cuts for F2 drugs are to occur in April 2012 following on from those in February 2011.

At the same time, any further falls in PBS expenditure growth rates will have implications for those participants involved in dispensing PBS prescriptions. In its 2010 Budget the government projected a real annual growth rate of just 2.1% over the next four years with year-on-year rates dropping down to 3.7% by 2012-13. However, growth rates are now at their lowest level in 15 years and may in fact decline again. In March 2011 it was reported that the Australian Government is not adding any new medicines to the PBS until 2013 due to current budget deficits.

It will also be interesting to see the effect on PBS expenditure levels resulting from a number of key patent expiries, which are due to occur over the period through 2014. These products will in time be replaced by lower cost, generic products. According to Pfizer, the Australian generics market is expected to double in size over the next five years (to be worth about $500 million) as a result of the ongoing PBS reforms.

Competition heats up

The competitive landscape of the industry is expected to continue changing as competition among various pharmacy chains continues to intensify and some pharmacy chains rely on aggressive pricing strategies in order to attract customers. Some industry sources believe that internal competition among the pharmacy segment (particularly those following an aggressive discounting model such as deep discounting or perceived value discounting) represents more of a threat than external forces, including supermarkets keen to enter or expand their share of the health and beauty market.

In particular, a period of prolonged and consistent price discounting occurred during 2010, and this trend may remain in the near term as consumers remain cautious. The recent entry of discount pharmacies has been credited with creating a very cost competitive environment, and recent industry polls are still showing a consumer preference for discounters.

Pharmacies are expected to contend with declining margins over the next five years, caused by the combination of the fallout effects associated with PBS price disclosure and the expected growth in competitive pressures. Regulatory changes (including generic drug pricing changes and any further PBS reforms) combined with rising input costs will also exert downward pressures on industry margins.

The recurring issue of deregulation of pharmacy ownership to allow supermarkets to enter the pharmacy arena was once again raised in early 2011. Despite continued calls for such moves, deregulation is not expected to occur over the next five years.

Differentiation and products

To combat growing competitive pressures among other variables, pharmacies may increasingly seek to differentiate themselves from low-cost competitors on the basis of the professional value added services they provide, such as professional healthcare advice. This service in particular is considered unique to pharmacies and as such will be emphasised as a basis of competitive differentiation from rival supermarkets or other OTC retailers. Pharmacies will also seek further operating efficiencies in order to compensate for falling margins.

These developments will result in further moves away from the traditional pharmacy business model, which is heavily dependent upon the dispensing of prescription drugs. According to the Pharmacy Workforce Planning Research Project, pharmacists must move away from the current retail business model where the focus is on dispensing and must instead provide more cognitive pharmacy services to drive future demand. Following a move away from compounding in recent years, compounding may in fact gradually re-emerge as an area of specialised pharmacy practice and could provide another means of differentiation.

Continued moves to switch the status of various industry products in the pharmaceutical segment from prescription to OTC status will have profound effects on the long-term functionality of the industry. Similarly, the increasing growth in the relative importance of complementary or alternative medicines will also affect the product profile of various industry participants. The Department of Health and Ageing National Coordinating Committee recently made the decision on Therapeutic Goods (NCCTG) to retain the two OTC schedules – pharmacy medicines (S2) and pharmacist only medicines (S3).

In the near term, there may be fallout effects associated with Pfizer’s extension of its direct distribution model, which allows direct sale of prescription pharmaceuticals (both PBS and non-PBS) to pharmacies from February 1, 2011.

While Pfizer argues that this move represents a compelling order to pharmacies, upstream wholesalers (which will now lose up to 20% of their business as a result of this new strategy) may in fact increase their fees at the expense of pharmacy. API has already changed its trading terms with an effective cut of up to 25% of the discount pool available to pharmacies. According to the President of the National Pharmaceutical Services Association, the entire distribution system is now under threat by Pfizer’s decision to move to a direct supply service. From April 2011, a number of teething problems have surfaced with the change of model from the pharmacy point of view.

In the near term, the industry may be indirectly affected by new consumer product safety reporting requirements set out by the ACCC that came into effect on 1 January 2011. While therapeutic and pharmaceutical goods are not covered by these regulations, they will still apply to other front-of-store products sold by various pharmacies.

Continued developments in technology, including the increasing use of the internet (e.g. the use of national electronic prescription platforms, e-commerce and the development of net markets), will also serve to gradually change the profile of the industry. Overall, the industry is expected to remain in the mature phase of its life cycle over the five years through 2015-16.

Key success factors

• Membership of joint marketing or distribution operations: A key success factor for companies in this industry is having an association or affiliation with a buying group or chain.
• Ability to control stock on hand: Companies need to ensure adequate stock controls are in place in order to reduce inventory costs and increase stock turns.
• Superior financial management and debt management: Companies should ensure that effective cash flow management controls are in place.
• Production of goods currently favoured by the market: The product mix needs to be appropriate for the target market; the products stocked are perceived as offering value for money.
• Experienced work force: The quality of staff needs to be high to ensure quality customer service.
• Attractive product presentation: The store layout and display of stock must encourage customers to purchase and reinforce the company image.
• Proximity to key markets: The store needs to be located where there is a high volume of passing traffic and preferably near a medical practitioner or a medical centre.